Business Corporation Law Versus Conflicts of Interest How Both Impact Boards

There is a natural inclination in business to work with those whom you know and trust. Relying on relationships that have developed over time is just a common-sense way to ensure a fair deal from a competent vendor who will perform their job with minimal fuss. But, when an individual board member stands to profit in any way from hiring a particular vendor, and fails to disclose that relationship, then you’re talking about a potential conflict of interest, which is decidedly less kosher.

Individual states have assorted rules and regulations designed to prevent self-dealing in co-op, condo and HOA settings, and to ensure that association business stays on the up-and-up for the benefit of every owner or shareholder, rather than specific individuals. In New York, for example, there is the Business Corporation Law (BCL), under which most cooperatives in the state were created. New additions to the BCL went into effect on January 1st of this year, and as such, it’s worth taking another look at the law, similar legislation in other states  – including New Jersey  – and conflict of interest in general. 

(Hopefully Not) Dirty Jersey

According to attorney John J. Roman, Jr., a partner with Hubschman & Roman, P.C., in Palisades Park, New Jersey, co-ops are a rarity in the state, with the majority concentrated in the Fort Lee area of Bergen County. As such, the laws governing condominiums are usually more pertinent when considering conflicts of interest.

“There is very little legislation in the state of New Jersey that governs cooperatives,” says Roman. “The only thing I can think of off-hand is the Cooperative Recording Act for new cooperatives that were formed after the legislation was enacted, which was back in 1987. And I don’t imagine that many cooperatives were formed after that date.

“Therefore, anything that’s going to control conflicts of interests in co-ops or condos would be within the Not-For-Profit Corporation Act – which I would assume is similar in nature to BCL in New York, and contains some provisions about disclosure for interested directors – or the New Jersey Condo Act,” he continues. “My advice to boards would be to avoid taking interest in referring out any business unless it’s been fully disclosed, at which point you must recuse yourself from voting on any issue wherein you’d have some potential conflict.”

Should a group of owners or shareholders fear that a board member is engaged in self-dealing, there is action that can be taken outside of a scheduled board election. “They could ask to have a board member removed for cause, if cause were determined,” notes Roman. “Or they can inform the Department of Community Affairs (DCA) and get them involved. That said, I’m not sure how strongly the DCA would react in these situations. They might look at every complaint, but their actually coming out and taking action may be extremely limited. Barring that, owners or shareholders can file suit, complain to management, put other residents on notice as to what’s going on, or advise the board attorney. And hopefully the board attorney isn’t complicit, or hasn’t failed to ask some pertinent questions.

“As a board attorney myself, I always make it a point to ask about any potential conflicts with everything I get involved in, and ask if board members have any interest in prospective vendors,” Roman continues. “For the most part – and I represent 40-some-odd associations – it’s rare that you see anything like this. If somebody recommends an accounting firm where their son works, normally the rest of the board will refuse to hire that firm. But I’m sure it goes on where, say, a management company has a relationship with some vendors... I’d think these conflicts may be even more common with managers than with actual board members.”

Across the Hudson

“Generally, cooperatives are formed under and governed by the BCL, while condominiums are formed under and governed by Article 9-B of the New York Real Property Law (commonly known as the Condominium Act), and homeowners’ associations are formed under and governed by the New York Not-For-Profit Corporation Law,” explains Stephen M. Lasser, Managing Partner with Lasser Law Group in New York City. “The BCL and NFPCL are similar in that they both are mostly corporate governance statutes and detail the protocol for election of the members of boards by the owners of the cooperative or homeowners’ association, and the procedures that the elected members of the boards must follow. On the other hand, the Condo Act only provides basic corporate governance standards for condominium boards and, as a result, the governance of condominiums relies more heavily on the specifics of each condominium’s bylaws.”

Before getting lost in the weeds parsing the differences between these statutes, it’s worth noting that, as Lasser points out, co-ops, condos, and HOAs function quite similarly on a board level, and New York courts have adopted the same judicial standard of review for all three: the business judgment rule.

“It would be hard to overstate the importance of the BCL, as any dispute between owners and board will likely eventually be evaluated thereunder,” Lasser says. “The business judgment rule provides that, as long as a board acts for a legitimate corporate purpose, within its authority, and in good faith, a court will defer to and uphold its business decision. Despite this deferential standard, a court will look deeper into a board’s decision if an aggrieved owner can demonstrate that the board acted outside its authority, in bad faith, or in a way that did not legitimately further a corporate purpose.”

Nor-Eastern

In New England, where co-ops are a rare commodity, the law tends to be less specific.

“Our Condominium Statute (Chapter 183A) does entitle unit owners to make appointments at the locations at which association records are kept, and to view said records, including any contracts with outside vendors,” says Gary M. Daddario, a partner with the law firm of Winer & Bennett in Tyngsboro, Massachusetts. “That said, the statute does not prohibit self-dealing. Oddly enough, on that subject, it’s not uncommon to see language in an association’s governing documents that specifically allows  for self-dealing. In New Hampshire, recent amendments to its Condominium Act (R.S.A. 356-B) at least require certain disclosures to the community in the event that a property manager hired by the association has an interest in a contract that the association enters into with a vendor.

“Self-dealing typically occurs when a board member happens to own or be employed by a company that offers a service or product needed by the association,” Daddario continues. “The instinctive thought process is that the familiarity will result in the association getting the best deal, but the reality is that whether they get the best price or not, the association could end up in a difficult situation. If the project doesn’t go well, or the work isn’t done properly, it will be much more difficult and awkward to address than with a vendor who is at arm’s length. Not to mention that some folks are just naturally inclined to believe that there must have been kickbacks, or other sketchy behavior involved.”

When unit owners have to address suspected nefarious activity in-house, they have a few options, according to Daddario. “For starters, they can replace the board at the next election. If things are more urgent, they can seek removal of one or more board members pursuant to the removal provision in their governing documents. The most serious recourse would be for the unit owners to seek relief in a legal claim against the board, which is problematic as they would be, in certain respects, suing themselves, as members of the organization, and would likely bear the expense in some way.”

In the Land of Lincoln

In Illinois, both the General Not for Profit Corporation Act (IL-GNFPCA) and the Condominium Property Act (ICPA) offer guidance pertaining to conflicts of interest, according to attorney Sima Kirsch of the Law Office of Sima L. Kirsch in Chicago.

Section 108.60 of the former, for example, “considers a conflict of interest to arise when a director is directly or indirectly a party to a transaction,” says Kirsch, while section 18(a) (16) of the latter “prohibits a board from entering into a contract with a board member or corporation in which the board member or their immediate family has a 25 percent or larger interest, unless two conditions are met: the board must notify unit owners of the intent to enter into the contract within 20 days after the decision is made, and the unit owners must be afforded an opportunity to file a petition and vote to approve or disapprove the contract.

“Generally, if a director has a ‘personal interest’ in a matter of concern to the association, they should recuse themselves – although doing so is a rare occurrence,” Kirsch adds. “Therefore, the board must be vigilant and request that the director – even with the protective measures of 18(a) (16) of the Act and 108.60 of the GNFPCA – not participate in the vote on the issue at hand – which includes deliberation.”

Should that fail, Kirsch suggests that the group alleging a conflict put a petition in writing and send it by certified mail to the board requesting a special meeting to have the board member in question recuse themselves. Barring that, the aggrieved are left with mediation – should the association’s declaration have a provision that calls for it – or filing suit. 

“At the core of the conflict of interest issues is the general principle of Illinois law that the ‘duties imposed upon a director of the corporation as a fiduciary require him to manage the corporation with undivided and unqualified loyalty, and prohibit him from profiting personally at corporate expense or permitting his private interests to clash with those of the corporation,’ further that, ‘… a director who has a personal interest in a subject under consideration is disqualified to vote on the matter and may not be counted for the purposes of making a quorum,’” Kirsch explains.

When conflicts of interest arise, the GNFPCA, the ICPA, case law pertaining to the specific topic, or some combination of the three should provide a remedy. “Many times, it only takes the filing of the lawsuit to resolve the problem, or the first appearance before the court,” notes Kirsch. “Also, owners should be aware that, if they were not advised or did not know of the conflict, than the burden is on the board to offer evidence that the transaction was fair and not detrimental to the association.”        

Mike Odenthal is a staff writer/reporter for The New Jersey Cooperator. 

Related Articles

Q&A: Can a Vendor Be a Board Member?

Q&A: Can a Vendor Be a Board Member?

Q&A: Changing the Rules to Benefit a Board Member

Q&A: Changing the Rules to Benefit a Board Member

Q&A: When Spouses Are on the Board Together

Q&A: When Spouses Are on the Board Together

The Limits of Board Powers

What You Can – and Can’t – Do

Issues That Cross State Lines

A Look at Condo Legislation Trends

Q&A: Can a Board Remove a Children's Playground?

Q&A: Can a Board Remove a Children's Playground?