Q&A: Board Members Not Shareholders

Q We have a board of directors who decides to use the proprietary lease when it is to their advantage. We have had a least three separate elections where there have been board members elected who were not shareholders. When a lawsuit is brought against the board of directors, will the insurance cover the entire board, even the ones who are not shareholders? Some of these board members are being sued as individuals.

—Concerned about the Board

A “Your question raises two separate issues. First concerns the responsibility of an insurance company to cover officers who may not be duly elected,” says Stuart Lieberman, Esq., of the law firm of Lieberman & Blecher, P.C. in Princeton. “Second concerns the kind of relief that is available in instance wherein board members are engaged in self-dealing.

“Most association boards have insurance in order to protect the association and its directors from claims either brought in court or through other adversarial mechanisms (such as arbitration claims, claims by government agencies, etc.). These policies differ from state to state, but generally they cover claims that fall within the scope of coverage.

“The insurance policies also provide an obligation to assume defense costs in certain instances. That either means paying costs of attorney to provide a defense or paying costs needed to reimburse an association that has itself hired a lawyer.

“The question that you raise concerns whether an insurance policy such as this will likely provide coverage where a board member may not technically qualify to be a member of the board. Apparently, the association in question requires board members to also be shareholders. This is not a question that can be answered in the abstract. For one thing, many boards have directors who do not technically qualify to be directors. Often, these directors are not even aware of the legal deficiency. Presumably, in most of these cases, the technical imperfection would not be a bar against coverage.

“For analogy’s sake, I note that many individuals that serve on land use boards, and other government bodies, who do not satisfy the legal requirements for the positions they hold. Yet, when these deficiencies are used to overturn decisions of public bodies, such attempts are usually unsuccessful.

“However, the case of a director who knows that he or she should not serve as a director because he or she is not a shareholder, may prompt a different analysis. If an insurance company could show that the individual was aware that he or she lacked an essential legal prerequisite, but nonetheless served, the carrier may attempt to bar coverage based on a theory of fraud.

“Inevitably, the final outcome would be predicated upon the very particular facts at hand. Included in this mix would have to be the precise language in the insurance policy as well as a review of legal decisions of the jurisdiction in question.

“Any board that governs or administers a residential development acts in a fiduciary duty. And in this regard, the second issue raised concerns remedies available when a board member does not meet the standard.

“If board members are taking actions which are primarily designed to benefit themselves rather than the organization as a whole, it may very well be that they have violated their legal responsibilities as board members.

“Remedies that are available run the range from a mere reversal of decision in question, to the assessment of monetary damages aimed at punishing the director for acting in bad faith.

“Insurance may not be available to defend or indemnify these claims if the carrier determines that a director has intentionally avoided his or her legal responsibilities. This is so because intentional conduct is never covered by insurance.” n

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