Business relationships at board's discretion

Frequently, an association board of directors will be required to address a situation involving a director who may have a business relationship with one of the association's contractors, sometimes even the management company. There is very little statutory or case law authority on this subject so a conscientious board must diligently investigate the circumstances and once the facts have been determined, get a legal opinion.

Without a great deal of guidance based upon legal authority, the board will need to rely upon general principles of business law, business ethics and common sense.

Here are some typical situations a board may have to address and how to respond;

First, for condominiums in that State of Illinois, the Illinois Condominium Property Act (765 ILCS 605, et.seq.) governs situations where a board wishes to enter into a contractual relationship with a contractor whereby one of the directors or a member of the directors immediate family (spouse, parent, child) has 25 percent or more interest. This is easy to address as the statute is clear; notice of intent must be sent to all owners within 20 days after the decision is made and 20 percent of the owners can file a petition for an election to approve or disapprove the contract within 20 days, and the election must be held within 30 days.

So far, so good! But, what about a sibling, how about a board member who is an employee and not an owner, or owns less than 25 percent, or a dozen other variations.

The condominium act only address ownership interest, not any of the other fact patterns.

This is where the board must use a rule of reason and some common sense. How would this look to an owner who is unhappy with the board who finds out about this by accident? Is it illegal, immoral or unethical? The answer is no, but, again using a reasonable person standard, a board should notify the ownership that it is going to enter into this relationship. The key principle at work here is, if in doubt, always make a full disclosure.

Even though it may appear improper on it's face, it is not and further, should circumstances bear this out, why shouldn't an association not be able to take advantage of a relationship that may generate a cost savings, or provide high quality services?

What about kick-backs you may ask? One would be naive to think that if a board member is so inclined, they could not find a way to get a referral fee without disclosing the relationship. Of course, where there is a known relationship, the board member may not vote on any matter in which they have an economic interest in the outcome, and if this relationship is fully disclosed and recorded in the minutes of an open meeting, this action should absolve the director of any accusations of improper conduct.

Second, another frequent scenario; the board wants to fire the management company and hire the president as the manager and keep he/she as the president as well.

Illegal, improper, unethical ... the answer is again, no. The same strategy applies. Full disclosure to the ownership, abstention on all voting where there is a possibility of an economic interest, contract negotiated at arms length and reviewed by legal counsel and the relationship can proceed.

Third, the Illinois General Not For Profit Corporation Act addresses Director Conflict of Interest (805 ILCS 105/108.60) and offers a very broad standard. If the transaction is fair to the corporation, even if the director is directly or indirectly a party to the transaction, it not grounds for invalidating the transaction.

The burden of proof would be on the person contesting the fairness of the transaction to show, that there was not a full disclosure, or that the interested director did not abstain from voting.

The interested director can be counted toward the quorum even though their vote is not counted and the term "indirectly interested" is defined as a "material financial interest" in which the director is an officer, director or general partner.

Fourth, the developer still owns units and has someone elected to the board even after the owner turnover. A developer is an owner just like any other, is supposed to pay assessments, has a right to vote, and as a result is not precluded from serving on the board. Again, there must be an abstention on any vote where there is an interest in the outcome, but what about confidential discussions about suing the builder? Here there is no case law or statutory authority, but it is my opinion that a person who could breach confidentiality because of a discussion pertaining to litigation strategy, or a confidential discussion with the association's attorney can be excluded from a closed session of the board to discuss these matters.

For that matter, any director who is a litigant, or has threatened litigation or is the subject of potential or pending litigation whereby the association is the plaintiff could also be excluded. This preserves the sanctity of the closed session and avoids a restrained discussion which can lead to whispering campaigns and secret meetings.

The subject of the meeting should be advised that a closed meeting is being convened without them.

Lastly, what about a director who sits on the board who is an attorney and handles the associations legal matters. Conflict? Perhaps, but not necessarily. If the attorney does not have an interest, is not charging a fee and is trying to save the board money, it is a noble gesture, however, the problem arises, not so much for the board but the attorney. When a fee is charged of legal services, independent judgment as a director is now compromised. How can a director attorney make a tactical decision that could cost the association of which he or she is a member, more money which impacts their assessments. They are paying themselves and even if they abstain from voting, they always have an economic interest in the outcome which obviates the not-for-profit indemnification provisions. The is also no errors and omissions coverage for a director/attorney when the attorney commits malpractice, in his or her capacity as an attorney and for that matter, probably no malpractice insurance as well. For this reason, but mostly for the reason that the board should have independent legal advise, the board should seek the services of outside counsel and for that matter an independent auditor, property manager and anyone who must provide objective, non-interested advise.

One must always keep in mind that Section 108.70 of the Not for Profit Corporation Act addresses the limited liability of directors and officers which is frequently mirrored in some form in most declarations, provides that a director and/or officer is precluded from indemnification from liability in the event they engage in willful or wanton conduct which is defined as an actual or deliberate intention to cause harm or which shows an utter indifference to or conscious disregard for the safety of others or the property. One can only imagine how these definitions could be stretched by an aggressive litigator, an indifferent judge or an insurance company looking to limit its exposure.

In conclusion, though not required by any statute or appellate court opinion, I always advise boards that they should govern themselves by the same standard as is required by attorneys in the Canons of Ethics, i.e. a director (an attorney) must avoid even the appearance of impropriety. Another way to put it is, if you have to ask if the conduct in question is improper ... it probably is.