By Tim Moeller & Britton Weimer, Moeller Graf, P.C.

The business-judgment rule is an important legal doctrine in Colorado that applies to directors of common interest communities.  Most often, the business-judgment rule is used as a defense to complaints pertaining to discretionary board decisions.  The business-judgment rule requires courts to defer to corporate deliberations and avoid second-guessing the good-faith decisions of directors. 

Legal Overview

The business-judgment rule “bars judicial inquiry into actions of corporate directors taken in good faith and in the exercise of honest judgment in furtherance of a lawful and legitimate furtherance of corporate purposes.” Hirsch v. Jones Intercable, Inc., 984 P.2d 629, 637 (Colo. 1999). The rule recognizes the practical reality that courts “are ill equipped and infrequently called on to evaluate what are and must be essentially business judgments.” Id. at 638.

“Courts presume that a corporation’s directors possess the expertise and knowledge to make business decisions.” Walker v. Women’s Professional Rodeo Ass’n, 498 P.3d 648, 658 (Colo. App. 2021). However, the rule does not confer blanket immunity – it does not protect directors who engage in “fraud, self-dealing, unconscionability, and similar conduct” that is “incompatible with good faith and the exercise of honest judgment.” Id.

Generally, directors are afforded wide discretion in making decisions for the association, and if a director acts in good faith, such actions should not form a basis for imposing liability on that director. However, the business-judgment rule does not extend to transactions where the director has a conflict of interest, such as the director’s use of corporate funds for personal benefit.

The business-judgment rule extends to nonprofit organizations. "In the absence of some clearly arbitrary and unreasonable invasion of a member's rights, courts will not review the internal operation and affairs of voluntary organizations." Jorgensen Realty, Inc. v. Box, 701 P.2d 1256, 1258 (Colo. App. 1985). “Courts are reluctant to intervene, except on the most limited grounds, in the internal affairs of voluntary associations." Bloom v. Nat’l Collegiate Athletic Ass’n, 93 P.3d 621, 624 (Colo. App. 2004). 

Community associations are especially well positioned to invoke the rule, because of the discretionary nature of many board decisions. “Unlike other types of contracts that require specific acts at specific times by contracting parties, covenant enforcement may require the exercise of discretion as to both the timing and the manner of enforcement.” Colorado Homes v. Loerch-Wilson,43 P.3d 718, 723 (Colo. App. 2001). Indeed, in Colorado Homes, the Court recognized that the business-judgment rule may apply to claims against community-association directors for breach of contract and breach of fiduciary duty.

Thus, for community association boards, the business-judgment rule provides a vital defense to many claims for negligence, breach of contract and breach of fiduciary duty when performing board obligations. However, it rarely provides a defense to intentional torts such as fraud, to claims for conflicts of interest, or to actions that exceed the board’s authority under Colorado law or the governing documents.

Practical Tips

For HOA directors, the business-judgment rule provides some degree of comfort. If they can demonstrate that disputed actions were done in good faith and consistent with the governing documents and Colorado law, they will normally have a solid defense to a negligence action.

As is so often the case in preventing litigation, one key is to carefully document the material decisions, when they happen, before any lawsuits are filed. While it is often unfair, judges and juries may think that, if it wasn’t put in writing at the time, then “it probably didn’t happen.”

The board will have additional protection when it consults experts on specialized matters beyond the knowledge of the board, such as engineering, legal, investment, and accounting decisions. When the directors follow an expert’s advice, it is difficult for third parties to later second-guess the decision and show bad faith. Written opinions by experts are especially helpful.

Finally, as a risk-management backstop in case the court finds the business-judgment defense inapplicable, it is always prudent to have Directors & Officers and Commercial General Liability insurance, to help cover lawsuits that make it through the business-judgment shield.

Tim Moeller has been practicing community association law for 25 years.  He and David Graf started Moeller Graf, P.C.  in 2005.  The firm solely represents Colorado community associations. 

 

Britton Weimer is an experienced litigation, transactional and insurance attorney representing community associations with Moeller Graf in Englewood Colorado.