Background: The Business Judgment Rule
The opinion issued by the Maryland Court of Special Appeals recently in the case of Cherington Condominium v. Kenney delved into issues relating to the Business Judgment Rule. You may recall our recent discussion of the BJR here. In this case, the association argued that the business judgment rule protected their decision. The Court of Special Appeals disagreed, stating that the interested director transaction rule requires the association to prove additional facts to allow its action here to survive judicial review. For associations, this is another hurdle they have to clear and another pitfall to watch out for in the ever-more-complex world of association governance.
How we Got Here
As a refresher, the Court of Special Appeals is Maryland’s intermediate appellate court. Most cases that come out of the Circuit Courts (the highest trial court for each county around the state) have a right of appeal to the Court of Special Appeals. When the Court of Special Appeals issues a reported opinion, it becomes binding precedent on all trial courts of Maryland (we discussed this briefly here where COSA wrote an opinion I thought they should publish to benefit us all).
The Cherington Condominium case was indeed reported, and thus becomes binding precedent on Maryland trial courts. For reasons discussed below, I find that somewhat problematic.
A quick note before we really dig in: COSA frequently puts a relevant quote in the opening paragraph of its opinions. They are often from pop culture: a book, song, or movie that the general public might recognize, and which give some context to the opinion. In this case, they chose a quote from “Seinfeld” in which Jerry mocks condominium board members for being overly pedantic and hyper-technical. I understand it’s meant in jest – just read my blog; I mock almost everything.
But I’m not writing binding precedent for an entire state, and I’m definitely not deciding a long and difficult dispute between two seemingly genuine parties. If you were a condominium board member who had spent your years volunteering to try to keep your buildings from literally falling down, and you invested months of your free time and thousands of your budgeted dollars to defend a decision you made in the best interests of your association, and you went to the second-highest court in your state to have that decision adjudicated, and this was the first sentence of the opinion deciding that case, would you feel like you got a fair shake? What if, after reading that quote mocking board members for being too pedantic and hyper-technical, you read the remainder of the opinion and discovered that the court went on to overturn your decision for not being hyper-technical enough?
Seems pretty ironic to say the least.
Perhaps when it permeates into binding judicial precedent, the demonization of condominium boards (at least some of whom are decent, dedicated individuals) may have gone too far.
But that’s getting ahead of ourselves.
The Case
Let’s start at the very beginning (a very good place to start). Cherington Condominium is composed of 87 townhouse style condominium units, and twelve garden style units in a stacked building. Their documents are here:
A couple of interesting things right off the bat. These condo documents create something called the “Lawn and Garden Area,” which are part of the townhouse units. Basically, they are the front yards of the townhouses, but the developer has given the Condo association the “sole discretion” to decide whether and how to maintain them. Seriously, the wording goes: “The Board of Directors may elect, in its sole discretion, to assume such maintenance responsibilities with respect to the Lawn and Garden Area as the Board may deem necessary or appropriate, including, without limitation, responsibility for mowing, fertilizing, trimming, pruning and/or otherwise maintaining the grass, tress, shrubs and other planted materials, and any replacements thereof, as my be located within the Lawn and Garden Areas.”
I mean, that’s not ambiguous. If you were a unit owner and received that in your resale package upon purchase of the unit, you would be on clear notice that the board might decide to do this. If you were buying a townhouse unit, you would be aware that you could receive this benefit. If you were buying a garden unit, you would be aware that this was a possible budget line item. And if you were considering running for the board or contemplating whom you should vote for, you would be aware that this person would have such authority. So this seems like a reasonable way to go: we are going to create a community, and tell them all that they get the choice of what to do about the lawn and garden areas. When we consider such budget issues and changes, a huge factor is advance notice. That seems to be provided to all potential parties here.
But this little provision ended up leading to litigation going all the way to the Court of Special Appeals. And let me tell you something: litigation, while sometimes necessary, is expensive, is time-consuming, and rarely leads to a perfect result. So if we can avoid it, we try. What lesson could we take away here that might prevent future litigation?
Developers draft these documents and come up with new and creative ways to govern community living. But since this decision suggests that Maryland courts are going to invalidate or substitute their judgment for the community in such instances, then perhaps the lesson is to have fewer “discretionary” provisions such as this. Courts sometimes think they are protecting individual owners from an overbearing board in similar instances, but really they are creating uncertainty and hamstringing the board from doing its job. Giving a clear mandate on what must be done rather than a discretionary provision (even one as well-drafted and cogent as the one in this case) may be a solution for future community documents.
Case: The Budget and the Maintenance Contract
The fact here is that the Board at Cherington availed itself of that discretionary maintenance provision. They budgeted through their normal process and they voted to increase expenditures on the garden style units to keep up with what they were spending. They also entered into a contract with AW Landscaping to maintain the Lawn and Garden Area, ostensibly as provided for in the documents.
The Case: The Challenge in the CCOC
Based upon its authority, the Board entered into this contract to maintain the Lawn and Garden Areas, and a garden-style owner challenged it. The first stop in such a challenge is the CCOC, which reviews and rules on such disputes.
The CCOC panel said: “The record indicates that some of the garden style unit owners are dissatisfied with the services being provided. It also indicates that in the past year the Board has been available to discuss these issues and hopefully improve the quality of these services. The percentages make it unlikely that the garden style unit owners will have representation on the Board so it behooves the Board to be available to hear their concerns and to work with these owners to address their issues.”
I’m 100% on board with the sentiment here about working with all owners and hearing their concerns. But I take umbrage with the logical leap made in the underlined portion. I represent many mixed garden/townhouse condominiums. And I can honestly tell you that I have no idea which board members live in garden or townhouse units, and can certainly not tell it from how they vote or conduct business. So the idea that they are somehow Electoral College-level voting blocs that prevent the other from ever sitting on the board is a major stretch. Furthermore, most condos I know would gladly have a board member from any area of the condo join and share the load, so to imply that the garden-style owners are somehow locked out here when the explicit testimony is that none of them has ever volunteered to serve is a majorly skewed point of view. It creates a perception of hostility where there is no evidence of any.
The Montgomery County CCOC reviewed the case and dismissed it, finding that the Board acted within its powers. Now to give you a bit of context, the Commission on Common Ownership Communities is not known as a board-friendly haven for hiding illegal and overbearing acts. Broadly speaking, when an association overreaches, the CCOC will nail them on it. So this ought to give anyone reading the case at least a little pause. The CCOC, which is composed of professionals who do nothing but community association stuff all day long, took a hard look at this and found it acceptable.
The Case: The Challenge in the Circuit Court
The garden-style owner appealed to the Circuit Court. Here’s where things get a bit crazy. The case is just going along, and the parties are arguing whether or not the contract was valid. The condo is claiming that the business judgment rule protects their decision. We discussed above what that means and whether or not it was a valid claim; here, it was certainly plausible. The Circuit Court, however, rather than sort through the analysis we discussed above, took a different view. The court, of its own accord, asked about the interested director rule. This is a provision of the corporate code that states any interested director must be disqualified from a vote on the issue.
The first thing I must point out is: the interested director provision is actually in this condo’s bylaws. Seriously, check it out: Article III, Section 16. It references the Corporate Code of Maryland. Why do I point this out? Because neither the Circuit Court, who is raising this matter and explaining why it applies, nor the Court of Special Appeals, who does a whole legislative history on it, ever acknowledges this anywhere in the record. So it is kind of concerning that while all this legal analysis is going on, no one is asking how the rule being incorporated into the bylaws plays into it. And I think it should, which we will get to in a minute.
So the Circuit Court says, hey, I think the interested director transaction rule applies.
Now, being a judge is incredibly complex. You see all these different cases, and you bring experience and know-how and legal knowledge and prior opinions all with you when you hear a case. You probably have a broader world view of the case than the parties, and you are searching for the “right” answer to the questions presented. So a lot goes into your decision, and you can and should consider ideas you are familiar with to ground your decision.
But there are some practicalities that are good to keep in mind. For instance, if there is an issue that seems relevant to you, but neither party has raised it, perhaps there is a reason behind that. Here, the court asks about the interested director rule, and counsel for the condo, probably somewhat stunned, responds: “Typically when I think of that interested director, I think of not setting up a budget, but more of a transaction or a contract entering in like a family member or something like that.”
Which is exactly right! This circuit court judge has no particular way of knowing the specific usage of this interested director rule in condo context, but the court should care about how it is commonly used. Here, we have both a law firm who commonly represents and advises on community association issues and a law firm who sues communities and alleges they are doing everything wrong and illegally. And neither one of them claimed that this was an interested director issue.
That ought to at least set off alarm bells. Perhaps at this point we ask the parties to research and brief the issue. We have in our state four members of the prestigious CCAL who dedicate their time and efforts to forging greater understanding and engaging in better governance of community associations. Why not ask them to weigh in? We could get an opinion from the CCOC or the Attorney General possibly arguing the other side. I’ll throw into the mix that for the communities I advise, I have always told them some variation of the same thing. “Interested director” means receiving some financial interest; it means being on both sides of the transaction. If you are the “A” in AW Landscaping, you have to disclose that. But just being a resident of a certain area in the community? No. Even the attorney representing the garden-style owner in this case seemed to be on board with that; they didn’t raise the issue at the Circuit Court on their own. So it seems pretty safe to say that the prevailing interpretation of this rule in the condo context prior to this case was that it applied only to persons on both sides of the contractual agreement.
Now Brian, you say, who cares what the common usage is? The court is supposed to give the correct answer, and not validate prior misinterpretations.
True, I respond. But the COSA opinion is going to set a precedent, and dictate how all future boards have to interpret the rule for thousands of condos across the state. So before you go and change the status quo, forcing these condos to incur legal fees for interpretation and new guidance and potentially invalidating or calling into question years of prior decisions and actions, perhaps we should at least consider if there is already an agreed upon definition. And also, while the court may presently be convinced of the wisdom in applying this standard to the case at bar, perhaps the overwhelming prevailing opinion to the contrary and the previously unforeseen consequences may give the court some pause.
Regardless, that did not happen here. The Circuit Court said this applies to any condo contract where directors gets some nebulous amount of personal value; they don’t have to be on the other side of the contract.
Now we’re going to go back to the Bylaws, because here’s where it really gets difficult to understand. Article III, Section 16 says: “No contract or other transaction between the Association and one or more of its Directors, or between the Association and any corporation, firm, entity or association in which one or more of the Directors are directors or officers or are pecuniarily or otherwise interested, shall be either void or voidable… if such action complies with the provision of Section 2-419 of the Corporations and Associations Article.”
Take a look at the definition again. The provision applies to contracts between the association and:
— one or more of its Directors (no)
— any corporation, firm, entity, or association in which on or more of the directors are pecuniarily or otherwise interested (no)
Pursuant to its own Bylaws, the condo is in the clear here. And this language tracks the Corporations and Associations Article. They did not enter into a contract with any entity where a Director has any financial stake. This plainly supports what the condo argued at the Circuit Court, and what was the common understanding (by both condos and those who challenged them!) throughout Maryland.
Despite this, the Circuit Court held the other way and ruled that the townhouse unit owners on the board were “interested directors” for the purpose of this transaction.
The Case: The Appeal to the Court of Special Appeals
So up to the Court of Special Appeals the case went. And the Court of Special Appeals, as mentioned briefly above, opens with a glib reference to a thirty year old sitcom. From there, we dig into the meat of the case. The garden style owner states that some of these charges against the garden-style unit owners were “a clear sign of discrimination,” and the Court of Special Appeals quotes that in its reported opinion.
Folks, we have got to stop throwing this word around. Systematic racially restrictive covenants are discrimination. Paying one gender less than the other is discrimination. The validly elected board of your condo entering into a contract for professional services within their discretion that affects some owners slightly differently than others is not discrimination, and the fact that the Court quotes that statement and puts it in the opinion (when the owner was talking about costs not even before COSA) is a bit concerning. Was it unjust, or prejudicial, or based upon race/gender/disability? No. And there isn’t even a suggestion that it was, nor is there any evidence of animosity or an untoward motive by the Board. Perhaps the Court should not take hot-button words thrown around by litigants and place them in a reported opinion.
The Court states: “Notably, all members of the Board lived in townhouse units.” I’m not sure why that by itself is notable for this case, especially since there is direct testimonial evidence that “no garden unit owners had ever nominated themselves as candidates for positions on the Board despite the fact that all members of the community had been invited to do so.” Again, we have a problem of perspective from the outset: were the garden-style owners victims of some vicious conspiracy by the board? Or were the people on the board the only ones willing to dedicate their free time over the 25-year existence of the condo? Only now, when a decision affects them in the pocketbook, do these garden-style owners take an interest in the budgeting process. Seems like the Court is looking for a reason to second-guess the board here.
The association wisely limited its issue to just a single question: Did the Circuit Court err in applying the interested director transaction analysis?
(Note: They actually phrased it as “did the Circuit Court err in ignoring the BJR and applying the interested director transaction analysis?” which COSA made a great show of refuting, despite the fact that as we explained here, it is more complicated than that. I hope that didn’t make a difference; the prior discussion of how boards sometimes view the BJR certainly provides some context here. But I’m going to ignore that discussion and get into the two findings that COSA makes here that I think are very harmful for community associations.)
Finding the First: COSA holds that the interested director analysis can be applied to the imposition of budgeted assessments upon owners as a “transaction.” This, with all due respect, is a mistake. First of all, there is already a statutory provision for how the budget gets enacted. Second, nearly every provision of the budget is going to impact some owners slightly differently than others. Are 2-bedroom unit owners and 3-bedroom unit owners differently affected? How about when the condo enacts a budget line item for the elevator and there are board members from only the bottom three floors, but not the top three? If some units have driveways and others do not, does each group have to be represented in the budgeting process? This line of questioning goes on forever. Have you ever talked with a community association manager during budget season? They are stressed man. It is already insanely difficult to accomplish that task, and now they have to analyze whether any board member gets any more benefit from a single contract or assessment than anyone else? Third, I don’t think this standard gets applied to the CFOs of corporations governed by the same statutory framework. Do companies have to disqualify their interested directors when they vote on perk packages or reimbursement mileage or who gets what office? No. These are internal board decisions that are delegated to the executive body for precisely that reason. So why should we treat a condo differently? In sum, adopting a community association budget is simply not a “transaction” for purposes of this statute.
Finding the Second: COSA holds that because the AW Landscaping transaction sort of benefits the townhouse unit owners, they are “interested directors” for the purpose of the statute. They hold that whatever gain they receive from the condo maintaining the Lawn and Garden Area is a “personal financial interest” in the contract. As we discussed above, this not only flies in the face of the conventional usage of the term, but it also is unclear where the interpretation comes from. A plain reading of the statute, or the governing documents, or the case law and legislative history demonstrates that the concern here is to keep someone from making a deal with his or her own company. Hiring your roofing company or snow removal contractor to service the condo where you volunteer as a board member is obviously something we want to disclose to members and have non-interested directors sign off on. But internal budget decisions that affect some owners more greatly than others, or the scope of work on a certain contract that impacts the condo disproportionately, is not. That sort of issue is clearly within the scope of authority of the Board – in fact, here, it is explicitly given to them at their discretion by the Declaration and Bylaws. Saying that this is now impermissible seems to be contradicted by the Court of Appeals in Elvaton v. Rose, which asked whether a board action was authorized by the Declaration and Bylaws and struck it down when the answer was negative.
COSA does acknowledge the problems with the direct analysis of each issue here: they state “at the very least, the AW Landscaping Assessment challenged here is a hybrid with elements of a contract between the Association and a third party and elements of a “transaction” between the Association and its board members.” Let’s parse that for a second: The entire process of adopting a budget, entering into a contract, and providing for maintenance is a hybrid “transaction” where everyone involved is potentially interested. Remember when I wrote about the BJR possibly swallowing up its utility by being applied to everything? Do you see how this is exactly the opposite end of the spectrum? If every transaction involves an interested director in the condominium context, then every budget has to be adopted by following 2-419. But obviously that’s not what we want. Courts don’t want that either! COSA would have to create a whole separate Condo Budget Review Docket just to handle all the reviews they will have to engage in. So it’s problematic.
The Takeaway
Do you know why I write these caselaw breakdowns? To help future boards understand what is required of them by the binding precedent already in place in Maryland. Recall that first statutory law, and then binding case law, are the first two ways in which associations may determine their obligations. So when a case is reported, like this one, I want to let my condo clients understand what it means for them going forward.
According to COSA in this case, the board was composed of “interested directors.” Thus, it should have utilized the provisions of 2-419 to hold a vote of the disinterested board members. Oh, but wait. There weren’t any disinterested board members. So the COSA says that “makes judicial review all the more significant.” Maybe, but it also does not explain how the condominium could have complied with the provisions of 2-419. As far as I can tell, this means that any landscaping contract that Cherington enters into for the rest of time has to be approved in advance by a court.
Ouch.
Also, Court “acknowledges” that garden-style unit owners would also have been interested, but that “at the very least” (again) they would have had a different interest. So it seems that Cherington in the future could also go out, solicit board members from the garden-style units (who have never volunteered to be on the board), force them to join the board (after a properly held annual meeting election where they obtained quorum of course), and then vote on the contract. Piece of cake.
To Report, or Not to Report
Look, I didn’t hear this case. I wasn’t a judge reviewing evidence and testimony. I didn’t see the contracts, or how upset the garden-style unit owner was about having been “discriminated” against. I really don’t know the right answer.
What I do know is that at present, this is a reported opinion that is now binding upon condominiums across Maryland, and it seems like it adds more uncertainty than anything else. I get it; hard cases make bad law. I also understand that this might have been a tough situation; neither the Circuit Court nor the COSA seemed to like the 87 v. 12 dynamic set up by the condo structure. The COSA points out that “the circumstances of this case are unique” and “an assessments allegedly benefits the board members to the detriment of unrepresented members” and “there could be no vote of disinterested members.”
If that’s true, then just decide it based on its own unique facts and make it an unreported opinion. Because at present, if a condo with a divided board like this one comes to me and asks how to pass a budget and hire a landscaper without getting sued, I’m going to tell them: “You can’t. Definitely do your best but according to the recent case law you are automatically subject to judicial review, so get ready to go to court. Every. Single. Time. You. Adopt. Your. Budget.”
You may have read a recent blog I wrote where I wondered aloud why the case was not reported; I thought it was a wonderful guideline on how courts might view the situation and what factors a board should consider when approaching it. Conversely, I have a hard time seeing the value of reporting this particular case, which provides little to no guidance on what a similarly-situated condo could do to avoid being sued, and calls into question literally thousands of previously-thought-acceptable board decisions in the state of Maryland, costing already financially-strapped and time-challenged condos precious monetary resources and unnecessary delays.