Board Member Liability after Fletcher v. The Dakota, Inc.

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A recent decision of the Appellate Division, First Department,[1] Fletcher v. The Dakota, Inc.,[2] has significantly changed the circumstances in which tort claims may be asserted against board members of cooperatives  and condominiums in their personal, rather than only corporate, capacities.  We believe this decision is not the last word on this issue.  However, board members should be aware that until or unless the apparent holding of the case is rejected by the New York Court of Appeals or narrowed by the Appellate Division itself,  board members who are successfully sued personally and are not protected by sufficient insurance or indemnifications by their cooperative or condominium, may expose their personal assets  to a successful plaintiff.

Prior to Fletcher, a line of cases in the First Department had formulated a rule that an individual cooperative or condominium board member could not be sued in his or her personal capacity for torts committed by the board unless the plaintiff alleged separate and independent tortious conduct by that person in addition to activities as a board member.  The rule was expressed most fully in the opinion of the First Department in Pelton v. 77 Park Avenue Condominium in 2006.[3]   In Pelton, the court reasoned that volunteer cooperative and condominium board members should not be subject to claims of discrimination or similar wrongdoing unless the plaintiff could allege and prove specific independent tortious acts by an individual board member that overcame the public policy supporting the business judgment rule.[4]

The panel of five judges in Fletcher (from the same court that decided Pelton, but without any of the judges that sat on the Pelton panel) overruled the previous cases, even though none of the litigants had asked it to do so.  Fletcher involved claims of alleged discrimination brought by a tenant-shareholder against the cooperative and against two of the directors personally.  On appeal of a motion to dismiss certain of the claims, the Appellate Division found that Pelton imposed undue burdens on plaintiffs who seek to hold board members personally liable for wrongful actions of a cooperative or condominium.  The Court held that “although participation in a breach of contract will typically not give rise to individual director liability, the participation of an individual director in a corporation’s tort is sufficient to give rise to individual liability.”[5]

At this point it is unclear how broadly the Court means to apply its new rule – whether only to torts of intentional discrimination or to all torts, whether or not intentional and whether or not discriminatory, including negligence, breach of fiduciary duty, trespass and other tort claims.  Future decisions will have to define the parameters of the rule.[6]  Moreover, it is entirely possible that without further guidance from the Court, some trial courts may give the decision broad application favoring plaintiffs.

To protect themselves, boards of cooperatives and condominiums should review the indemnification provisions of their by-laws to ensure that individual board members are indemnified by the cooperative or condominium as broadly as is legally permitted.  They should also review their directors’ and officers’ liability and umbrella insurance policies to ensure they are as broad and generous as possible.  Cooperative boards should further consider obtaining shareholder approval to insert a special provision in their cooperative’s certificates of incorporation, as permitted by the New York Business Corporation Law, to eliminate, except under extreme circumstances, the  personal liability of directors to their shareholders for breach of their fiduciary duties.  Please contact us if we can advise you in these matters.

The best initial protection for all boards, of course, is to make decisions carefully and deliberately.  They should, moreover, keep in mind that indemnification provisions and insurance in New York have never covered fraudulent or dishonest acts or omissions, willful violations of any statute or regulation, punitive damages, or a director’s acts that are committed in bad faith, are “the result of active and deliberate dishonesty” or from which the director has “ personally gained in fact a financial profit or other advantage to which he was not legally entitled.”[7]

[1] The Appellate Division, First Department is the intermediate New York State appellate court for Manhattan and the Bronx.  This particular decision, because of its procedural context, is not appeal-able.

[2]  2012 WL 2532149 (N.Y.A.D. 1st Dep’t July 3, 2012).

[3]  38 A.D.3d 1, 825 N.Y.S.2d 28 (1st Dep’t 2006).

[4]  The business judgment rule provides that, in order for a board decision to be subject to judicial scrutiny, “an aggrieved shareholder-tenant must make a showing that the board acted (1) outside the scope of its authority, (2) in a way that did not legitimately further the corporate purpose or (3) in bad faith”.  40 W. 67th St. Corp. v. Pullman, 100 N.Y.2d 147, 155, 760 N.Y.S.2d 745, 790 N.E.2d 1174 (N.Y. 2003).

[5] 2012 WL 2532149, at *1.

[6] Our firm is co-counsel for the defendants in the Fletcher case.  In a subsequent decision, defendants were granted summary judgment dismissing all of plaintiff’s claims.

[7] N.Y. Business Corporation Law § 721; Biondi v. Beekman Hill House Apartment Corp., 94 N.Y.2d 659, 731 N.E.2d 577, 709 N.Y.S.2d 861 (N.Y. 2000).

 

This memorandum was initially issued by the cooperative/condominium practice group of Balber Pickard Maldonado & Van Der Tuin, PC which joined Smith, Gambrell & Russell, LLP on February 1, 2017 and now practices as part of SGR’s cooperative/condominium practice group.

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