Chapter 7 - § 7.12 • GOOD FAITH, FIDUCIARY DUTY, CONFLICTS OF INTEREST, AND ETHICAL OBLIGATIONS

• Jurisdiction: Colorado

§ 7.12 • GOOD FAITH, FIDUCIARY DUTY, CONFLICTS OF INTEREST, AND ETHICAL OBLIGATIONS

§ 7.12.1—Good Faith and Fiduciary Duty

The Nonprofit Corporation Act establishes general standards of conduct for directors and officers. It requires directors and officers with discretionary authority to discharge their duties in good faith,¹²⁵ with the care an ordinarily prudent person in a like position would exercise under similar circumstances, and in a manner the director or officer reasonably believes to be in the corporation's best interests.¹²⁶ The CCIOA specifically makes the statute on general standards of conduct applicable to investment of association reserve funds,¹²⁷ and also provides that every duty "governed" by the CCIOA "imposes an obligation of good faith in its performance or enforcement."¹²⁸ The Uniform Act has the same provision, and a comment to it says that good faith is required in the performance and enforcement of all agreements and duties. Good faith, it says, means "honesty in fact" and observance of reasonable standards of fair dealing. The term is not defined by either the CCIOA or the Uniform Act, but it is derived from and used in the same manner as in the Uniform Commercial Code.¹²⁹

It is widely held that associations and governing boards have a fiduciary duty to unit owners.¹³⁰ However, the CCIOA appears to depart from that position. It says that governing board members appointed by the declarant must exercise the care required of fiduciaries of the unit owners in the performance of their duties,¹³¹ whereas those not appointed by the declarant are not liable for actions taken or omissions made in performance of their duties except for wanton and willful acts or omissions.¹³² The comparable Uniform Act provision is different. It requires directors who are not appointed by the declarant to exercise the degree of care and loyalty required of a director of a corporation organized under state law, while those appointed by the declarant must exercise the degree of care and loyalty required of a trustee.¹³³ A comment does not discuss the difference in the standards but does observe that the one for declarant-appointed directors imposes a "very high standard of duty."¹³⁴ Interestingly, the Uniform Condominium Act imposes a fiduciary duty on declarant-appointed directors but only requires those elected by the unit owners to exercise "ordinary and reasonable care."¹³⁵ A commentary to that Act explicitly explains the rationale for the different standards. The lower standard imposed on directors elected by the unit owners is intended to increase the unit owners' willingness to serve.¹³⁶ Thus, the difference in the standards applied is clearly intentional in both the Uniform Acts and, no doubt, in the CCIOA as well. One curiosity remains: if a duty "governed" by the CCIOA must be performed in "good faith," but directors elected by the unit owners are only liable for "wanton and willful acts or omissions," is there liability if a director fails to act in good faith but is not "wanton and willful?"

It does not appear that any Colorado appellate court has addressed the statute that speaks of "wanton and willful acts or omissions," but several courts have touched on the fiduciary duty of associations. Two courts have concluded that common interest community associations have a fiduciary duty to owners to enforce restrictive covenants.¹³⁷ In a homeowners association case from the mid-90s, a court found that a director did not breach a fiduciary duty, but conceded that, in general, corporate directors "occupy a fiduciary relationship and owe a fiduciary duty to the corporation."¹³⁸ Finally, a federal court denied an association's motion for summary judgment on a breach of fiduciary claim based on an alleged failure to maintain the common elements.¹³⁹ These cases suggest that despite the statutory "wanton and willful" standard, Colorado courts would entertain a breach of fiduciary duty claim against an association and might accept one against directors.

Part of any fiduciary duty of the association and its directors is to comply with the governing documents. Boards, however, often discuss taking certain actions that may violate those documents or even the CCIOA. Generally, until a board actually takes the proposed action, a suit is not ripe for adjudication.¹⁴⁰

§ 7.12.2—Conflicts of Interest

One commentary identifies three types of conflicts: (1) self-dealing (when a director makes decisions in his or her corporate role that financially or materially affect that director as a private citizen or the director's family); (2) accepting benefits (when a director accepts substantial gifts, bribes, services, or other significant benefits that might be perceived to influence that director); and (3) use of confidential information (when a director acquires confidential information in his or her corporate role and uses it for personal gain).¹⁴¹

It is not uncommon in common interest communities for directors to attempt to steer contracts for goods or services to businesses in which they, their family, or their friends have a financial interest or sometimes to businesses that have offered the director "gifts." Often it is with the best of intentions: the promise of a lower price or superior service. However, the potential for fraud also exists. Thus, the Nonprofit Corporation Act has a statute on conflicting interest transactions that the CCIOA makes specifically applicable to members of the governing board.¹⁴² The statute defines a "conflicting interest transaction" as a contract, transaction, or other financial relationship between a corporation¹⁴³ and a director¹⁴⁴ or between the corporation and a party related to a director¹⁴⁵ or an entity in which a director of the corporation is a director or officer or has a financial interest.¹⁴⁶

Generally, a conflicting interest transaction is neither void nor voidable. It may not be enjoined, be set aside, or give rise to an award of damages or other sanctions in a proceeding by a member or by or in the right of the corporation, solely because the conflicting interest transaction: (1) involves a director of the corporation or a party related to a director or an entity in which a director of the corporation is a director or officer or has a financial interest; or (2) solely because the director is present at or participates in the meeting of the board of directors or of a committee of the board of directors that authorizes, approves, or ratifies the conflicting interest transaction; or (3) solely because the director's vote is counted for that purpose.¹⁴⁷ However, one of three conditions must be met:

1) The material facts about the conflicting interest transaction and the director's relationship or interest must be disclosed or known to the board or committee, and then the board or committee must in good faith authorize, approve, or ratify the transaction by the affirmative vote of a majority of the disinterested directors, even though they are less than a quorum.¹⁴⁸
2) The material facts about the conflicting interest transaction and the director's relationship or interest must be disclosed or known to the those entitled to vote,

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