THE BUSINESS JUDGMENT RULE
Tim and Steve Sellers
This is the first in a four part series that explores the protections the law provides for those who serve their communities as association directors and officers in North and South Carolina.
Association officers and directors are a caring bunch. They spend hours working to better their communities with no pay and often with little gratitude expressed for their efforts. As they serve, directors and officers often face threats of lawsuits and liability from members who disagree, sometimes very aggressively, with their decisions. Board members are understandably concerned about potential personal liability, and this concern can discourage people from being willing to serve.
Associations cannot function without good leaders. Good leaders will not serve if there is an unreasonable risk that they may be held personally liable for their actions. Fortunately, there are a number of protections in place for the officers and directors of nonprofit corporations in both North and South Carolina. Some of these are provided for by operation of law while others are defined by statute. Others require some affirmative action by the association.
Some members demand that their association leaders must always be “perfect.” They are quick to second-guess every decision with which they disagree. Thankfully, the courts in North and South Carolina do not hold officers and directors to such a high (and unreasonable) standard. Rather, both North Carolina and South Carolina courts apply the “business judgment rule” when they review the actions of officers and directors. Essentially, the business judgment rule gives officers and directors the benefit of the doubt. It recognizes that officers and directors should be allowed significant discretion and latitude as they discharge their duties, and that they should not be held to an unreasonable standard of perfection.
In 2010, a North Carolina court described the business judgment rule this way in State v. Custard:
Absent proof of bad faith, conflict of interest or disloyalty, the business decisions of officers and directors will not be second-guessed if they are “the product of a rational process,” and the officers and directors “avail themselves of all material and reasonably available information” and honestly believed they were acting in the best interest of the corporation.
The court went on to say that the decisions of officers and directors remain protected by the business judgment rule even if their decisions were “wrong, stupid or egregiously dumb.”
The South Carolina Court of Appeals has also held that the business judgment rule protects association officers and directors. In Fisher v. Shipyard Vill. Counsel of Co-Owners, Inc. (2014) the court described the degree of protection the rule provides this way:
In a dispute between the directors of a homeowners association and aggrieved homeowners, the conduct of the director should be judged by the “business judgment rule” and absent a showing of bad faith, dishonesty or incompetence, the judgment of the directors will not be set aside by judicial action. … The business judgment rule precludes judicial review of actions taken by a corporate governing board absent a showing of a lack of good faith, fraud, self-dealing, or unconscionable conduct. … Under the business judgment rule a court will not review the business judgment of a corporate governing board when it acts within its authority and it acts without corrupt motives and in good faith. … The burden of proving good faith is not on the governing board; the burden of proving a lack of good faith is borne, rather, by those challenging the board’s actions.
Clearly, in either state, the key to securing the protection of the business judgment rule is to make sure that your officers and directors avoid conflicts of interest, engage in meaningful and rational processes when making decisions and always act in good faith and in the association’s best interest. Directors and officers who rely on and apply these common sense rules of thumb will enjoy the benefit of the business judgment rule and need not worry about their actions being second-guessed in court.