Fiduciary Duty and the Business Judgment Rule

When an owner agrees to serve on a condominium board, the owner must recognize that he or she takes on additional legal responsibilities and obligations. Specifically, Section 18.4 of the Illinois Condominium Property Act states that a condominium board must "exercise the care required of a fiduciary of the unit owners." A basic legal definition for a "fiduciary" is a person who is required to act for the benefit of another person on all matters within the scope of that relationship.

Similar to how for-profit corporate boards are treated, Illinois courts apply a reasonableness or "business judgment" approach in assessing the actions of condominium boards. The business judgment approach (a/k/a the "business judgment rule") prevents second-guessing of board members when they perform their duties in a diligent and good faith manner. In short, the business judgment rule creates a presumption that the condominium board's judgment was in good faith and for the best interest of the association.

However, on December 19, 2008, the First District Appellate Court (the appellate court for Cook County) published an opinion that arguably expands on the fiduciary duty that is owed by condominium boards. This case, Davis v. Dyson, Case No. 1-07-2927, involved a property manager that embezzled more than $550,000 from a condominium association by allegedly forging one of the board member's signature on over 100 Association checks. The unhappy plaintiff/owner alleged that the board failed to take proper precautions to protect the association, such as failing to review any of the monthly bank statements and failing to perform a financial review or proper audit.

This recent court decision is significant as the court signaled that it will not let board member defendants off the hook simply by showing that they acted in "good faith". Rather, the board must show good faith AND diligence. Specifically, the court stated that the board members "may not close their eyes to what is going on about them in corporate business, and must in appropriate circumstances make such reasonable inquiry as an ordinarily prudent person under similar circumstances."

The decision is also significant as the court seemed to rule that regardless of evidence of good faith by the board, a breach of fiduciary duty occurs when a board fails to comply with a law or statute to the detriment of the condominium association.  In this case, the plaintiff alleged that the board failed to secure sufficient fidelity bond insurance, which is required by law, and may have covered this illegal misappropriation of funds. On this issue, this case reinforces the importance of the board working only with a competent and experienced insurance professional when securing insurance coverage for the association.

While the Davis v. Dyson decision should serve as a wake-up call to condominium boards in Illinois, it should not unduly affect a unit owner's noble decision to serve on an association board.  The reason is that most claims against association boards are covered by directors and officers' liability insurance. Additionally, most modern declarations contain a provision whereby the association indemnifies and holds the individual board members harmless from claims or judgments. However, as always, there are exceptions, as the association may not provide indemnity protection if an individual board member acted in bad faith or with malice.