Introduction to Colorado Owner Associations and the Duties of Directors
Types of and number of associations in Colorado
Colorado has an estimated 13,000 to 15,000 owner associations.
Colorado owner associations can be property owner associations, single family owner associations, townhome associations, condominium associations and more.
The community governed and operated by the association may be small to large (from 2 homes or properties, to over 40,000 homes).
Associations are typically private nonprofit Colorado corporations
Most Colorado associations are incorporated as a Colorado nonprofit corporation, or if not incorporated, act as a nonprofit entity.
The association’s purpose is not to provide investment returns or stock dividends, since there are no shareholders. Rather, its purpose is typically to preserve, enhance and protect the values of the properties of members.
While a nonprofit, associations are similar to for profit businesses in many ways. Associations are confronted with various governance, maintenance and operational tasks.
Typically, a community association is governed by a board of directors and the board handles the regular operation of the association. Some boards of directors may be responsible for five, six and seven figure annual budgets.
Associations are not part of government and directors are not treated like publicly-elected officials. As persons privately elected or appointed to govern a private nonprofit corporation, directors owe duties to the association and the members. Those duties are reviewed and discussed in this article.
Colorado statutes that apply
As nonprofit corporations, Colorado owner associations are primarily subject to two different state statutes (in addition to the State and Federal Constitutions and other laws): the Colorado Revised Nonprofit Corporation Act and the Colorado Common Interest Ownership Act.
- Colorado Revised Nonprofit Corporation Act. This statute covers many areas dealing with Colorado nonprofit corporations. The provisions of this statute on duties and liability of board members are the focus of this article.
- Colorado Common Interest Ownership Act. This state statute, referred to and known by its acronym CCIOA, governs many aspects of owner associations, but is not the focus of this article.
What about conflicts between the Nonprofit Act and CCIOA?
At times, both the Colorado Revised Nonprofit Corporation Act and CCIOA may apply with differing results. For application of these statutes to associations, the association should consult with its attorney.
General Discussion on Duties of Directors of Nonprofit Corporations
Directors of Colorado owner associations have duties set out in the Colorado Revised Nonprofit Corporation Act and in CCIOA. These duties are similar to the duties of other for profit business operations. These responsibilities are generally owed to the association and to its members, not to the general public or the world at large. This article focuses on duties under the Colorado Revised Nonprofit Corporation Act.
Associations have perpetual life and rarely go out of business or file bankruptcy
Think about it! Associations are perpetual organizations for the benefit of their members. As long as the members do not terminate the covenants and the community, the association continues in existence.
The Association cannot liquidate without the approval (through amendment or termination) of its members.
This means the association should be prudent in how it operates, governs, and contracts, since Chapter 7 bankruptcy liquidation is not generally possible or recommended.
Duty to Act Within the Scope of Authority
Directors owe a duty to their associations and to their members to perform their duties in accordance with the authority granted to them by statute and in the association’s governing documents.
If directors exceed this authority, and damage results, the directors may be personally liable for their unauthorized actions.
Duty of Care
Under the terms of the Colorado Revised Nonprofit Corporation Act, directors must discharge their duties (as set forth in the governing documents and applicable statutes) with the duty of care.
Three key components of the duty of care:
- Good faith;
- The care an ordinarily prudent person in a like position would exercise under similar circumstances; and
- In a manner the director reasonably believes to be in the best interests of the association.
If directors have made a decision based on this standard of care, a court will generally not second guess that decision. This is frequently referred to as the “Business Judgement Rule.”
CCIOA note: For owner associations that govern common interest communities created after July 1, 1992, CCIOA states that directors (those not appointed by the declarant) shall not be liable for actions taken or omissions made in the performance of their duties except for wanton and willful acts or omissions. Prudence dictates that all directors adhere to the standard of conduct set forth in the Nonprofit Act.
Duty of Undivided Loyalty
Directors have a duty to act for the association’s benefit only and not for their personal benefit or the benefit of others.
Courts take this duty seriously, often using expressions such as “utmost good faith” and placing the burden on the director to demonstrate the fairness of any transaction in which the director is personally involved if the transaction is challenged.
The duty of loyalty requires directors to exercise their powers in the Association’s best interests.
By assuming office, directors acknowledge that, with regard to any association operations or governance, the best interests of the association must prevail over the director’s individual interests or the particular interests of the members electing him or her.
The basic legal principle to be observed here is a negative one: a director shall not use his or her position for individual personal advantage.
Duty of Confidentiality
A director should not, in the regular course of business, disclose information about the association’s activities unless it is already known by the members or is part of the association’s records.
In the normal course of business, a director should treat as confidential all matters involving the association until there has been general public disclosure or unless the information is a matter of public record (i.e., reported in the minutes) or common knowledge.
An individual director is not a spokesperson for the association and thus disclosure of association activities should be made only through the association’s designated spokesperson, usually the president or manager.
A presumption of confidential treatment should apply to all current information about legitimate board or association activities.
Duty to Avoid Improper Conflicts of Interest
A conflict of interest is present whenever a director has a material personal interest in a proposed contract or transaction to which the association may be a party. This interest can occur either directly or indirectly.
The director may be personally involved with the transaction, or may have an employment or investment relationship with an entity with which the association is dealing, or it may arise from some family relationship.
A conflict of interest may result from a director performing services for the association (e.g., a landscape contractor, banker, insurance agent, attorney or real estate broker).
The board should not assume that a conflict cannot exist for a director who receives no monetary or other tangible benefit from a transaction with the association. For example, access to information which could be used for individual profit might put the director in conflict with the association. The law seeks to recognize these problems, not by treating conflicts of interest as inherently improper or as a legal offense, but by prescribing the methods by which the board of directors and the individual directors should disclose conflicts and how they should proceed in the face of such situations.
Conflict of interest policy
CCIOA requires all associations to adopt a written conflict of interest policy. If an association does not have that policy, it should adopt one as soon as possible.
Nonprofit Act approach to conflicts
It is important to remember that conflicting interest transactions are not illegal.
Under the Nonprofit Act, a conflicting interest transaction is not void or voidable simply because the interested director was present at or participates in the meeting or voted upon the action. Rather, the transaction will stand if:
- The material facts are disclosed or known to the board and a majority of the disinterested directors approve the transaction; or
- The material facts are disclosed or known to the members and the members approve the transaction; or
- The transaction is fair to the association.
An interested director counts towards quorum for the meeting.
CCIOA approach to conflicts
Although CCIOA once treated a nondisclosed conflict as void, it now follows the same approach as the Nonprofit Act.
Best practices approach to conflicts
When a director has an interest in a transaction being considered by the board, the best course of action starts with disclosing the conflict before the board discusses or takes action on the matter.
Upon disclosure, the remaining board can provide a disinterested review of the matter.
In the event of litigation, a non-disclosing director, and possibly the disinterested directors supporting the action, will have the burden of proving that the transaction was fair.
As a practical matter, a non-disclosing director exposes himself and the board to substantial risks, including political risks, in such an undisclosed conflict.
The Business Judgment Rule and Conflicts of Interest
The Business Judgement Rule (discussed above) will not shield a non-disclosing director or an unreasonably uninformed director from liability.
Disclosure enables the other directors to evaluate a proposed transaction not only in terms of fairness, but also in terms of its impacts on the association’s image.
Generally, the disclosure should include the existence of the interest and its nature (e.g., those arising from financial or family relationships, or professional affiliations, etc.) and should be made before the board takes any action on the matter.
The director may consider it prudent to be absent from the part of the meeting in which the matter is discussed, unless his input or information may be needed.
The minutes should reflect the absence from discussion and/or abstention for any vote relating to the transaction.
In some cases, a director may have an interest in the transaction but be unable to disclose the nature of the conflict due to duties running to others. In this case, the director should at least state that an interest exists, consider leaving the portion of the meeting, or at least abstain from the discussion and vote.
There may also be conflicting interests which create such problem for the director’s participation that the director should consider resigning.
Duty to Avoid Intentional Misconduct and Knowing Violations of Law
Directors have a duty to avoid deliberate wrongdoing, misbehavior and known violations of law.
Duty to Avoid Unlawful Distributions of Association Assets
The Nonprofit Act imposes personal liability on a director who votes for or assents to a distribution of association assets made in violation of the Nonprofit Act or the association’s Articles of Incorporation.
Duty to Avoid Loans from the Association to a Director
The Nonprofit Act does not allow a director to receive a loan from the association.
Duty to Not Appropriate a Corporate Opportunity
A corporate opportunity is a business opportunity which becomes known to a director or officer, due to his position within the association. In essence, the opportunity or knowledge belongs to the association, and directors owe a duty not to use that opportunity or knowledge for their own benefit.
The association may have the right to damages for improper appropriation or use of the opportunity by a director. The theory is that the director who takes that opportunity holds it in “constructive trust” for the association.
The association may obtain a court order to prevent use of the knowledge or opportunity. Or, angry members may bring their own lawsuit for their benefit in what is called a derivative action. Insider misappropriation may also be criminal theft.
- Assess the risk. Volunteer directors must recognize that they face risk and exposures, just like other business corporation directors. Learn, understand, and seek to discharge your duties.
- The HOA and the Community are at risk. It is not too extreme to suggest that the community association, as a form of real estate operation and governance, will be at risk.
- Avoid Casual and unmindful acts. Those who provide professional advice and services to associations should focus attention on the consequences of casually or unmindfully undertaking and serving as a director of a community association.
- Learn and become educated. Directors and potential directors should be educated on duties, best practices and risk management to limit liability.
- Get Professional advice. By receiving and acting on this advice, directors can effectively serve their communities without risking their personal assets.
- Consider resigning. If directors cannot serve relatively free from claims, they should resign.
- Qualified and capable board members are needed to govern vibrant and effective owner associations. The roles of community associations and the directors that govern these associations are so important that capable persons must be attracted to be directors.
- The developer control period. The period of developer control is critical to the initial health of a community association. Developers should make diligent efforts to attract good candidates for appointment to the boards of the associations in communities they create.
- After developer control. After transition, associations must continue to attract capable owners to be directors. The risks of failure to do so are loss of value in the community and division among the members.
- Efforts should be made and procedures implemented to limit hostility toward board members. Service on the board of directors of a community association should add to community spirit and property values of the members. Directors should not have to lose sleep, lose friends, or get sued. Sometimes it is inevitable that relationships between directors and other members of the community will become adversarial, whether because of the economy, personal circumstances, or due to the manner in which homes and properties are being managed. However, establishing effective procedures in advance to address these situations can limit the disruption of board meetings by angry members, limit personal confrontations, and reduce the likelihood of lawsuits.
The Final Word – Be informed and stay informed on duties and how to limit liability
A major concern that inhibits or prevents candidates from serving on the board is their concern that they will be exposed to lawsuits and other claims. A good way to address liability concerns of board member candidates is to educate potential directors on their duties and how to protect themselves from liability.