“Business Judgment Rule” Applies to HOAs
California’s common law “business judgment rule,” as described by the courts, protects from court intervention “those management decisions which are made by directors in good faith in what the directors believe is the organization’s best interest.” When the rule’s requirements are met, “a court will not substitute its judgment for that of the corporation’s board of directors.” The rule establishes a presumption that the directors’ decisions are sound, and prohibits courts from interfering.
Courts have also recognized an exception to the business judgment rule’s presumption “for actions taken without reasonable inquiry, with improper motives, or as a result of a conflict of interest.” But a plaintiff must allege sufficient facts to establish an exception to the rule. “Conclusory allegations” are not enough. The complaint must allege specific facts “which, if proven, would establish fraud, bad faith, overreaching, or an unreasonable failure to investigate material facts.”
The business judgment rule is typically applied in disputes between corporate shareholders and corporate boards. But in a case recently published by California’s Third Appellate District — Lauckhart v. El Macero Homeowners Association (order for publication here) — the court applied the business judgment rule to the decisions of another species of corporate entity — an HOA board.
Facts: CC&Rs authorize HOA to acquire property; HOA acquires property
The El Macero subdivision was developed in Yolo County during the 1960s and 1970s. The developer, Mace Properties, Inc., recorded a declaration of CC&Rs. Homeowners in the subdivision also incorporated the El Macero Improvement Association to support the development.
During construction, Mace Properties dedicated a parcel — “Lot A” — to the County, which intended to operate a well on the parcel to serve homes in the subdivision. The well eventually ran dry and the County abandoned it.
In 1995, homeowners in the subdivision recorded a new declaration of CC&Rs, and renamed the Improvement Association to the El Macero Homeowners’ Association, which included all owners. The CC&Rs authorized the Association to acquire real property and levy assessments on homeowners. At that time, there was no common area in the subdivision.
In 2020, the County formally abandoned the dedication of Lot A and the parcel was conveyed to the HOA as common area within the subdivision.
Trial court: demurrer sustained based on business judgment rule; case dismissed
Plaintiffs Richard Lauckhart and Sharon and Ronald Baumgartner sued to prevent the HOA from acquiring Lot A and levying maintenance assessments relating to Lot A against the subdivision homeowners pursuant to the Davis-Stirling Common Interest Development Act (Civil Code sections 4000 et seq.). Among other claims, plaintiffs contended the HOA’s acquisition of Lot A breached the CC&Rs, and sought an injunction barring the HOA from accepting Lot A as common area or imposing assessments to fund its maintenance.
The HOA filed a demurrer to plaintiffs’ complaint. With a demurrer, the court must assume all facts alleged are true, and evaluates whether those facts as alleged state a valid claim. The court does not take evidence, but may take judicial notice of certain documents, and here the court took judicial notice of the 1995 CC&Rs, the articles of incorporation, and other recorded documents.
The trial court sustained the HOA’s demurrer without leave to amend and dismissed the complaint, holding the HOA’s acquisition of Lot A was protected under the business judgment rule and could not be enjoined by the court.
Plaintiffs appealed.
Court of Appeal: affirmed; HOA board entitled to presumption under business judgment rule
The Court of Appeal affirmed.
The court held that plaintiffs’ complaint alleged no facts that the HOA acquired Lot A due to “fraud, bad faith, or an unreasonable failure to investigate material facts.” Instead, the complaint merely alleged “overreach” — that the HOA “was not authorized to acquire Lot A, and Lot A was not necessary” for the HOA’s uses and purposes.
The court held: “These allegations are insufficient as a matter of law to rebut the business judgment rule. The governing documents expressly grant the Association the authority plaintiffs allege the Association does not have.”
The court observed that the 1995 CC&Rs gave the HOA broad authority to “acquire, by any manner, own, improve, and maintain real property” in connection with the HOA’s affairs, and also gave the HOA authority to levy assessments. The HOA’s 1964 articles of incorporation likewise granted broad authority to “purchase, hold, and use real property” including areas adjacent to the subdivision “as may hereafter be added.”
Since the complaint alleged no facts justifying an exception to the business judgment rule, the court presumed as a matter of law that the decision by the HOA’s board “to acquire Lot A was based on sound business judgment and was necessary and useful for the Association’s purposes, and we will not interfere in that decision.”
Lesson
Under the holding of the Lauckhart opinion, the “business judgment rule” applies to decisions by an HOA board.