Article Archives >> Lead Stories >> December 1-15, 2005

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Director Loses Suit Against Other Directors
For Fraud, Conflict, Breach of Fiduciary Duty
Court gives textbook answers to uphold conduct
under business judgment rule and statutory provisions

A director and member of a nonprofit homeowners association in Wyoming have been stymied in their efforts to recover damages on behalf of the association in a derivative suit for breach of fiduciary duty against other present and former members of the Board. They have also lost a claim that an amendment to the bylaws expanding the size of the Board was improper and have been ordered to pay legal fees and costs by the Supreme Court of Wyoming. The opinion reads like a primer on nonprofit governance. (Mueller v. Zimmer, No. 05-09, 12/5/05.)

The Star Valley Ranch Association is a nonprofit mutual benefit corporation that manages a recreational residential subdivision. It is governed by a Board of Directors that hires a general manager to run the day-to-day operations. A general manager may not serve on the Board. The plaintiffs claimed that through fraud, misrepresentation and conflicts of interest, the directors and former managers had deprived the Association of funds and that the directors breached their fiduciary duty by failing to recover the money.

One of the former directors was elected to the Board in 1996 and resigned in 2000 to become general manager. Contemporaneously with his resignation, he submitted a request for unpaid overtime incurred attending Board-ordered meetings and other obligations. The Board denied the request.

It was later discovered that he was overpaid by about $2000 for his services, and after giving credit for paid time off, the Board asked him to return $1380. He responded by asking again for his overtime, and they ultimately resolved the matter by dropping both claims and signing a mutual release.

After the general manager resigned, the Board asked one of the directors to serve as a “Business Agent” so he could perform the general manager’s duties without having to resign. When another dispute arose concerning overpayment of salary, totaling at most $1520, the Board approved an offset of $562 and agreed to waive the balance, saying the amount was too small to justify the costs of litigation.

The plaintiffs alleged that the first manager’s claims were fraudulent but the Court said there was no evidence to support the claim. Claims based on “speculation” about the circumstances were insufficient.

Whether or not the manager’s claims had merit, however, was not the question, the Court said. The dispute was resolved by the mutual release.

On the second manager’s alleged failure to reimburse, the plaintiffs argued that no reasonable Board would have settled under the circumstances. But the Court applied the business judgment rule and dismissed the claim. Quoting from a legal text, the Court said “where the board acts with due care, good faith, and in the honest belief that they are acting in the best interests of the [organization], the Court gives great deference to the substance of the directors’ decision and will not invalidate the decision, will not examine its reasonableness, and will not substitute its views for those of the board if the latter’s decision can be attributed to any rational business purpose…. A Court does not substitute its own notion of what is or is not sound business judgment in place of the board’s judgment.”

The Court said that the plaintiffs did not establish any facts to suggest that the Board’s actions were in bad faith or that any of the directors had a personal interest. “Whether or not a particular action by a Board is ‘reasonable’ is not for us to decide,” the Court said. “That determination is vested in the discretion of the Board.”

The plaintiffs also claimed that the financial arrangements with the two managers were ultra vires, beyond the powers of the corporation, because they were not based on specific personal service contracts as required by the bylaws of the organization. The Court cited the Wyoming statute, based on the Model Nonprofit Corporation Law, which provides that the validity of corporate action may not be challenged as ultra vires except to enjoin an act where a third party has not yet acquired legal rights.

In this case, the claim was clearly barred because it did not seek an injunction and the parties had acquired and completely settled their legal rights. The Court said the claim was frivolous and it could only conclude that it was pursed in bad faith

The plaintiffs also claimed that one of the directors, an attorney, was engaged in a conflict of interest transaction without prior approval of the Board when he charged the Association for reimbursement for expenses incurred in using the resources of his law firm to perform his duties as a director. The Court ruled that the director was not doing business with the corporation, but was acting in furtherance of the Association’s business in his capacity as a director. Therefore there was no conflict of interest that required prior approval.

Finally, the plaintiffs charged that the members’ approval of a bylaw change expanding the Board from five to seven members was invalid. The Bylaws provided that there should be five members unless changed by amendment adopted “by a majority of the voting power” of the members of the Association. A separate bylaw provided that the bylaws could be amended by two-thirds majority of the voting power of those members present at a meeting in person or by proxy. A majority of members constituted a quorum for a members’ meeting.

At a meeting held with 1042 votes present out of 2027, the amendment was passed 753 to 126, the rest apparently abstaining. The Court agreed with the trial court in holding that the more specific provisions relating to the amendment of the bylaws controlled and that the bylaws had been properly approved.

The plaintiffs also charged that the amendment was not valid because it did not appear in the minutes of the corporate proceedings. The failure to be included in minutes does not mean that the vote did not happen, and the action could be proved by oral testimony, the Court said.

YOU NEED TO KNOW

Homeowners’ associations generate a lot of the law on nonprofit governance because members appear to care passionately about it, even when the amounts of money involved are relatively small.

The Court was clearly correct in upholding the business judgment rule protecting the Board’s action in settling small monetary disputes in the absence of any evidence of bad faith or self-dealing. Its holding that reimbursement of out-of-pocket expenses does not involve a conflict of interest is an interesting response to a novel argument. The organization’s failure to include the amendment of the bylaws in the minutes was not fatal, but was obviously a sloppy error that needlessly gave the plaintiffs another ground for argument.

Article Archives >> Lead Stories >> December 1-15, 2005