Lamden v. La Jolla Shores Clubdominium Homeowners Ass'n

Opinion

A building in a condominium development suffered from termite infestation. The board of directors of the development’s community association 1 decided to treat the infestation locally (“spot-treat”), rather than fumigate. Alleging the board’s decision diminished the value of *253 her unit, the owner of a condominium in the development sued the community association. In adjudicating her claims, under what standard should a court evaluate the board’s decision?

As will appear, we conclude as follows: Where a duly constituted community association board, upon reasonable investigation, in good faith and with regard for the best interests of the community association and its members, exercises discretion within the scope of its authority under relevant statutes, covenants and restrictions to select among means for discharging an obligation to maintain and repair a development’s common areas, courts should defer to the board’s authority and presumed expertise. Thus, we adopt today for California courts a rule of judicial deference to community association board decisionmaking that applies, regardless of an association’s corporate status, when owners in common interest developments seek to litigate ordinary maintenance decisions entrusted to the discretion of their associations’ boards of directors. (Cf. Levandusky v. One Fifth Ave. Apt. Corp. (1990) 75 N.Y.2d 530, 537-538 [554 N.Y.S.2d 807, 811, 557 N.E.2d 1317, 1321] [analogizing a similarly deferential rule to the common law “business judgment rule”].)

Accordingly, we reverse the judgment of the Court of Appeal.

Background

Plaintiff Gertrude M. Lamden owns a condominium unit in one of three buildings comprising the La Jolla Shores Clubdominium condominium development (Development). 2 Over some years, the board of governors (Board) of defendant La Jolla Shores Clubdominium Homeowners Association (Association), an unincorporated community association, elected to spot-treat (secondary treatment), rather than fumigate (primary treatment), for termites the building in which Lamden’s unit is located (Building Three).

In the late 1980’s, attempting to remedy water intrusion and mildew damage, the Association hired a contractor to renovate exterior siding on all three buildings in the Development. The contractor replaced the siding on *254 the southern exposure of Building Three and removed damaged drywall and framing. Where the contractor encountered termites, a termite extermination company provided spot-treatment and replaced damaged material.

Lamden remodeled the interior of her condominium in 1990. At that time, the Association’s manager arranged for a termite extermination company to spot-treat areas where Lamden had encountered termites.

The following year, both Lamden and the Association obtained termite inspection reports recommending fumigation, but the Association’s Board decided against that approach. As the Court of Appeal explained, the Board based its decision not to fumigate on concerns about the cost of fumigation, logistical problems with temporarily relocating residents, concern that fumigation residue could affect residents’ health and safety, awareness that upcoming walkway renovations would include replacement of damaged areas, pet moving expenses, anticipated breakage by the termite company, lost rental income and the likelihood that termite infestation would recur even if primary treatment were utilized. The Board decided to continue to rely on secondary treatment until a more widespread problem was demonstrated.

In 1991 and 1992, the Association engaged a company to repair water intrusion damage to four units in Building Three. The company removed siding in the balcony area, repaired and waterproofed the decks, and repaired joints, between the decks and the walls of the units. The siding of the unit below Lamden’s and one of its walls were repaired. Where termite infestation or damage became apparent during this project, spot-treatment was applied and damaged material removed.

In 1993 and 1994, the Association commissioned major renovation of the Development’s walkway system, the underpinnings of which had suffered water and termite damage. The $1.6 million walkway project was monitored by a structural engineer and an on-site architect.

In 1994, Lamden brought this action for damages, an injunction and declaratory relief. She purported to state numerous causes of action based on the Association’s refusal to fumigate for termites, naming as defendants certain individual members of the Board as well as the Association. Her amended complaint included claims sounding in breach of contract (viz., the governing declaration of restrictions [Declaration]), breach of fiduciary duty, and negligence. She alleged that the Association, in opting for secondary over primary treatment, had breached Civil Code section 1364, subdivision *255 (b)(1) 3 and the Declaration 4 in failing adequately to repair, replace and maintain the common areas of the Development.

Lamden further alleged that, as a proximate result of the Association’s breaching its responsibilities, she had suffered diminution in the value of her condominium unit, repair expenses, and fees and costs in connection with this litigation. She also alleged that the Association’s continued breach had caused and would continue to cause her irreparable harm by damaging the structural integrity and soundness of her unit, and that she has no adequate remedy at law. At trial, Lamden waived any damages claims and dismissed with prejudice the individual defendants. Presently, she seeks only an injunction and declaratory relief.

After both sides had presented evidence and argument, the trial court rendered findings related to the termite infestation affecting plaintiff’s condominium unit, its causes, and the remedial steps taken by the Association. The trial court found there was “no question from all the evidence that Mrs. Lamden’s unit . . . has had a serious problem with termites.” In fact, the trial court found, “The evidence . . . was overwhelming that termites had been a problem over the past several years.” The court concluded, however, that while “there may be active infestation” that would require “steps [to be] taken within the future years,” there was no evidence that the condominium units were in imminent structural danger or “that these units are about to fall or something is about to happen.”

The trial court also found that, “starting in the late ’80’s,” the Association had arranged for “some work” addressing the termite problem to be done. Remedial and investigative work ordered by the Association included, according to the trial court, removal of siding to reveal the extent of damage, a “big project... in the early ’90’s,” and an architect’s report on building design factors. According to the court, the Board “did at one point, seriously consider” primary treatment; “they got a bid for this fumigation, and there was discussion.” The court found that the Board also considered possible problems entailed by fumigation, including relocation costs, lost rent, concerns about pets and plants, human health issues and eventual termite reinfestatioh.

*256 As to the causes of the Development’s termite infestation, the trial court concluded that “the key problem came about from you might say a poor design” and resulting “water intrusion.” In short, the trial court stated, “the real culprit is not so much the Board, but it’s the poor design and the water damage that is conducive to bringing the termites in.”

As to the Association’s actions, the trial court stated, “the Board did take appropriate action.” The court noted the Board “did come up with a plan,” viz., to engage a pest control service to “come out and [spot] treat [termite infestation] when it was found.” The trial judge opined he might, “from a personal relations standpoint,” have acted sooner or differently under the circumstances than did the Association, but nevertheless concluded “the Board did have a rational basis for their decision to reject fumigation, and do . . . what they did.” Ultimately, the court gave judgment for the Association, applying what it called a “business judgment test.” Lamden appealed.

Citing Frances T. v. Village Green Owners Assn. (1986) 42 Cal.3d 490 [229 Cal.Rptr. 456, 723 P.2d 573, 59 A.L.R.4th 447] (Frances T.), the Court of Appeal agreed with Lamden that the trial court had applied the wrong standard of care in assessing the Association’s actions. In the Court of Appeal’s view, relevant statutes, the governing Declaration and principles of common law imposed on the Association an objective duty of reasonable care in repairing and maintaining the Development’s common areas near Lamden’s unit as occasioned by the presence of termites. The court also concluded that, had the trial court analyzed the Association’s actions under an objective standard of reasonableness, an outcome more favorable to Lamden likely would have resulted. Accordingly, the Court of Appeal reversed the judgment of the trial court.

We granted the Association’s petition for review.

Discussion

“In a community apartment project, condominium project, or stock cooperative . . . unless otherwise provided in the declaration, the association is responsible for the repair and maintenance of the common area occasioned by the presence of wood-destroying pests or organisms.” (Civ. Code, § 1364, subd. (b)(1).) The Declaration in this case charges the Association with “management, maintenance and preservation” of the Development’s common areas. Further, the Declaration confers upon the Board power and authority to maintain and repair the common areas. Finally, the Declaration provides that “limitations, restrictions, conditions and covenants set forth in this Declaration constitute a general scheme for (i) the maintenance, protection and enhancement of value of the Project and all Condominiums and (ii) the benefit of all Owners.”

*257 In light of, the foregoing, the parties agree the Association is responsible for the repair and maintenance of the Development’s common areas occasioned by the presence of termites. They differ only as to the standard against which the Association’s performance in discharging this obligation properly should be assessed: a deferential “business judgment” standard or a more intrusive one of “objective reasonableness.”

The Association would have us decide this case through application of “the business judgment rule.” As we have observed, that rule of judicial deference to corporate decisionmaking “exists in one form or another in every American jurisdiction.” (Frances T., supra, 42 Cal.3d at p. 507, fn. 14.)

“The common law business judgment rule has two components— one which immunizes [corporate] directors from personal liability if they act in accordance with its requirements, and another which insulates 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.” (Lee v. Interinsurance Exchange (1996) 50 Cal.App.4th 694, 714 [57 Cal.Rptr.2d 798], citing 2 Marsh & Finkle, Marsh’s Cal. Corporation Law (3d ed., 1996 supp.) § 11.3, pp. 796-797.) A hallmark of the business judgment rule is that, when the rule’s requirements are met, a court will not substitute its judgment for that of the corporation’s board of directors. (See generally, Katz v. Chevron Corp. (1994) 22 Cal.App.4th 1352, 1366 [27 Cal.Rptr.2d 681].) As discussed more fully below, in California the component of the common law rule relating to directors’ personal liability is defined by statute. (See Corp. Code, §§ 309 [profit corporations], 7231 [nonprofit corporations].)

According to the Association, uniformly applying a business judgment standard in judicial review of community association board decisions would promote certainty, stability and predictability in common interest development governance. Plaintiff, on the other hand, contends general application of a business judgment standard to board decisions would undermine individual owners’ ability, under Civil Code section 1354, to enforce, as equitable servitudes, the CC&R’s in a common interest development’s declaration. 5 Stressing residents’ interest in a stable and predictable living environment, as embodied in a given development’s particular CC&R’s, *258 plaintiff encourages us to impose on community associations an objective standard of reasonableness in carrying out their duties under governing CC&R’s or public policy.

For at least two reasons, what we previously have identified as the “business judgment rule” (see Frances T., supra, 42 Cal.3d at p. 507 [discussing Corporations Code section 7231] and fn. 14 [general discussion of common law rule]; United States Liab. Ins. Co. v. Haidinger-Hayes, Inc. (1970) 1 Cal.3d 586, 594 [83 Cal.Rptr. 418, 463 P.2d 770] [reference to common law rule]) does not directly apply to this case. First, the statutory protections for individual directors (Corp. Code, §§ 309, subd. (c), 7231, subd. (c)) do not apply, as no individual directors are defendants here.

Corporations Code sections 309 and 7231 (section 7231) are found in the General Corporation Law (Corp. Code, § 100 et seq.) and the Nonprofit Corporation Law (id., § 5000 et seq.), respectively; the latter incorporates the standard of care defined in the former (Frances T., supra, 42 Cal.3d at p. 506, fn. 13, citing legis. committee com., Deering’s Ann. Corp. Code (1979 ed.) foll. § 7231, p. 205; 1B Ballantine & Sterling, Cal. Corporation Laws (4th ed. 1984) § 406.01, p. 19-192). Section 7231 provides, in relevant part: “A director shall perform the duties of a director ... in good faith, in a manner such director believes to be in the best interests of the corporation and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.” (§ 7231, subd. (a); cf. Corp. Code, § 309, subd. (a).) “A person who performs the duties of a director in accordance with [the stated standards] shall have no liability based upon any alleged failure to discharge the person’s obligations as a director . . . .” (§ 7231, subd. (c); cf. Corp. Code, § 309, subd. (c).)

Thus, by its terms, section 7231 protects only “[a] person who performs the duties of a director” (§7231, subd. (c), italics added); it contains no reference to the component of the common law business judgment rule that somewhat insulates ordinary corporate business decisions, per se, from judicial review. (See generally, Lee v. Interinsurance Exchange, supra, 50 Cal.App.4th at p. 714, citing 2 Marsh & Finkle, Marsh’s Cal. Corporation Law, supra, § 11.3, pp. 796-797.) Moreover, plaintiff here is seeking only injunctive and declaratory relief, and it is not clear that such a prayer implicates section 7231. The statute speaks only of protection against “liability based upon any alleged failure to discharge the person’s obligations . . . .” (§ 7231, subd. (c), italics added.)

As no compelling reason for departing therefrom appears, we must construe section 7231 in accordance with its plain language. (Rossi v. Brown *259 (1995) 9 Cal.4th 688, 694 [38 Cal.Rptr.2d 363, 889 P.2d 557]; Adoption of Kelsey S. (1992) 1 Cal.4th 816, 826 [4 Cal.Rptr.2d 615, 823 P.2d 1216]; Delaney v. Superior Court (1990) 50 Cal.3d 785, 798 [268 Cal.Rptr. 753, 789 P.2d 934].) It follows that section 7231 cannot govern for present purposes.

Second, neither the California statute nor the common law business judgment rule, strictly speaking, protects noncorporate entities, and the defendant in this case, the Association, is not incorporated. 6

Traditionally, our courts have applied the common law “business judgment rule” to shield from scrutiny qualifying decisions made by a corporation’s board of directors. (See, e.g., Marsili v. Pacific Gas & Elec. Co. (1975) 51 Cal.App.3d 313, 324 [124 Cal.Rptr. 313, 79 A.L.R.3d 477]; Fairchild v. Bank of America (1961) 192 Cal.App.2d 252, 256-257 [13 Cal.Rptr. 491]; Findley v. Garrett (1952) 109 Cal.App.2d 166, 174-175 [240 P.2d 421]; Duffey v. Superior Court (1992) 3 Cal.App.4th 425, 429 [4 Cal.Rptr.2d 334] [rule applied to decision by board of incorporated community association]; Beehan v. Lido Isle Community Assn. (1977) 70 Cal.App.3d 858, 865 [137 Cal.Rptr. 528] [same].) The policies underlying judicial creation of the common law rule derive from the realities of business in the corporate context. As we previously have observed: “The business judgment rule has been justified primarily on two grounds. First, that directors should be given wide latitude in their handling of corporate affairs because the hindsight of the judicial process is an imperfect device for evaluating business decisions. Second, ‘[t]he rule recognizes that shareholders to a very real degree voluntarily undertake the risk of bad business judgment; investors need not buy stock, for investment markets offer an array of opportunities less vulnerable to mistakes in judgment by corporate officers/ ” (Frances T., supra, 42 Cal.3d at p. 507, fn. 14, quoting 18B Am.Jur.2d (1985) Corporations, § 1704, pp. 556-557; see also Findley v. Garrett, supra, 109 Cal.App.2d at p. 174.)

California’s statutory business judgment rule contains no express language extending its protection to noncorporate entities or actors. Section *260 7231, as noted, is part of our Corporations Code and, by its terms, protects only “director[s].” In the Corporations Code, except where otherwise expressly provided, “directors” means “natural persons” designated, elected or appointed “to act as members of the governing body of the corporation.” (Corp. Code, § 5047.)

Despite this absence of textual support, the Association invites us for policy reasons to construe section 7231 as applying both to incorporated and unincorporated community associations. (See generally, Civ. Code, § 1363, subd. (a) [providing that a common interest development “shall be managed by an association which may be incorporated or unincorporated”]; id., subd. (c) [“Unless the governing documents provide otherwise,” the association, whether incorporated or unincorporated, “may exercise the powers granted to a nonprofit mutual benefit corporation, as enumerated in Section 7140 of the Corporations Code.”]; Oil Workers Intl. Union v. Superior Court (1951) 103 Cal.App.2d 512, 571 [230 P.2d 71], quoting Otto v. Tailors’ P. & B. Union (1888) 75 Cal. 308, 313 [17 P. 217] [when courts take jurisdiction over unincorporated associations for the purpose of protecting members’ property rights, they “ ‘will follow and enforce, so far as applicable, the rules applying to incorporated bodies of the same character’ ”]; White v. Cox (1971) 17 Cal.App.3d 824, 828 [95 Cal.Rptr. 259, 45 A.L.R.3d 1161] [noting that “unincorporated associations are now entitled to general recognition as separate legal entities”].) Since other aspects of this case—apart from the Association’s corporate status—render section 7231 inapplicable, anything we might say on the question of the statute’s broader application would, however, be dictum. Accordingly, we decline the Association’s invitation to address the issue.

For the foregoing reasons, the “business judgment rule” of deference to corporate decisionmaking, at least as we previously have understood it, has no direct application to the instant controversy. The precise question presented, then, is whether we should in this case adopt for California courts a rule—analogous perhaps to the business judgment rule—of judicial deference to community association board decisionmaking that would apply, regardless of an association’s corporate status, when owners in common interest developments seek to litigate ordinary maintenance decisions entrusted to the discretion of their associations’ boards of directors. (Cf. Levandusky v. One Fifth Ave. Apt. Corp., supra, 75 N.Y.2d at p. 538 [554 N.Y.S.2d at p. 811] [referring “for the purpose of analogy only” to the business judgment rule in adopting a rule of deference].)

Our existing jurisprudence specifically addressing the governance of common interest developments is not voluminous. While we have not previously *261 examined the question of what standard or test generally governs judicial review of decisions made by the board of directors of a community association, we have examined related questions.

Fifty years ago, in Hannula v. Hacienda Homes (1949) 34 Cal.2d 442 [211 P.2d 302, 19 A.L.R.2d 1268], we held that the decision by the board of directors of a real estate development company to deny, under a restrictive covenant in a deed, the owner of a fractional part of a lot permission to build a dwelling thereon “must be a reasonable determination made in good faith.” (Id. at p. 447, citing Parsons v. Duryea (1927) 261 Mass. 314, 316 [158 N.E. 761, 762]; Jones v. Northwest Real Estate Co. (1925) 149 Md. 271, 278 [131 A. 446, 449]; Harmon v. Burow (1919) 263 Pa. 188, 190 [106 A. 310, 311].) Sixteen years ago, we held that a condominium owners association is a “business establishment” within the meaning of the Unruh Civil Rights Act, section 51 of the Civil Code. (O’Connor v. Village Green Owners Assn. (1983) 33 Cal.3d 790, 796 [191 Cal.Rptr. 320, 662 P.2d 427]; but see Harris v. Capital Growth Investors XIV (1991) 52 Cal.3d 1142, 1175 [278 Cal.Rptr. 614, 805 P.2d 873] [declining to extend O’Connor]; Curran v. Mount Diablo Council of the Boy Scouts (1998) 17 Cal.4th 670, 697 [72 Cal.Rptr.2d 410, 952 P.2d 218] [same].) And 10 years ago, in Frances 71, supra, 42 Cal.3d 490, we considered “whether a condominium owners association and the individual members of its board of directors may be held liable for injuries to a unit owner caused by third-party criminal conduct.” (Id. at p. 495.)

In Frances 7, a condominium owner, who resided in her unit, brought an action against the community association, a nonprofit corporation, and the individual members of its board of directors after she was raped and robbed in her dwelling. She alleged negligence, breach of contract and breach of fiduciary duty, based on the association’s failure to install sufficient exterior lighting and its requiring her to remove additional lighting that she had installed herself. The trial court sustained the defendants’ general demurrers to all three causes of action. (Frances T., supra, 42 Cal.3d at p. 495.) We reversed. A community association, we concluded, may be held to a landlord’s standard of care as to residents’ safety in the common areas (id. at pp. 499-500), and the plaintiff had alleged particularized facts stating a cause of action against both the association and the individual members of the board (id. at p. 498). The plaintiff failed, however, to state a cause of action for breach of contract, as neither the development’s governing CC&R’s nor the association’s bylaws obligated the defendants to install additional lighting. The plaintiff failed likewise to state a cause of action for breach of fiduciary- duties, as the defendants had fulfilled their duty to the plaintiff as a shareholder, and the plaintiff had alleged no facts to show that *262 the association’s board members had a fiduciary duty to serve as the condominium project’s landlord. (Id. at pp. 512-514.)

In discussing the scope of a condominium owners association’s common law duty to a unit owner, we observed in Frances T. that “the Association is, for all practical purposes, the Project’s ‘landlord.’ ” (Frances T., supra, 42 Cal.3d at p. 499, fn. omitted.) And, we noted, “traditional tort principles impose on landlords, no less than on homeowner associations that function as a landlord in maintaining the common areas of a large condominium complex, a duty to exercise due care for the residents’ safety in those areas under their control.” (Ibid., citing Kwaitkowski v. Superior Trading Co. (1981) 123 Cal.App.3d 324, 328 [176 Cal.Rptr. 494]; O’Hara v. Western Seven Trees Corp. (1977) 75 Cal.App.3d 798, 802-803 [142 Cal.Rptr. 487]; Kline v. 1500 Massachusetts Avenue Apartment Corp. (1970) 439 F.2d 477, 480-481 [141 App.D.C. 370, 43 A.L.R.3d 311]; Scott v. Watson (1976) 278 Md. 160 [359 A.2d 548, 552].) We concluded that “under the circumstances of this case the Association should be held to the same standard of care as a landlord.” (Frances T., supra, 42 Cal.3d at p. 499; see also id. at pp. 499-501, relying on O’Connor v. Village Green Owners Assn., supra, 33 Cal.3d at p. 796 [“association performs all the customary business functions which in the traditional landlord-tenant relationship rest on the landlord’s shoulders”] and White v. Cox, supra, 17 Cal.App.3d at p. 830 [association, as management body over which individual owner has no effective control, may be sued for negligence in maintaining sprinkler].)

More recently, in Nahrstedt v. Lakeside Village Condominium Assn. (1994) 8 Cal.4th 361, 375 [33 Cal.Rptr.2d 63, 878 P.2d 1275] (Nahrstedt), we confronted the question, “When restrictions limiting the use of property within a common interest development satisfy the requirements of covenants running with the land or of equitable servitudes, what standard or test governs their enforceability?” 7

In Nahrstedt, an owner of a condominium unit who had three cats sued the community association, its officers and two of its employees for declaratory relief, seeking to prevent the defendants from enforcing against *263 her a prohibition on keeping pets that was contained in the community association’s recorded CC&R’s. In resolving the dispute, we distilled from numerous authorities the principle that “[a]n equitable servitude will be enforced unless it violates public policy; it bears no rational relationship to the protection, preservation, operation or purpose of the affected land; or it otherwise imposes burdens on the affected land that are so disproportionate to the restriction’s beneficial effects that the restriction should not be enforced.” (Nahrstedt, supra, 8 Cal.4th at p. 382.) Applying this principle, and noting that a common interest development’s recorded use restrictions are “enforceable equitable servitudes, unless unreasonable” (Civ. Code, § 1354, subd. (a)), we held that “such restrictions should be enforced unless they are wholly arbitrary, violate a fundamental public policy, or impose a burden on the use of affected land that far outweighs any benefit” (Nahrstedt, supra, at p. 382). (See also Citizens for Covenant Compliance v. Anderson (1995) 12 Cal.4th 345, 349 [47 Cal.Rptr.2d 898, 906 P.2d 1314] [previously recorded restriction on property use in common plan for ownership of subdivision property enforceable even if not cited in deed at time of sale].)

In deciding Nahrstedt, we noted that ownership of a unit in a common interest development ordinarily “entails mandatory membership in an owners association, which, through an elected board of directors, is empowered to enforce any use restrictions contained in the project’s declaration or master deed and to enact new rules governing the use and occupancy of property within the project.” (Nahrstedt, supra, 8 Cal.4th at p. 373, citing Cal. Condominium and Planned Development Practice (Cont.Ed.Bar 1984) § 1.7, p. 13; Note, Community Association Use Restrictions: Applying the Business Judgment Doctrine (1988) 64 Chi.-Kent L.Rev. 653; Natelson, Law of Property Owners Associations (1989) § 3.2.2, p. 71 et seq.) “Because of its considerable power in managing and regulating a common interest development,” we observed, “the governing board of an owners association must guard against the potential for the abuse of that power.”