The Problem of Choosing One Association over Another When Serving on Multiple Boards: The duties of loyalty and care

On October 21, 2016, after a three day trial in the U.S. Bankruptcy Court for the Southern District of Florida, one of the largest (if not the largest) residential developers in the Nation, D.R. Horton, Inc., and four employees of D.R. Horton who served as developer-appointed directors on multiple boards of directors received a devastating blow – a $16.3 million judgment against them for numerous violations that included, violations of the directors’ fiduciary duties, conspiracy to breach fiduciary duty and violations of Florida’s Deceptive and Unfair Trade Practices act being among them.

While this decision of the Court has no real precedential value (meaning that this decision is not mandatorily binding on other courts), because it is a federal bankruptcy trial court decision, it is certainly noteworthy and citable in that it provides guidance to attorneys and directors alike – that is, if the judgment is upheld during D.R. Horton’s appeal which will inevitably follow.

As to the facts of the case, in 2005, D.R. Horton began developing the master community of Majorca Isles Master Association, Inc. (the “Master Association”). The Master Association was created to administer a 681 condominium unit project in Miami Gardens for low to moderate income families. It was to be comprised of a total of nine other condominium sub-associations. As is quite typical with developer-controlled associations, D.R. Horton appointed its employees to serve on the various boards of directors. In fact, and quite notably, the four employees named as defendants in the bankruptcy case were appointed to serve on the Master Association’s board of directors and the condominium sub-associations’ boards of directors, too. As such, the directors owed a separate and individual duty of loyalty and care to each association they served.

By the time the housing crisis swept the Nation, only 355 units had been constructed and only five condominium sub-associations had been organized, after which construction halted. Due to the recession, unit owners stopped making their assessment payments. Along the way, and as provided for in the governing documents, the board opted for the condominium sub-associations to collect the assessments due to the Master Association directly from the unit owners within the condominiums. Although D.R. Horton was required to fund the $50,000 per month operating deficit of the Master Association, it stopped doing so. Further complicating the conditions, the individuals serving on both the condominium sub-associations and Master board decided to keep all the funds collected in the condominium sub-associations and did not pay the portions due to the Master Association. As a result, the Master Association was severely underfunded and became insolvent which led to its bankruptcy.

In determining where the assessment monies received by the condominium sub-associations (however little it was) should go, the developer-appointed directors were faced with a conflict as they were on the board of directors for not only the Master Association but also for the condominium sub-associations, too. The developer-appointed directors decided to favor the condominium sub-associations over the Master Association and, in so doing, diverted funds due to the Master Association to the condominium sub-associations. Additionally, in order to stop the bleeding of D.R. Horton, who was losing large sums of money fulfilling its deficit funding obligations, D.R. Horton prematurely turned the Master Association over to member control. This act would effectively terminate its deficit funding obligation. Prior to turnover, the developer-appointed directors opted to discontinue services and amenities which the owners were entitled to receive from the Master Association.

During the Court’s discussion of the evidence presented regarding the developer-appointed directors’ breach of fiduciary duties, the Court provided that the directors owed fiduciary duties to the Master Association, to the multiple condominium sub-associations and to their employer, D.R. Horton. The evidence showed that all of the directors were aware of their fiduciary obligations and testified as to having intentionally breached these duties in one way or another.

Among numerous violations as to what the Court described as outright fraud, the Court found that the developer-appointed directors breached their fiduciary duties of loyalty and care to the Master Association by favoring the condominium sub-associations and their employer. For their breach of fiduciary duties, the Court ordered just over $3.8 million in actual, consequential and special damages and $12.5 million in punitive damages intended to “deter future, unlawful, malicious conduct and otherwise fulfill the intent of punitive damages.”

In quoting Justice Cardozo, a revered Associate Justice of the U.S. Supreme Court in the 1930’s, the Court provided that:

Many forms of conduct permissible in a workaday world for those acting at arm’s length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior…

There are important lessons to be learned from this case. When serving on multiple boards of directors such as a master and sub-association which may have competing interests, if the interests of those entities become adverse to one another, then it may be best to, at a minimum, abstain from any decisions that favor one entity over the other if possible and/or appropriate. The conflicted director should also consider resigning from one of the entities to make room for a replacement director who will not be hamstrung in his or her decision making. Moreover, if three or more directors serve on the same multiple boards at odds with one another and make decisions together, then they leave the door wide open for allegations of “conspiracy to breach fiduciary duty,” too, which will serve to exacerbate the situation and resulting damages as occurred in the case against D.R. Horton.

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