It’s not illegal, per se, in California. But to borrow a phrase from Saturday Night Live, it’s “Bad Idea Jeans.”
First, let’s look at the law.
California generally recognizes the right of corporate board members to enter into whatever agreements they like – even where there are obvious conflicts of interest – as long those involved disclose their interests to shareholders and the rest of the board.
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There have been cases where other parties challenge a contract, hoping to have courts declare the contracts void, because of the conflict of interest between a board member and an associate. See California Corporations Code, Section 310.
The Board member with a personal interest in the contract, however, should recuse himself or herself from the vote – otherwise I would suspect you are dealing with someone with some serious ethical blind spots.
If the contract was duly approved by the Board, though, and the Board knew about it the conflict and went ahead with the contract anyway, and the Board members were all properly elected and acting within the roles delegated to them by the operating bylaws – and in the case of HOAs, the CC&R documents (code of covenants and restrictions), the courts have upheld the contracts.
Courts are loath to be thrust into the role of protecting grownups from their own bad decisions.
It seems obvious when you take a step back – it’s not unusual for a CEO to also be chairman of the Board of Directors, though it’s not always great corporate governance. Generally, in a free economy, though, private corporations are at liberty to be stupid.
So while it probably doesn’t expose anyone to criminal charges (barring fraud or theft – the likelihood of which is substantially increased whenever you have a conflict of interest), it may well expose the HOA and individual board members to some awfully thorny lawsuits if the contract doesn’t go down very smoothly.
See, these insider situations work great, until something goes wrong. And something always goes wrong.
For some reason, people you would think would know better make these insider deals anyway. If that sounds like your board, though, here is how to make it work, and how to protect everyone involved from liability as much as possible:
The director involved should inform the Board of the nature of the conflict of interest, in writing.
The secretary should ensure that the conflict is noted in the minutes of the HOA meeting.
The director involved should recuse himself from the vote.
Not only that, the director involved should actually leave the room, so that all the remaining board members are free to discuss the matter freely amongst themselves, with no possibility of intimidation or ‘pulling their punches.’
The board should make certain that the contract is fair and reasonable and could be defended in court on that basis. If an owner/member of the HOA sues a board member, the board members must be able to demonstrate this in order to short-circuit potential liability.
Board members should have their officers and directors’ liability insurance premiums paid up.
Writing about personal finance and investments since 1999, Jason Van Steenwyk started as a reporter with Mutual Funds Magazine and served as editor of Investors’ Digest. He now publishes feature articles in many publications including Annuity Selling Guide, Bankrate.com, and more.
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