Homeowners associations in Maryland are creatures of statute. The Maryland HOA Act is found at Title 11b of the Maryland Code, Real Property Article. That statute defines a homeowners association as a person having the authority to enforce the provisions of a declaration, and states that it includes an incorporated or unincorporated association.
In practice, nearly all homeowners associations are incorporated. This is for a few reasons: it creates a protection from individual liability for board members, it allows the association to have a resident agent for legal process, it makes opening and operating bank accounts easier, and it quite frankly reflects the reality that the association is indeed a corporation. Associations have budgets, conduct elections, enter into contracts, carry insurance, and generally undertake all the activities ordinarily done by corporations.
Consequently, homeowners associations and their boards of directors are subject to many of the same legal standards, and are often reviewed in the same fashion, as corporate boards. This includes having their decisions challenged by members of the corporation (in this case homeowners), and even having to defend those decisions in a court of law.
Enter the business judgment rule. The Business Judgment Rule, originally applied in shareholder derivative suits against the directors of a corporation, creates a “presumption that directors of a corporation acted in good faith and in the best interest of the corporation.” Reiner v. Erlich, 212 Md. App. 142, 156 (2013). In Black v. Fox Hills N. Cmty. Ass’n, Inc., 90 Md. App. 75, 81 (1992), the Maryland Appellate Court (then the Court of Special Appeals) held that the business judgment rule applies to condominium boards of directors. Subsequent decisions have cited Black to apply the Business Judgment Rule to homeowners association boards as well.
When a challenge is brought against the decision of a homeowners association, the association board will often present the Business Judgment Rule as a defense, pointing out that the court is obligated to presume that they acted in good faith and in the best interests of the association. In order to defeat this defense, “the party challenging the validity of a board’s actions must produce evidence sufficient to rebut this presumption.” Wittman v. Crooke, 120 Md. App. 369, 376 (1998). The Black court held that this rule then “precludes judicial review of a legitimate business decision of an organization, absent fraud or bad faith.” Black, 90 Md. App. at 82.
Once the Business Judgment Rule defense is raised, the plaintiff bears the burden of proving fraud or bad faith sufficient to rebut the presumption set forth above: “The general rule under Maryland law is that decisions made by a homeowners association’s board of directors will not be disturbed unless there is a showing of fraud or bad faith.” Reiner, 212 Md. App. at 155. If the plaintiff is unable to make such a showing, then the Business Judgment Rule compels the court to not second-guess the decision of the association: “There was no allegation in the complaint of any fraud or bad faith. Absent fraud or bad faith, the decision . . . was a business judgment with which a court will not interfere.” Black, 90 Md App. at 83. Put another way, a plaintiff who just disagrees with the decision made by the homeowners association likely has no legal recourse; they must prove that the decision they disagree with was made fraudulently or in bad faith. This preserves the democratic nature of associations: the elected board, to whom certain powers are delegated by the governing documents, makes decisions on behalf of the association, and individual owners cannot use the judicial process to substitute in their own judgment. The implied mandate is: if you want to make decisions for the association, run for the board and get elected by the homeowners.
While many of the cases discussed below were issued by the Appellate Court of Maryland (previously the Court of Special Appeals), and some are even unreported, that should not diminish from the instructive nature of the case law. The Supreme Court of Maryland (Court of Appeals) has cited the concepts herein with approval and specifically mentioned some of the homeowners association cases in its discussions of the Business Judgment Rule: “If the voluntary membership organization is incorporated in Maryland, the business judgment rule applies to decisions regarding the corporation's management. See Maryland Code Article 2, § 405.1 of the Corporations and Associations Article (codifying the standard of care required of directors of a corporation). See also Parish v. Maryland & Virginia Milk Producers Assn., 250 Md. 24, 75–76, 242 A.2d 512, 540 (1968), cert. denied, 404 U.S. 940, 92 S.Ct. 280, 30 L.Ed.2d 253 (1971); Black, 90 Md.App. at 81–83, 599 A.2d at 1231; J. Hanks, Jr., Maryland Corporation Law § 6.8, at 174–77 (1990 & 1996 Supp.). The business judgment rule insulates business decisions from judicial review absent a showing that the officers acted fraudulently or in bad faith.” N.A.A.C.P. v. Golding, 342 Md. 663, 673 (1996)(certain citations omitted)(emphasis added).
Early cases applying the Business Judgment Rule to homeowners association board decisions typically resulted in the decision of the board being upheld, as the doctrine was being fleshed out. Black, decided in 1992, is the clearest and most cited example: The plaintiffs claimed that a fence was approved and installed in violation of the association's covenants and restrictions, and sued the association challenging their judgment. The Black court held that it was immaterial whether the fence actually violated the association's governing documents, because the enforcement of those rules was within the exclusive purview of the association. “The decision which the association made to approve the owners' fence was a decision which it was authorized to make. Whether that decision was right or wrong, the decision fell within the legitimate range of the association's discretion… There was no allegation in the complaint of any fraud or bad faith. Absent fraud or bad faith, the decision to approve the fence was a business judgment with which a court will not interfere.” Black, 90 Md App. at 83.
Citing Black with approval, the Maryland Appellate Court (then the Court of Special Appeals) decided Reiner v. Erlich, 212 Md. App. 142 (2013) in similar fashion: “In sum, we hold that the business judgment rule applies because this case falls squarely within the purview of Black. Here, the Association rendered a decision denying the Reiners' roof request. The Reiners—much like the plaintiffs in Black—sued because they disagreed with the Association's decision. The Reiners did not allege any fraud or bad faith on the part of the Association. Under Black, ‘[t]he ‘business judgment’ rule, therefore, precludes judicial review’ of that decision. Accordingly, the Association was entitled to summary judgment as a matter of law.” Id. at 156. On two separate occasions, two decades apart, the Court of Special Appeals held that the business judgment rule protects the decisions of a homeowners association board from second-guessing by aggrieved owners or by judges reviewing the case.
The Court of Special Appeals continued to stand by the rationale espoused in Black in 2020, when it reviewed a case of an owner wishing to make alterations to the property, and the association declining. The court once again upheld the decision of the association, holding: “Like in Black, where the homeowners failed to allege any bad faith or fraud, here, the homeowners have not alleged any bad faith or fraud on the Association's part. While they have stated that ‘there is no evidence that [the Association] acted reasonably and fairly,’ they have provided no evidence or argument that the Association's actions were in bad faith or fraudulent. Breard v. Homeland Ass'n, Inc., No. 735, Sept. Term, 2020, 2020 WL 10055365, at *12 (Md. Ct. Spec. App. June 15, 2020). Without any such proof, or even an allegation of any specific facts to support any suggestion of bad faith or fraud, the decision of the association stood.
In perhaps the most strongly worded case supporting the Business Judgment Rule, the Court of Special Appeals once again upheld the decision of a homeowners association board in Baroni v. Avenel Cmty. Ass'n, Inc., No. 857 Sept. Term 2015, 2016 WL 1644046 (Md. Ct. Spec. App. Apr. 26, 2016). This case is unreported, meaning that it is not precedential and may not be cited, but the insight into the continuing protection of decisions by homeowners associations is very telling. The owners here, like in Reiner, protested the decision of the association board that required them to install a certain type of roof. In finding that the Business Judgment Rule prevents the court from overturning the decision of the homeowners association, the court stated: “The Modifications Committee, which under the Declaration was vested with exclusive jurisdiction to rule on the Baronis' application to alter their home by replacing their natural cedar shake roof with an asphalt Grand Manor roof, made the decision to deny the application. The Modifications Committee and then the Association followed the prescribed internal procedures for the homeowners association in making that decision. In keeping with the 2006 Roof Specifications, the Modifications Committee denied the application for purely aesthetic reasons, as fully authorized under the Land Use Standards binding all Avenel homeowners. After an internal appeal to the Association, the application was finally denied. As in Black and Reiner, because the Association gave ‘due consideration’ to the Baronis' application, its decision is not subject to judicial scrutiny absent a showing of fraud or bad faith.” Id. at 9. The fundamental point of the doctrine is clear, and is hammered home in these several decisions: when an association decides something within its purview, that decision is final. Aggrieved homeowners may disagree, and they may want to ask the court to substitute in its own judgment for that of the association, but unless they can make a showing of fraud or bad faith, the court should decline to do so.
Based upon these early successes, homeowners associations began to rely upon the Business Judgment Rule to support their actions and decisions more frequently. Of course, not every decision ever made by a homeowners association is protected by the Business Judgment Rule; there are limitations. First, the decision must be one that the association is entitled to make in the first place. Some of the early decisions, including Reiner, contained very broad language that suggested that associations could take actions that even violated their own documents. Subsequent associations and their attorneys began to argue this before various Maryland courts: that the Business Judgment Rule allows associations to take any action they choose to, even if it is not a power granted to them by their documents.
In Yadav v. Pindell Woods Homeowners Ass'n, Inc., No. 817, Sept. Term,2016, 2017 WL 6611976 (Md. Ct. Spec. App. Dec. 26, 2017), the Court of Special Appeals took time to dispel some of this confusion. Perplexingly, they chose to do so in an unreported opinion, meaning that it cannot be cited if future attorneys do misinterpret or overextend the prior case law in favor of their association clients. Nonetheless, Footnote 3 very clearly refutes the argument that began to surface after Reiner: “it is our obligation to dispel a confusion that our prior opinions may have created. Pindell Woods argues that its interpretation of the Declaration (addressed in the prior section of this Opinion) is protected from court review by the business judgment rule. That is wrong. The question of whether an entity has or does not have the power to take an action—whether an action is ultra vires or not—is outside of the business judgment rule and remains subject to court review. Greenbelt Homes v. Nyman, 48 Md. App. 42, 57 n.4 (1981) (“An ultra vires act is one not within the express or implied powers of the [organization] as fixed by its charter.”). Some of our cases have, by use of short-hand, obscured this black-letter rule. See, e.g., Reiner, 212 Md. App. At 156 (“[D]ecisions made by a homeowners association ... will not be disturbed unless there is a showing of fraud or bad faith”). Whether an entity has the power to take an action or whether it is ultra vires, however, remains outside of the business judgment rule. Sadler v. Dimensions Healthcare Corp., 378 Md. 509, 539 (2003).” Id. at Fn. 3.
In Yadav, the owners planted several trees without permission, and they sued the association for the right to keep them in place. The association then counter-sued, saying that the business judgment rule allows them to not only prohibit the trees, but to do so even if their documents did not allow them to. In upholding the association’s decision to remove and prohibit the trees, the Court of Special Appeals clarified that while this particular decision was within their purview and thus protected by the Business Judgment Rule, that if the association did not have the power to take such an action, the Business Judgment Rule does not somehow extend that power to them. The concept of an ultra vires decision thus clearly removes a case or question from the Business Judgment Rule analysis; if an action by a homeowners association board is not within the power granted to it by the Declaration, then the decision must be overturned.
Around the same time as Yadav, the Court of Appeals also confronted another common situation where associations and their attorneys had begun to over-extend the Business Judgment Rule. Not only must a decision be within the power of the association board for the Business Judgment Rule to apply, but the association board also must actually exercise judgment. That is, the Business Judgment Rule is not a blanket protection from any lawsuit or challenge; it protects scenarios where the association board has considered a situation and acted (or decided not to act).
The case that brought this issue to the Court of Special Appeals was Warshanna v. Hickory Hollow Cmty. Ass'n, Inc., No. 2056 Sept. Term 2014, 2016 WL 181614 (Md. Ct. Spec. App. Jan. 12, 2016), once again an unreported decision, but once again one that provides significant insight and direction. Here, the owners alleged that the association had obligations to maintain certain common areas under its exclusive control. These responsibilities included a defective storm drain that caused water damage to the sidewalk, defects on the surface of their parking pad that collected water and ice, and trash bags dumped into the common areas that attracted vermin. The owners alleged that the association refused requests to remedy these issues. The trial court here granted summary judgment to the association, apparently accepting the argument offered by the association that its declining to act on these issues was a decision protected by the Business Judgment Rule. In overturning that decision and remanding for further proceedings, the Court of Special Appeals held: “Unlike the associations in Black and Reiner, the Association has thus far failed to demonstrate the basic prerequisite for application of the business judgment rule. The business judgment rule applies to judgments, but the record contains no admissible evidence that anyone exercised any judgment in allegedly failing to respond to the [owners’] maintenance requests…. At present, the record does not even disclose who made any decisions, or how or why the decisions were made… To obtain the benefits of the business judgment rule, a person must do more than simply invoke the rule: the person must show that he or she actually exercised business judgment or discretion in some ascertainable way. See Reiner, 212 Md.App. at 156 (the business judgment rule applies when a board has “rendered a decision”).” Id. at 9-10.
This last portion is really the crux of the issue and a huge takeaway for practitioners: in order to avail itself of the Business Judgment Rule, an association board must demonstrate that it exercised some judgment. Taking action to enforce the documents in cases such as Black and Reiner was sufficient, as the board clearly voted and moved forward with enforcement measures in those instances. In Warshanna, however, the initial allegations were simply that the board failed to act. At the time of the decision, no facts had been introduced to demonstrate that the association board had exercised its judgment to not act. The court was mindful to point out that should such facts be introduced into the record, the Business Judgment Rule could still apply to the matter at hand. However, without any facts in the record to support an allegation that the board had exercised its judgment, no Business Judgment Rule defense could properly be asserted.
A third limitation on the Business Judgment Rule, in addition to the ultra vires exception and the requirement that actual judgment was exercised, is that it does not shield the association from otherwise valid contractual or tort claims. In Sadler v. Dimensions Healthcare Corp., 378 Md. 509 (2003), the Court of Appeals (now the Supreme Court of Maryland) reviewed a challenge to a hospital credentialing decision, and the resulting potential tort and contract claims against the hospital. In refuting the argument that such liability was protected by the Business Judgment Rule, the court stated: “The business judgment rule, which limits the court's role in reversing the actions of a corporation, has never precluded full litigation of complaints sounding in tort or contract against the corporation. A corporation, as a private entity, may be held liable for tortious conduct and breaches of contracts, perpetrated by its officers, directors, and agents, against third parties. See Maryland Code (1975, 1999 Repl. Vol., 2002 Supp.) § 2–103 of the Corporations and Associations Article. Nothing in the jurisprudence of this State would hold otherwise.” Id. at 532. While not directly addressing the actions of a homeowners association board, this case is cited with approval in several of the association-related cases mentioned herein. The Sadler decision also led the court in Schuman v. Greenbelt Homes, Inc., 212 Md. App. 451 (2013) to review the decisions of a homeowners association board to determine if they had impermissibly defined what a common law nuisance was, which would have been akin to asserting a Business Judgment Rule defense to a tort action. The Schuman court ultimately found that the association had acted within its rights, but the language there is instructive on how courts should treat cases similar to Sadler, where a body of law outside of the association documents is at issue.
The sum of litigation over the application of the Business Judgment Rule to the decisions of homeowners association boards leads to a few broad concepts to observe. First, if the association has acted within the powers granted to it by the governing documents, then it may asset a Business Judgment Rule defense to any challenge of its actions. Second, such a Business Judgment Rule defense will (or should) fail if the allegations involve ultra vires activities (beyond the power granted in the governing documents), or if the facts alleged support a tort or breach of contract claim independent from the documents. Finally, in order to avail itself of the Business Judgment Rule as a defense to its actions, the homeowners association must be able to point to facts that demonstrate that it did indeed exercise its judgment.
Brian R. Fellner is the founding attorney of Fellner Legal Services. Brian is an experienced lawyer and litigator who provides legal services to condominiums, homeowners associations, and cooperatives throughout Maryland, Virginia, and the District of Columbia. He has represented clients in all facets of community association governance, management, and dispute resolution. From writing bylaws or rules to enforcing covenants and contracts to collecting delinquent assessments, Brian has worked tirelessly to provide excellent legal services to FLS clients and communities of all sorts. The FLS motto is: Service. Success. Simple.
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