Board Members' Worst Nightmare: When Bad Faith Ruins Everything

The Business Judgement Rule protects a lot of board decisions, but when your actions are ruled “in bad faith,” everything changes. Steven Sladkus, partner at Schwartz Sladkus Reich Greenberg and Atlas, unpacks a shocking case where board members faced personal liability after a judge found they acted in bad faith. What started as a commercial unit alteration dispute spiraled into a nightmare scenario where the board became "defenseless" in court, despite following professional advice from their attorney, managing agent, and engineers. This extraordinary case offers crucial lessons every board member must understand about fiduciary duty, the business judgment rule's limits, and protecting yourself when decisions go wrong. Habitat's Carol Ott conducts the interview.

The business of running a building is demanding work that requires making endless decisions — some that can quickly lead your board into a quagmire of legal difficulties. Legal Talk interviews New York's leading co-op/condo attorneys to find solutions, and get some guidance, on these challenges. For more co-op and condo insights, sign up to receive Habitat's free newsletters or become a Habitat subscriber today!

Transcript

Carol Ott: Welcome to Legal Talk, a conversation about governance issues that New York's co-op and condo boards are tackling today. I'm Carol Ott with Habitat, the New York City magazine for co-op and condo board directors. My guest today is Steven Sladkus, partner in the law firm, Schwartz Sladkus Reich Greenberg and Atlas. Board directors wear lots of hats, that require lots of decision making, but no matter which decision is in front of them, they owe a fiduciary duty to all their residents. Steven, you're working with a board where their actions as fiduciaries are being seriously challenged. What happened and why are they in this pickle now? 

Steven Sladkus: There are claims that the board treated a commercial unit owner very unfairly.

The commercial unit owner claims that the board jerked him around, dragged out his alteration plans for years, and eventually the commercial unit owner got tired of it all and sued. 

Carol Ott: And just let me understand. So there was a commercial unit owner who was in business? 

Steven Sladkus: There was a commercial unit owner who wanted to do alterations to accommodate a prospective tenant who he had for the space, which required certain changes. And the board over time, again is alleged to have put up roadblock after roadblock. So finally after so many roadblocks happened and the commercial unit owner was afraid that he was going to lose his tenant, he commenced a lawsuit. 

Carol Ott: And that lawsuit, was there an outcome or is it still dragging on? 

Steven Sladkus: It's still dragging along, but at a much shorter pace than one would think one of these lawsuits would, because without naming names, although it's all publicly filed, the judge found very early on in the case that the individual board members acted in bad faith, and because of that, he thought it was so egregious. And again, I'm not saying I agree with it, but the court found that the board member's conduct was so egregious that he struck the answer for the board in a litigation, which means essentially to any non-lawyers listening to this, the board became defenseless.

Carol Ott: So let me step back. Bad faith is resonating about the business judgment rule. So I'm a little confused how the business judgment rule corresponds with fiduciary duty and now they've been found to have bad faith.

Steven Sladkus: Well, in short, the business judgment rule. Protects a board from judicial review of a board's decision, right? Because courts don't wanna start second guessing boards. But there are exceptions to the business judgment rule. There's bad faith, self-dealing, and discriminatory conduct, which could be the traditional discrimination or discrimination like you're treating one unit owner or shareholder differently than another one.

Okay. Those are the typical three exceptions. So when the judge, in this particular case saw bad faith, the board members weren't anymore protected by the business judgment rule, and you asked me what did the court find that they did in bad faith. They were alleged to have made certain statements.

And made some requirements that the court felt were not required or they had no basis to be requested without getting too deep into it. But there were enough circumstances in the judge's mind to feel, you know what, this isn't just one thing, it's not two things, it's not three things. It's 10 things.

When the judge saw that many things, he said, this is about as bad as it gets. Again, I don't necessarily agree with it, but that's what the court said. 

Carol Ott: Now, I'm assuming the board wasn't acting all alone. They probably had a managing agent. They probably had a lawyer, maybe they had an architect or an engineer.

Were they consulting with any of these professionals? 

Steven Sladkus: A hundred percent. This was all before my time as general counsel, thankfully. But with prior counsel, yes, the board relied on advice of counsel extremely heavily in making the decisions they made. There's also, and again, it's all publicly filed.

Part of the issue that the court also had was something the managing agent did. So it's not necessarily decisions by these board members that they made on their own. They were relying on a professional attorney. They were relying on architects and engineers also. And they were relying on their managing agent.

Carol Ott: So I thought part of the issue or the pass with bad faith or under the business judgment rule. If the board acted, obviously, they consulted their professionals who gave them advice, which they, I presume, then acted on. How does that get them out of sync? Then where does the bad faith come in?

Steven Sladkus: The problem is that as much as you may wanna rely on a professional, it's the board members who are making the ultimate decision. And in this particular case, the court found that there were enough, what the judge thought were quote unquote bad decisions, that ultimately the decisions were made by the board, which got them sued.

Carol Ott: So as I listened to this, either the board acted on its own, it didn't go along with the recommendations of its professionals, or its professionals, gave them improper recommendations. 

Steven Sladkus: In this particular case, both the lower court and the appellate division speak to what those respective courts thought about the advice the board received.

Those courts were not that happy with the advice they received, the board. So here the board is left in a terrible situation where they rely on professionals, like all the boards who you speak to for years and years. They always rely on professionals, right? All board members are volunteers.

And even though I'm a lawyer and on my board, I wanna listen to my lawyer because, you take a couple steps back and get an objective view on things. So it's a little chilling in this particular case for a board to have relied on more so their attorney, a little less so their managing agent, and then get stuck with a judge's determination that, hey board, you are the ones who made the decision.

You are the ones who are ultimately gonna possibly be on the hook. 

Carol Ott: So I would say it's an understatement to say it's a little chilling. 

Steven Sladkus: It's an understatement. 

Carol Ott: Yes. So most boards are relying on the guidance of their professionals. So in this case, the professional perhaps didn't give them good advice.

I'm just gonna ask you for other boards. Are you supposed to, you go to a doctor and the doctor, if you've got something, often says, get a second opinion. Is this, I understand this case is unusual, but should boards be getting second opinions. 

Steven Sladkus: Under the normal course? It's really not necessary.

And Carol, like you said, this particular case is a total anomaly. I've never seen anything like this in 30 years, and I'm sure quite frankly, you've never seen anything quite like this. But I think what board members can and should draw from this is, make a record, that if the board is making a decision and you and your gut feel it's wrong, you disagree with it, make a record of it. Because that way if there's a litigation or claims against you personally as a board member for participating in a board decision, at least there's a record to say, Hey, you really didn't participate in this decision. You stood firm and you registered your objection to whatever decision was being made. 

Carol Ott: I have two follow up questions. If I'm in a co-op or a condo and there is litigation. And now there's a board election and a new board member comes on.

The litigation has happened, as they drag on for years, and I come onto the board knowing that there is litigation. I have no part of it. Like, I'm the brand new person on the block. In this case, if I had joined the board after whatever it was that they did, would I be liable for their actions?

Steven Sladkus: Unfortunately the way this case has gone, that is what's happening so far. It is. And maybe you're bringing up another point, that if your building is involved in a major litigation and you get elected at the very tail end of it even, you might wanna make a record to say, look, I know nothing about this.

I wanna make it clear I've made no decisions. I will be making no decisions about this. I'm more interested in balancing the building's budget, dealing with the super who's having a tough time with something, and other things. I personally don't think you need to resign if there's a sticky issue going on.

But at the same time, sometimes it makes sense to distance yourself a little bit if you're really deep into a very contentious issue. And you think, or even if there's a claim against the board members individually, which a lot of people like to do as plaintiffs, that maybe you take a step back and say, look I can't be involved in this.

Or listen and register your objection when you think it's necessary. 

Carol Ott: So let me ask you, in this case we've been talking about, so the courts have basically said to the board, what you did was wrong, and I'm assuming , the end result, there's always punitive damages.

So, will their insurance kick in? Are they gonna be personally liable here? How is that gonna work out ? 

Steven Sladkus: I don't wanna get too particular with this case in terms of insurance, but I will make the a hundred percent statement that if there are any punitive damages ultimately awarded, it's public policy that neither the building or the insurance company would indemnify for punitive damages. That falls squarely on you as a board member.

Carol Ott: Okay, wait a minute. I don't know what the lawsuit in this case was, but I'm sure it was a huge amount of money and if the court says, yeah, commercial unit owner, you win. You are gonna get this huge amount of money. It's not gonna be the co-op or condo that's gonna pay it? 

Steven Sladkus: It would be the condo to pay it.

But I was talking about when you mentioned punitive damages, could possibly be assessed against the individual board members who acted in bad faith. And if there is an assessment of punitive damages that's not insurable or indemnifiable. 

Carol Ott: When there's finding of bad faith, is there always punitive damages with that?

Steven Sladkus: No. No. No, there is not. There is not. But I think one thing we're leaving out in this particular case is the unit owner's claim, the first claim was against just the condominium. There was a second claim made by some upset unit owners suing the board members individually for creating a potential liability to the condominium with the commercial unit owner.

 There they're seeking not only compensatory damages, but punitive damages against those board members individually. 

Carol Ott: Okay. In plain English? 

Steven Sladkus: Yeah. 

Carol Ott: What are they exactly seeking? 

Steven Sladkus: In plain English, what they're seeking is if in the first case where the commercial unit owner prevails --

Carol Ott: And the commercial unit owner already prevailed.

Steven Sladkus: Yeah. Prevailed on liability. There was a hearing on damages, so we're just waiting for that number to come down. Okay, so let's, I'm making up a number. God forbid, $50 million, the guy wins. Okay? In case number two, there are unit owners saying wait a minute, this is crazy. The board members made bad decisions.

 It was found that they acted in bad faith. So why should all the unit owners have to pay this mammoth $50 million judgment? Everybody's gonna have to chip in some money to pay it. I'm gonna sue each and every one of you individual board members and take it out of your personal, excuse me, rear ends.

And you are gonna bear the brunt of this instead of all the rest of the unit owners, 'cause you got us into the pickle. 

Carol Ott: So this is every board director's nightmare. 

Steven Sladkus: Night. Mayor.

Carol Ott: And if that were to happen, this happened a million years ago in, in the Biondi case, which our listeners may or may not know about, but there was a board that was alleged to have discriminated and it ended up that the board president was personally liable and I think it was for something like $150,000 or something like this.

Steven Sladkus: Yeah they were right. Damages and then punitive damages. Biondi then turned around and said, Hey, co-op board, right under the bylaws, you have to indemnify me. I'm a board member. And the co-op said, sorry, you're out on your own. We are not indemnifying you for punitive damages. And the same thing here. By the way, I think that went to the Court of Appeals and he lost. 

Here in the second case that was commenced by a group of unit owners who were upset. I haven't looked at the papers lately. I'm almost certain they're claiming punitive damages as well. And if there ever is some sort of finding of that, there could be a big problem for them because no insurance company is gonna cover that.

Carol Ott: And either way, whether those unit owners are successful or not, as long as damages are gonna be paid, however they're gonna be paid. This particular building's insurance next year, I presume, is either not gonna be renewed or is gonna through the roof. Okay, so this is a little bit of a nightmare.

Bottom line, then, let me ask you, what advice would you give to other board directors who just are listening to this story and maybe wondering, oh my God, what should we be doing? 

Steven Sladkus: Is there something we should be doing? 

So I'm a big fan of this and I'm not at all saying that this particular board a acted in any bad way .

But I think generally speaking, it's good for boards to take the approach, let's work things out and make an alteration work, versus let's find any which way we can to make it not work, right? I just think we're all neighbors and why not try to make something work? Listen, not everybody's gonna agree all the time, and there are impasses all the time, which keeps people like me very busy. But it's better to have the approach, let's fix it than let's break it. The second thing I'd say to board members is, you should under the normal course, be able to trust your professionals, architects, engineers, attorneys, and the like. But if you feel in your gut that something's wrong, don't be afraid to speak up and make a record about it, because you just never know.

If you all get sucked into a lawsuit as board members because the board voted one way and you felt against it, you'll be really happy that you made a record, that you objected to the decision that was made. And there's nothing wrong with speaking your mind and standing up for yourselves. 

Carol Ott: Okay. That's terrific advice to this very tragic story for board directors.

 Thank you very much for joining us today. 

Steven Sladkus: Absolute pleasure. Nice to see you, Carol.