Lessons in Fiduciary Duty

In an October 21, 2016, published decision titled In Majorca Isles Master Ass’n, Inc., 560 B.R. 824 (Bankr. S.D. Fla.) (“Majorca Isles”), the United States Bankruptcy Court awarded a Florida Master Association with an incredible $16.3 million judgment against a developer and its appointed trustees, in what the Court described as a “modern day story of David and Goliath.”  Setting aside the transition aspects of the case, the decision provides an excellent guide for boards and property managers – particularly those involved with master associations – facing issues of poor record keeping and conflicts of interest.

In Majorca Isles, developer D.R. Horton appointed trustees to sit on both a master association (the “Master”) and its five subsidiary associations (the “Subsidiaries”).  The Master was responsible for shared property and services, including swimming pools, clubhouses, parking areas, landscaping, gate facilities, security guards, and cable television.  The various governing documents of the Master and the Subsidiaries condominium associations provided:

  1. Each unit owner was personally obligated to pay assessments to the Master;
  2. The Master was empowered to impose, liens, late charges, and attorney’s fees on delinquent unit, and to bring foreclosure and money judgment actions against the individual owners;
  3. The Master was required to maintain complete and accurate records as to assessments paid by each individual owner;
  4. The Master could choose to delegate its assessment collections to the Subsidiaries, in which case the subsidiary associations were to pay the master assessments in full prior to the Subsidiaries’ expenses.

Despite these requirements, beginning in March 2006, the Master collected assessments from unit owners without creating any financial records of the assessments.  Then, in October 2007, the trustees determined to collect the Master’s assessments by “bulk billing” the Subsidiaries.  As a result of the bulk billing, the Master continued to create no financial records for individual owners.

As the great recession set in, revenue dropped and nearly half of the Master’s unit owners became delinquent.  The trustees, sitting on both the Master and Subsidiary boards, decided to cut funding to the Master in favor of the Subsidiaries, removing amenities like security personnel, home alarm monitoring, and cable television.  Facing growing delinquencies, the Master sought the assistance of a collections law firm in September 2009.  The firm, after reviewing the governing documents, advised the trustees: (1) the Subsidiaries were prohibited from paying their own expenses prior to fully funding the Master; (2) collections were made impossible by the lack of financial records; and (3) owners would likely be able to successfully defend against any collections actions due to the trustee’s non-conformance to the governing documents.  The trustees wrote off their attorney’s advice as “just a legal opinion”, and quietly abandoned attempts to recover the unpaid assessments.

Control of the master board turned over to the unit owners in January 2011.  Lacking records necessary to collect delinquencies, and unable to pay its expenses, the Master became immediately insolvent and filed Chapter 11 Bankruptcy, bringing it under the jurisdiction of the Bankruptcy Court and to the attention of Barry Mukamal, a bankruptcy trustee.  Mukamal, in what the Court described as an “extraordinary” service to the Master, recreated seven years of assessments records “from scratch,” and successfully pursued the developer and its trustees for a $16.3 million judgment.

Importantly, the Court found the individual trustees breached their fiduciary duties to the Master.  In doing so, the trustees managed to satisfy almost every major method for undermining the business judgment rule protecting fiduciaries: (1) acting despite a direct conflict of interest; (2) acting contrary to specific terms of the governing documents establishing their authority; and (3) disregarding the specific advice of qualified professionals such as legal counsel.  The Court concluded the trustees were personally liable to the Association for over $3.8 million for, among other things:

  1. $750,000 in delinquent assessments made uncollectable by the failure to institute a collection program, the failure to collect from the Subsidiaries, and the disregard of advice from outside counsel;
  2. $200,000 to recreate the Master’s financial records due to the failure to create or maintain adequate records; and
  3. $867,066 for unilaterally removing security services and cable television amenities, thereby favoring the Subsidiaries and the developer.

Majorca Isles must be read in the larger context of the trustees’ roles as employees of the developer, as among other things, the trustees were therefore not protected by any indemnification clause in the governing documents.  While the egregious conduct in the case would likely fall outside of a traditional indemnification clause, it is also likely the Court would have been more sympathetic to elected volunteer trustees.  Additionally, the Court’s decision, applying Florida statutes and common-law, can only serve as persuasive precedent in New Jersey.

Nevertheless, the decision drives home that trustees and property managers owing a fiduciary duty to a condominium or homeowners association can be sued for failing to create accurate and complete financial records, failing to establish a meaningful collections program, and failing to provide advertised amenities.  In particular, trustees and property managers should strongly consider abstaining from decisions where any of the following apply: (1) a direct conflict of interest splits fiduciary duties between a master and subsidiary association, or between an association and some third party; (2) the action, course of conduct, or lack of action contradicts the governing documents; or (3) the decision contradicts the advice of the qualified professionals such as engineers and legal counsel.