Service on a homeowners association (HOA) board of directors can be difficult to compartmentalize from a director’s personal life. After all, HOA directors must regularly make decisions governing the very neighborhood in which those directors, and their families, live. Therefore, it should come as no surprise that issues presenting a conflict of interest are likely to arise at some point during a board’s tenure. Conflicts of interest can come in various forms and can not only erode a community’s trust in their HOA leadership, but also carry serious legal consequences. The intent of this article is to provide some clarification on just what might legally constitute a “conflict of interest” as well as some introductory guidance for boards in navigating this common yet consequential issue.
As frequent readers of our articles may recognize, the overwhelming majority of HOAs in South Carolina are nonprofit corporations. Accordingly, this article applies to those South Carolina HOAs that are nonprofit corporations and therefore subject to South Carolina’s Nonprofit Corporation Act (the “Act”) and its provisions regarding director conflicts of interest.[1]
The Act defines a “conflict of interest transaction” as a transaction in which a director has a direct or indirect interest.[2] The Act specifies that a director has an indirect interest in a transaction if (1) another entity in which the director has a material interest or in which the director is a general partner is a party to the transaction; or (2) another entity of which the director is a, officer, director or trustee is a party to the transaction.[3] From this, we can surmise that a direct interest would be one in which the director individually and directly stands to materially benefit. In any event, the technical distinction of whether a director’s conflict of interest is direct vs. indirect is more academic than practically important for our purposes given the requirements for either such transaction which will be discussed below.
The Official Comment to the Act, which a court would foreseeably find persuasive, effectively summarizes that the provisions of the Act regarding conflict of interests apply to transactions in which the director has a “material interest.” The Official Comment notes that an interest is “material” if there is a “substantial likelihood that a reasonable person would consider it important in deciding what action to take.”[4] This indicates that an interest does not have even to be monetary to present a conflict of interest. A common example of a potential conflict of interest transaction for an HOA is the HOA contracting with a director’s business, such as a landscaping company, or the business of a director’s immediate family member. A nonmonetary but nevertheless material example might be a board vote on covenant enforcement action when the violating homeowner is a director. If one is unsure as to whether a director’s interest is material, it is generally best to err on the side of caution and proceed under the assumption that there is a conflict of interest in light of the fiduciary duties owed by directors as well as the potential consequences of running afoul of conflict of interest provisions.
It is important to note that although a director may have a conflict of interest in a transaction, an HOA board can still properly approve the transaction, but the board should follow a certain procedure set forth in the Act. According to the Act, a transaction in which a director a mutual benefit corporation has a conflict of interest may nevertheless be approved by the board if: “the material facts of the transaction and the director’s interest were disclosed or known to the board of directors or a committee of the board and the board or committee of the board authorized, approved, or ratified the transaction.”[5] The Act further provides specific instruction as to how that approval or ratification can occur following the disclosure of the material facts of the transaction and the director’s interest: “the conflict of interest transaction is authorized, approved, or ratified if it receives the affirmative vote of a majority of the directors on the board or on the committee who have no direct or indirect interest in the transaction, but a transaction may not be authorized, approved, or ratified … by a single director.”[6] In other words, the transaction can still be approved by the board, even if a director has a conflict of interest, if that interest is disclosed along with the material facts, and the directors who do not have such an interest approve the transaction. For example, if there are five directors on a board and one of them has a material interest in the transaction, that director should disclose that interest along with the material facts, and the remaining directors can vote to approve the transaction.
Interesting enough, the Act expressly provides that the interested director can still be present for the vote, or even cast a vote, without affecting the validity of the action as long as it otherwise receives the requisite approval.[7] However, that is arguably not a best practice and is something a board should carefully consider under their specific circumstances.
Moreover, even if a director has an immaterial interest in a transaction, HOA directors are still held to a general duty of loyalty to the HOA and must act in good faith in a manner the director reasonably believes to be in the best interest of the corporation.[8] Therefore, even if a director’s interest seems immaterial, it is best practice to proceed with caution, disclose the potential interest, and have the uninterested directors determine the approval of the transaction while also keeping in mind their own duty of loyalty to the HOA.
Failure to proceed appropriately with regard to conflicts of interest can lead not only to the voiding of the conflict-related transaction, but also liability for the HOA and personal liability for directors. It can also irreparably damage the trust between membership and HOA leadership. While the Act actually provides that a conflict of interest transaction is neither voidable nor the basis for imposing liability on a director if the transaction was “fair to the corporation at the time it was entered” or it was approved pursuant to the procedure we discussed above, an HOA board would prefer to avoid having to rely on a court to determine whether the transaction was “fair” at the time it was entered.[9] Therefore, even if the board feels strongly that a transaction presenting a potential conflict of interest is “fair,” it is still advisable to make sure the conflict is properly disclosed and the transaction is voted on by the uninterested directors.
Of course, an HOA’s governing documents may assign additional responsibilities or limitations to the board or its directors regarding conflicts of interest. Therefore, it is important for the HOA board to be familiar with their governing documents and ensure that they comply with their community-specific provisions. It is also prudent to consult with the HOA’s legal counsel with questions regarding the conflicts of interest as they can advise based on their knowledge of the law together with the specific documents and circumstances of your community.
This article is not intended to be an exhaustive discussion of applicable law regarding director conflicts of interest, nor any guarantee of the outcome of any litigation regarding the same. Our attorneys at McCabe, Trotter & Beverly, P.C. are experienced and well-equipped to answer questions you may have regarding this topic. Please contact us at 803-724–5000 for further information.
Ashley Green
McCabe, Trotter & Beverly, P.C. blogs and other content are for educational and informational purposes only. This is not legal advice and does not create an attorney/client relationship between McCabe, Trotter & Beverly, P.C. and readers. Readers should consult an attorney to understand how this information relates to their personal situation and circumstances. You should not use McCabe, Trotter & Beverly, P.C. blogs or content as a substitute for legal advice from a licensed attorney.
[1] S.C. Code Ann. § 33-31-101 et seq.; § 33-31-831.
[2] S.C. Code Ann. § 33-31-831(a).
[3] S.C. Code Ann. § 33-31-831(d).
[4] S.C. Code Ann. § 33-31-831 Official Comment (citing TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976)).
[5] S.C. Code Ann. § 33-31-831(c)(1).
[6] S.C. Code Ann. § 33-31-831(e) (emphasis added).
[7] Id.
[8] S.C. Code Ann. §§ 33-31-830; 33-31-831 Official Comment.
[9] S.C. Code Ann. § 33-31-831(a).