ADA M LEITM A N BAILEY, P.C.WE GET R ESULTS

Lawsuits Against Board Members Alleging

Discrimination

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PIERCING THE “BUSINESS JUDGMENT” RULE TO SUE CONDO AND CO-OP BOARD MEMBERS

By

Adam Leitman Bailey and John M. Desiderio*

Ever since the Court of Appeals decided Matter of Levandusky v. One Fifth Avenue

Apartment Corp.,1 New York courts have liberally applied the business judgment rule to

decisions made by condo and co-op boards in governing the buildings they control, thereby

insulating individual board members from personal tort liability where the boards have acted in

good faith. Recently, however, the Appellate Division First Department, in Fletcher v. Dakota,

Inc.,2 held that the business judgment rule does not protect individual board members from

personal tort liability where a board acting in its corporate capacity has acted in bad faith, but

where it is not alleged that individual board members have committed a tort independent of the

tort committed by the board itself. As the Court explained, “although participation in a breach of

contract will typically not give rise to individual director liability, the participation of an

individual director in a corporation’s tort is sufficient to give rise to individual liability.” In so

deciding, the First Department expressly overruled its prior decision in Pelton v. 77 Park Ave.

Condominium,3 which had held to the contrary. The Court said it wanted to “clear up an element

of possible confusion in this area of law that may arise out of [the Pelton decision].”

The plaintiff in Fletcher, an African-American resident shareholder of The Dakota co-op in

Manhattan, had applied for board approval to purchase an apartment adjacent to one he owns for

the purpose of combining the two apartments. The board refused to approve the purchase, and the

plaintiff alleged that, in refusing its approval, The Dakota and two of its directors had

discriminated against him on the basis of race. The defendant directors contended that the

discrimination claims should be dismissed against them because the complaint failed to allege that

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they had engaged in any acts separate and distinct from actions they took as board members. In

response, the Court stated that “there is no principle of corporate law that director liability arises

only where the director commits a tort independent of the tort committed by the corporation itself.”

In Levandusky, the Court of Appeals explained that, as developed in the context of

commercial enterprises, the business judgment rule “prohibits judicial inquiry into actions of

corporate directors ‘taken in good faith and in the exercise of honest judgment in the lawful and

legitimate furtherance of corporate purposes,’” and that, “[s]o long as the corporation’s directors

have not breached their fiduciary obligation to the corporation, ‘the exercise of [their powers] for

the common and general interests of the corporation may not be questioned, although the results

show that what they did was unwise or inexpedient.” Adopting the business judgment rule as the

standard for judicial review of the decisions of non-profit corporations, the Court of Appeals stated

that “courts are ill equipped and infrequently called on to evaluate what are and must be essentially

business judgments [and] by definition the responsibility for business judgments must rest with the

corporate directors; their individual capabilities and experience peculiarly qualify them for the

discharge of that responsibility.”

Levandusky further explained that “[t]he business judgment rule protects the board’s

decisions and managerial authority from indiscriminate attack. At the same time, it permits review

of improper decisions, as when the challenger demonstrates that the board’s action has no

legitimate relationship to the welfare of the cooperative, deliberately singles out individuals for

harmful treatment, is taken without notice or consideration of the relevant facts, or is beyond the

scope of the board’s authority.” (Emphasis added). Nevertheless, the Court of Appeals held that

“[s]o long as the board acts for the purposes of the cooperative, within the scope of its authority

and in good faith, courts will not substitute their judgment for the board’s, [and] unless a resident

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challenging the board’s action is able to demonstrate a breach of this duty, judicial review is not

available.”

The First Department’s Pelton decision had involved a claim of unlawful discrimination

brought by a condominium unit owner against the condominium’s board and its individual board

members. The plaintiff, who suffered from muscular dystrophy, alleged that the board and its

individual members had discriminated against him by failing to honor his request that the building

be made handicap accessible. Before commencement of the action, the plaintiff and the board had

engaged in more than two and one-half years of negotiation over the manner in which the building

could be made handicap accessible to accommodate the plaintiff’s needs. Seeking to dismiss

plaintiff’s complaint, the individual board members moved for summary judgment on their

counterclaims for a declaratory judgment that certain actions of the board, which had been taken in

response to the plaintiff’s request, constituted reasonable accommodations to his needs. The First

Department noted that Supreme Court had denied the board members’ motion for summary

judgment and had held that the business judgment rule “afforded no immunity [to individual board

members] where the board’s decision is alleged to have been made on an unlawful discriminatory

basis.”

In reversing the Supreme Court order, the First Department, in Pelton, quoting from the

Court of Appeals decision in 40 West 67th St. v. Pullman,4 explained that, before dispensing with

“[the] ‘deferential standard’ that has become the hallmark of the business judgment rule,” and

triggering judicial scrutiny of the actions of corporate boards, “an aggrieved shareholder-tenant

must make a showing that the board acted (1) outside the scope of its authority, (2) in a way that

did not legitimately further the corporate purpose or (3) in bad faith.” The First Department noted

that a review of the [Pelton] record clearly demonstrated that plaintiff had “failed to make a

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showing of any of the three elements that would trigger judicial scrutiny of the board’s action”5

(emphasis added) and that Supreme Court, in its denial of the individual board members’ motion

did not “point to a single fact giving rise to liability on the part of any of the defendants.”

The Pelton Court further noted that the individual board members had established that the

board’s reliance upon the professional advice of its architects and counsel had “satisfied the

business judgment rule’s requirement of taking action in good faith and in the exercise of honest

judgment in the lawful and legitimate furtherance of the condominium’s purposes.” The Court then

held that “[t]he burden thereupon shifted to plaintiffs, who, to defeat summary judgment, would

have to offer proof of unlawful discrimination sufficient to raise a triable issue of material fact.”

Up to this point, there was nothing in the Pelton Court’s opinion that was either

problematic or contrary to the reasoning of the Court of Appeals in Levandusky. However, Pelton

went on to hold as follows:

In bringing an action against the individual members of a cooperative or condominium board based on allegations of discrimination or similar wrongdoing, plaintiffs were required to plead with specificity independent tortious acts by each individual defendant in order to overcome the public policy that supports the business judgment rule. (Emphasis added).

The Court then noted that “neither the complaint nor plaintiffs’ submissions on the motion

assert a specific claim against any of the individual defendants other than as a member of the 77

Park board,” and that “control of the board’s policies lies in the hands of the board collectively, not

in the hands of any individual member.”

The Court thereupon concluded that the Levandusky standard, “which permits review of

improper decisions ‘when the challenger demonstrates that the board’s action has no legitimate

relationship to the welfare of the cooperative, deliberately singles out individuals for harmful

treatment, is taken without notice or consideration of the relevant facts, or is beyond the scope of

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the board’s authority,’ should also serve as a minimum standard for challenging the conduct of

individual board members.” (Emphasis added).

In effect, Pelton interpreted Levandusky’s standard as being applicable to improper “board

action” only -- and not applicable to the improper actions of those board members whose actions

as individuals, when collectively acting for the board, constitute improper “board action”

unprotected by the business judgment rule. This was clearly an illogical reading of Levandusky,

and such reasoning could only lead to illogical results in practice.6

Indeed, in Stalker v. Stewart Tenants Corp.,7 a decision rendered three months before

Fletcher, a separate First Department panel, citing prior First Department authority upon which

Pelton had relied,8 held that the plaintiffs’ complaint stated causes of action for housing

discrimination against the corporation, but that the individual board members who had approved

the discriminatory acts of the corporation were not themselves subject to personal liability. The

Stalker Court stated: “Although allegations of unequal treatment of shareholders may be sufficient

to overcome the protection afforded directors under the business judgment rule, individual

directors may not be subject to liability absent allegations that they committed separate tortious

acts.” It was this kind of ruling, which evidences the “confusion” the Fletcher Court perceived in

the application of the business judgment rule, that Fletcher sought to “clear up.”

Contrary to the situation in Pelton, the facts alleged in Fletcher, if proven, would clearly

show that the “board” had acted in a discriminatory manner and that the two defendant board

members were the driving forces behind the discriminatory “board” action. In reviewing the

reasoning of its prior decision in Pelton, the Fletcher Court concluded (a) that “the Levandusky

rule will not protect a board member where he engages in discriminatory conduct,” and (b) that

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“Pelton takes a rule that applies where a cooperative or condominium board is alleged to have

breached a contractual obligation,9 and incorrectly applies it where a board allegedly engaged in

the intentional tort of discrimination.” In addition, the Court stated that “Pelton failed to

disentangle the principles of individual corporate director liability in the breach of contract context

(understood to provide a shield against liability) from the principles applicable to tort cases (where

there is no such shield).”

The First Department noted, in Fletcher, (a) that “it has long been held by this Court that ‘a

corporate officer who participates in the commission of a tort may be held individually liable, . . .

regardless of whether the corporate veil is pierced,”10 (b) that “[i]n actions for fraud, corporate

officers and directors may be held individually liable if they participated in or had knowledge of

the fraud, even if they did not stand to gain personally,”11 and (c) that “officers, directors and

agents of a corporation are jointly and severally liable for torts committed on behalf of a

corporation and the fact that they also acted on behalf of the corporation does not relieve them

from personal liability.”12

This also has long been the law in the Second Department.13 However, contrary to the path

taken by the First Department in Pelton and the prior First Department cases upon which it relied,

courts in the Second Department have not used the business judgment rule to shield individual

condo and co-op board members from personal liability where their actions, as board members,

have caused “board action” that violated anti-discrimination laws. For example, in Sinensky v.

Rokowsky,14 the Second Department held that the plaintiff’s amended complaint adequately

alleged a cause of action for housing discrimination against individual board member defendants

who were responsible for the “board action” that constituted the illegal discrimination. The Court

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did not invoke the business judgment rule to shield the board member defendants from personal

liability for the unlawful discriminatory “board action.”

In view of the First Department’s long line of precedent which generally has held corporate

officers and board members personally liable for torts committed in their corporate capacity, the

First Department’s application of the business judgment rule, in Pelton and earlier cases, to shield

condo and co-op board members from liability for unlawful “board action,” appears to have been

an anomaly. The First Department’s departure from the general rule in such cases could only have

been explained by an overly sensitive concern for what the Pelton Court described as “the

formidable obstacle” that “the threat of baseless litigation, with its attendant serious financial and

personal burdens,” would pose “to those willing to volunteer their talent, experience and

knowledge for the common good of their homeowner communities by serving on such [boards].”

With its Fletcher decision, the First Department has clearly and firmly announced that it

will no longer treat allegations of unlawful action by condo and co-op board members any

differently than it will treat allegations of unlawful action by board members of business

corporations and that the business judgment rule can no longer be used to shield the discriminatory

conduct of individual condo and co-op board members.

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*Adam Leitman Bailey is the founding partner of Adam Leitman Bailey, P.C., and John M. Desiderio is Chair of the firm’s Real Estate Practice Litigation Group. 1 75 NY2d 530 (1990).

2 __ AD3d__, 948 NYS2d 263 (1

st Dept. 2012).

3 38 AD3d 1, 825 NYS2d 28 (1

st Dept. 2006); see also Brasseur v. Speranza, 21 AD3d 297, 800 NYS2d 669 (1

st Dept.

2005), 4 100 NY2d 147 (2003).

5 Although the Pelton decision dealt only with the appeal of the individual board members and granted summary

judgment dismissing the action against them, the First Department opinion suggests very strongly that the Court also believed the record showed the action against the “board” defendant to be equally baseless. 6 The Pelton decision, which shielded the board members in that case from liability, was no doubt based, in large

part, on the factual record which clearly showed that the plaintiff had unreasonably rebuffed the attempts of the 77 Park board to reasonably accommodate the plaintiff’s needs.

7 93 AD3d 550, 940 NYS2d 600 (1

st Dept. 2012) (Full disclosure: The authors’ law firm represented the plaintiffs in

Stalker. The action has since been settled.) 8 Konrad v. 136 E. 64

th St. Corp., 246 AD2d 324, 667 NYS2d 354 (1

st Dept. 1998).

9 See Murtha v. Yonkers Child Care Association, Inc., 45 NY2d 913 (1978).

10

Citing Peguero v. 601 Realty Corp., 58 AD3d 556, __ NYS2d ___ (1st

Dept. 2009). 11

Citing Savannah T&T Co. v. Force One Express, Inc., 58 AD3d 409, __ NYS2d __ (1st

Dept. 2009). 12

Citing Marine Midland Bank v. Russo Produce Co., 50 NY2d 31 (1980); see also Kleinerman v. 245 East 87 Tenants Corp., 74 AD3d 448, 903 NYSd 356 (1

st Dept. 2010); Ackerman v. 305 East 40

th Owners Corp., 1889 AD2d 665, 592

NYS2d 365 (1st

Dept. 1993). 13

See Westminster Construction. Co. v Sherman, 160 A.D.2d 867, 554 N.Y.S.2d 300 (2d Dept. 1990); Widlitz v Scher, 148 A.D.2d 530, 540 N.Y.S.2d 179 (2d Dept. 1989); Bellinzoni v Seland, 128 A.D.2d 580, 512 N.Y.S.2d 846 (2d Dept. 1987). 14

22AD3d 563, 802 NYS2d 491 (2d Dept. 2005) (Full disclosure: The authors’ law firm represented the plaintiffs in Sinensky. The action has since been settled.) .