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‘Self-interested’ homeowners board must defend assessment, Md. court says

“The business judgment rule creates a presumption that directors are acting in accordance with their fiduciary duties of care and loyalty,” Judge Andrea M. Leahy wrote for the court. (The Daily Record/File Photo)

A North Bethesda homeowners association’s board composed entirely of townhouse owners must defend its decision to raise landscaping assessment fees on apartment dwellers against a claim the board members were self-interested, Maryland’s second-highest court ruled Thursday.

In its reported decision, the Court of Special Appeals said the Cherington Condominium Association will have to show in an administrative proceeding that it was “fair and reasonable” for the board to charge apartment residents for groundskeeping that would seemingly benefit townhouse owners more than above-ground apartment residents.

The controversial assessment was levied against the both the association’s 87 townhouses and the 12 “garden style” apartment units, according to court papers.

The Court of Special Appeals decision was a victory for apartment dweller Heather Kenney in her ongoing challenge to the assessment.

In its 3-0 ruling, the court applied to the association’s board the “interested director” rule that judges generally apply to corporate boards embroiled in conflict of interest allegations.

The rule, as annunciated by Maryland’s top court 114 years ago, holds that a conflicted board can defend a controversial decision by showing it was “just and proper, and that no advantage was taken of the stockholders.” The 1908 Court of Appeals decision, Francis v. Brigham Hopkins Co., involved directors voting for their own salaries.

As in Francis, the homeowners association’s board consisted of “interested directors” in that they stood to gain from the landscaping assessment by having those not represented on the board – apartment owners – pay a share, the Court of Special Appeals said.

The appellate court rejected the association’s argument that the board’s decision was protected by the “business judgment rule,” which shields corporate governing bodies from liability for decisions made within their authority. The association cited its bylaws, which enable the board to maintain the landscaping “of the community grounds as well as the readily accessible yards of the townhouse units.”

But the Court of Special Appeals said the business judgment rule does not apply when the directors are shown to have had a personal interest in their decision.

“The business judgment rule creates a presumption that directors are acting in accordance with their fiduciary duties of care and loyalty,” Judge Andrea M. Leahy wrote for the court, citing Maryland corporate law. “The interested director transaction rule operates as a brake on that presumption when conflicted director transactions are present, requiring that either the conflicts be disclosed and approved, or the transactions implicating those conflicts be shown to be fair and reasonable to the corporation.”

The appellate court sent the case back to the Commission on Common Ownership Communities for Montgomery County to determine if the landscaping contract and related assessment was fair and reasonable.

The association’s attorney, J. Bradford McCullough, expressed concern with the court’s decision and stated via email Friday that he and his client are “weighing our options” and have not decided whether to seek review by the Court of Appeals.

“I fear that the opinion could encourage litigation that challenges community associations’ budgeting decisions,” added McCullough, of Lerch, Early & Brewer Chtd. in Bethesda.

Kenney’s attorney, Matthew D. Skipper, did not immediately return a telephone message Friday seeking comment on the decision. Skipper is with Skipper Law LLC in Crofton.

The case began in January 2019 when Kenney filed an administrative complaint with the commission, alleging the landscaping assessment violated the bylaws by requiring non-townhouse owners to pay. The commission dismissed the complaint, agreeing with the association that the assessment was authorized.

On appeal, however, the Montgomery County Circuit Court held that the board members were self-interested and remanded the case to the commission for further factfinding regarding the fairness and reasonableness of the assessment.

The Court of Special Appeals agreed.

“To be clear, our opinion does not make or mandate a finding that the board acted improperly,” Leahy wrote. “Ms. Kenney made a sufficient showing that the board has a conflict of interest under the interested director transaction rule, but on remand to the CCOC, the association may satisfy the interested director transaction rule by presenting evidence that the … assessment was fair and reasonable to the association and its members.”

Leahy was joined in the opinion by Judges Terrence M.R. Zic and J. Frederick Sharer, a retired jurist sitting by special assignment.

The Court of Special Appeals issued its decision in Cherington Condominium v. Heather Kenney, No. 157, September Term 2021.