Unit Owners’ Vote Insulates Condominium Board from Derivative Action

On May 16, 2014, Justice Scarpulla of the New York County Commercial Division issued a decision in DSW Lenox, LLC v. Rosetree on Lenox Ave., LLC, 2014 NY Slip Op. 31311(U), dismissing a derivative action against a condominium's board of directors.

The court's opinion in DSW Lenox addresses several distinct legal questions. This post focuses on the board’s refusal to commence litigation as an alleged breach of fiduciary duty.

In DSW Lenox, the plaintiff—the owner of a condominium unit—brought a derivative claim against the board members of the condominium, alleging that, by refusing to sue the condominium’s sponsor and developers for construction defects, the board members had breached their fiduciary duties.

The court began its analysis by reciting the applicable standards: the business judgment rule usually "prohibits judicial inquiry into actions of corporate directors" unless the plaintiff can allege that the directors breached their fiduciary duty. In the context of a condominium board, "an aggrieved unit owner 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."

In response to the plaintiff's allegation that the board members failed to act in the unit holders' best interests, the court held that "that claim is disproved by [the plaintiff's] admission that the unit holders themselves voted against the lawsuit"—the complaint itself admitted that "the purported Board members decided to poll the unit owners to ask whether a complaint should be filed and all unit owners except DSW voted against the suit." Accordingly, the plaintiff could not allege that the board's decision was contrary to the "collective interests of the cooperative."

The court also rejected the argument that the board members had improperly relied on the advice of attorneys who had conflicted interests—to allege breach of fiduciary duty, the plaintiff was obliged to show that the board members themselves had conflicting interests or would profit personally from the decision, or that their reliance on the legal advice was "unreasonable," and the plaintiff failed to meet that burden.

In light of the fact that a derivative action is intended to vindicate the rights of the shareholders from an overreaching board, a vote by the shareholders—here, the unit owners—authorizing the board's decision logically precludes a derivative action.