My Other Brother Is Also a Landscaper…

Last week, we discussed handling conflicts of interest for boards of directors of community associations. Our discussion included the relevant statutes from the Condominium Act and the Planned Communities Act, A.R.S. § 33-1243 and A.R.S. § 33-1811, respectively. This week, we address the analogous statutes from the Nonprofit Corporation Act and provide a resulting “best practices” tip for directors. As you may already know, the statutes are quite different and at their core, contradictory.

A.R.S. § 10-3860 through 3864 address Director’s Conflicting Interest Transactions. The definition of such a transaction includes any transaction to which the director is a party or stands to gain financially from the transaction, and the transaction is one that would reasonably be expected to exert an influence on the director’s judgment if he voted on the transaction. This statute is drafted more narrowly than the analogous community association statutes, and does not apply to as many situations. Also, the test of whether the transaction would “reasonably be expected to exert an influence” is not terribly helpful. The lack of a bright-line rule can make application of the nonprofit corporation statute more difficult since directors may argue about whether the statute applies to any given conflict.

If a transaction does qualify as an interested director transaction, the interested director must disclose the existence of the conflicting interest along with all relevant facts that are material to whether or not to proceed with the transaction. The director then must not vote on the matter or participate in the discussion about the matter, i.e. the director must recuse himself. The remaining, disinterested directors, of whom there must be a majority (and at least two), then act on the transaction. If there are not enough disinterested directors, the corporation may not act in compliance with these statutes. This is why the Arizona Legislature adopted the statutes specific to condominiums and planned communities – during the period of declarant control, no homeowners association would be able to undertake any transaction between the developer and the Association.

A.R.S. § 10-3864 requires nonprofit corporations to adopt a policy regarding interested director transactions, but the numerous exceptions negate the requirement for the overwhelming majority of community associations. The requirement to adopt a policy does not apply to corporations that only offer goods or services to members who are entitled to vote for the board of directors or corporations that have less than ten million dollars in net value.

If a corporation (or a board member) violates the requirement to disclose a conflict and abstain from discussion and voting on the matter, the contract is not automatically void as it is under the condominium and planned community statutes. Instead, A.R.S. § 10-3861 allows a court to set aside any transaction entered in violation of the statutes if a member, contractor, or other individual files suit. In other words, the contract is “voidable” by court action. However, even if the corporation or its directors violated A.R.S. § 10-3861, the transaction will not be set aside if the plaintiff cannot prove by clear and convincing evidence that the transaction was not fair to the corporation at the time it was entered.

As you can see, the application of the interested director transaction statutes that apply generally to all nonprofit corporations requires more complex legal analysis. First, whether a transaction applies is not nearly as clear. Second, a transaction that violates the statute is not automatically void; litigation is required to set aside the transaction. Third, the person suing to set aside the transaction is required to meet a higher standard of proof to be able to show the transaction was unfair to the corporation. Finally, the interested director of a planned community or condominium association will always have as a defense that the statutes did not apply, and that A.R.S. § 33-1243 and 33-1811 give him the right to vote on a transaction despite having a conflict.

So what should you do if you have a conflict as an association director in light of the complexities and the contradictory statutes? The best practice is to decline to be involved in either discussion of or voting on the issue or contract. Recuse yourself. That approach will rarely if ever result in a problem for a director with a conflict.

If you have questions about conflicts of interest, please contact Mark Holmgren or another attorney in the office.