Articles

PAYMENT OF COMPENSATION TO DIRECTORS 

MARCH, 2010

TO OUR CLIENTS AND ASSOCIATION MANAGERS:

We occasionally receive inquires from boards and managers as to whether it is legal for an association to pay compensation to the members of its board of directors. "Compensation" in this sense means payment by way of salary, fee or other considerations for services rendered as a director.  The term does not include reimbursement of out-of­pocket expenses incurred while performing the duties of a director, such as copying costs, mileage, etc., which is always permissible.

Restrictions in the Governing Documents May Control

California law does not prohibit payment of compensation to directors.  However, the bylaws, CC&Rs or other governing documents of the association may contain such a prohibition.  If so, the appropriate document will have to be amended before compensation can be paid.

Liability Exposure for Compensated Directors

Even if not prohibited by the governing documents of an association, there are strong arguments against providing such compensation.  Any board considering payment of compensation to directors should consider the increased liability exposure to individual directors which will result.  The possibility of being personally sued for acts or omissions related to a person’s duties as director is substantially increased in the case of compensated directors.

Civil Code Section 1365.7, part of the Davis-Stirling Common Interest Development Act, protects directors of an association managing a common interest development that is exclusively residential from personal liability for acts or omissions performed within the scope of the directors’ association duties, so long as the act or omission was performed in good faith and not willful, wanton or grossly negligent.  For this section to apply, the director must be a volunteer and the association must maintain certain minimum insurance coverage for general liability and officers and directors liability (as specified in the statute). The limitation of the protection of the statute to volunteer directors means that it may not apply in the case of compensated directors.

Compensated directors may lose their "volunteer" status under this statute and will not have this umbrella of liability protection available to them.  Of course, they may still be covered by the Association’s insurance, but some officers and directors liability policies have exclusions for compensated directors, so it is important to carefully review the policies with the association’s insurance agent if the board is considering the possibility of paying compensation to board members.

Most governing documents do provide for indemnification of the association’s directors.  However, a director named in a legal action might have to hire an attorney and participate in the defense of the lawsuit before the right to indemnification is triggered. Also, the right of a director to reimbursement of certain costs incurred as a result of any such litigation is subject to review and approval by the association’s current directors. Such right of indemnification should therefore be considered as a "safety net" for directors and not as their primary source of liability protection.

Status of Compensated Directors as Employees

The association may also have to consider the status of any compensated director as an employee of the association and may have to establish appropriate withholding and tax reporting procedures.  The association’s accountant will need to be consulted about this issue.

Recommendation Against Payment of Compensation to Directors

In view of the foregoing considerations, we advise that an association not provide for compensation of its directors.  We fully realize the difficulties in getting members to serve as directors, a job that is largely thankless and with many burdens and no real benefits.  However, the potential liability to compensated directors outweighs, in our opinion, any benefits that would accrue to the directors from any minimal compensation.

Requirements if Directors are to be Compensated

If, despite the liability exposure discussed above, an association decides to compensate its directors, it must fully disclose the fact and amount of compensation to be paid to its members.  The Corporations Code, Section 7233, states that any contract or other transaction between a corporation and one or more of its directors is permissible if:

(1) the material facts of the contract or transaction are fully disclosed to the members and the members vote to approve such transaction, with the interested directors not being entitled to vote; or (2) if the material facts of the transaction and the directors’ interest are fully disclosed to the board and the board approves the contract or transaction by a sufficient vote without counting the votes of the interested directors.  If one of these methods of approval is not used, the contract or transaction may be legally attacked and the interested directors will have to prove that it was just and reasonable as to the corporation at the time it was authorized, approved or ratified.  If they fail to do so, the directors may be forced to disgorge any compensation they have received.

In view of the foregoing, any resolution for payment of compensation to the directors should be approved by the members.  The Corporations Code provides that such approval must be by a majority of a quorum of the members.