Kenneth Michaels, Jr., Bauch & Michaels, LLC, Chicago
312-588-5000 | E-Mail Kenneth Michaels, Jr.
Business-Judgment Rule Supports Dismissal of Fiduciary Duty Claims
The Second District of the Appellate Court recently affirmed the dismissal of breach of fiduciary duty claims asserted by a condominium association against First American Bank and three of its employees who served on the association’s board of directors after the 2008 real estate market collapsed. The trial court found that the bank’s employee’s and former director’s affidavit, deposition transcript, and the supporting documents, including a reserve study later done, all shifted the burden to the plaintiff association to overcome the business-judgment rule. Fountain Square on the River Condominium Ass’n v. First American Bank, 2024 IL App (2d) 230076-U.
Facts
The condominium association was composed of 93 units in Elgin that were constructed between 2005 and 2008 by Novak Construction Company (Novak). 2024 IL App (2d) 230076-U at ¶4. Almost immediately upon the construction’s completion, water infiltration problems arose and the lender on the project, First American Bank, Novak, and the developer entered into a settlement agreement. The agreement called for substantial punch list work to be performed in exchange for settlement on amounts owed to Novak of $775,000, to be paid upon remediation of the water infiltration problem and completion of all the punch list work. 2024 IL App (2d) 230076-U at ¶5.
Wiss, Janney, Elstner Associates, Inc. (Wiss) was employed to inspect the improvements and certify that the water infiltration problems were corrected. Id. Portions of Wiss’ report were quoted in part in the opinion. The quoted text from the report, prepared in July 2009, raised questions that the water infiltration problem was likely to recur because of the water barrier design of the exterior walls. The report suggested that within 7 to 12 years the sealants would again deteriorate and fail under normal weather conditions. 2024 IL App (2d) 230076-U at ¶6. During August 2009, through a deed in lieu of foreclosure, the bank acquired ownership of 58 unsold units of the 93 units in the building. 2024 IL App (2d) 230076-U at ¶8. In December 2009, Wiss signed off, after sealants were replaced and field tests were conducted, that the water infiltration repairs had been completed in satisfaction of the settlement agreement. 2024 IL App (2d) 230076-U at ¶9.
When the bank took title to the majority of the units, it appointed three of its employees as the directors of the association. 2024 IL App (2d) 230076-U at ¶8. Braeside Condominium Management (Braeside) was hired as the property manager. Braeside promptly retained a firm to perform a reserve study that, when completed in 2010, projected that the building’s windows would need to be caulked in 2017, 2027, and 2037 to guard against water infiltration. 2024 IL App (2d) 230076-U at ¶10. In November 2010, control of the association was turned over to the unit owners although two of the bank’s employees remained on the board. 2024 IL App (2d) 230076-U at ¶11.
Four years later, the bank conveyed 58 units, 2 commercial units, and 72 parking spaces to a Canadian firm for $5.6 million. 2024 IL App (2d) 230076-U at ¶12. The sale was conducted “as is.” Id. At the time of the sale the association had $300,000 in its reserves. Id.
By 2015, residents were again reporting water leaks. 2024 IL App (2d) 230076-U at ¶13. In March 2016, the association hired Wiss to provide services for the building. Id. A consultant was also retained to investigate the cause of water leaks. It was determined that the building needed repairs and replacements to correct both design and construction defects affecting barrier walls and balconies, similar to the admonitions in Wiss’ 2009 report. 2024 IL App (2d) 230076-U at ¶14. The total repair costs for the building would exceed $1.7 million. Id.
Litigation ensued. In November 2018, the association filed a 17-count second amended complaint against the bank and its three employees who had served as directors alleging that they breached fiduciary duties by failing to address the window defects in the building. 2024 IL App (2d) 230076-U at ¶16. These breach of fiduciary duty counts also included claims for constructive fraud. Additional claims included violations of the Illinois Consumer Fraud and Deceptive Practices Act, 815 ILCS 505/2, and common-law fraud. Id. Other defendants were included in the action who were dismissed, but the focus in this opinion is the fiduciary duty claims against the bank and its employees.
The defendants moved to dismiss pursuant to §2-619(a)(9) of the Code of Civil Procedure. 2024 IL App (2d) 230076-U at ¶17. The motion to dismiss asserted the business-judgment rule as an affirmative matter to defeat the claims. It was supported by a detailed affidavit from one of the bank employees who had served several years on the association’s board. Id. The employee’s deposition was also taken in 2022. 2024 IL App (2d) 230076-U at ¶18.
The association countered with copies of the bank employee’s deposition transcript and affidavits from the management company and the association’s president. These affidavits discussed the reserve study that was conducted after the building was turned over and the Wiss report and communications. The affidavits also recounted costs incurred by the association in 2014 in making building repairs. Id. In February 2023, the trial court granted the defendants’ motion to dismiss with prejudice finding that the business-judgment rule served as an affirmative matter to defeat the association’s claims. 2024 IL App (2d) 230076-U at ¶19.
Analysis
The association appealed, arguing that the trial court (1) improperly applied the business-judgment rule as an affirmative matter; (2) erred in finding that the §2-619(a)(9) motion defeated the facts presented in the complaint; (3) incorrectly concluded that the plaintiff failed to rebut defendants’ assertion of the business-judgment rule; and (4) abused its discretion in granting the motion to dismiss with prejudice. 2024 IL App (2d) 230076-U at ¶22. The appellate court applied de novo review. 2024 IL App (2d) 230076-U at ¶23.
Section 2-619(a)(9) motions permit dismissal of a claim that is “barred by other affirmative manner avoiding the legal effect of or defeating the claim.” 735 ILCS 5/2-619(a)(9). 2024 IL App (2d) 230076-U at ¶24, quoting 735 ILCS 5/2-619(a)(9). The term “affirmative matter” has been defined as “a type of defense that either negates an alleged cause of action completely or refutes crucial conclusions of law or conclusions of material fact unsupported by allegations of specific fact contained in or inferred from the complaint.” 2024 IL App (2d) 230076-U at ¶24, citing Krilich v. American National Bank & Trust Company of Chicago, 334 Ill.App.3d 563, 778 N.E.2d 1153, 1160, 268 Ill.Dec. 531 (2d Dist. 2002). In considering a motion to dismiss under §2-619(a)(9), a trial court may consider matter that is not apparent on the face of the complaint, including pleadings, depositions, and affidavits supporting a defendant’s assertion about the affirmative matter. 2024 IL App (2d) 230076-U at ¶25. “The burden then shifts to the plaintiff who must establish that the affirmative defense asserted either is ‘unfounded or requires the resolution of an essential element of material fact before it is proven.’ ” Id., quoting Epstein v. Chicago Board of Education, 178 Ill.2d 370, 687 N.E.2d 1042, 1049, 227 Ill.Dec. 560 (1997), quoting Kedzie 103rd Currency Exchange, Inc, 156 Ill.2d 112, 619 N.E.2d 732, 735, 189 Ill.Dec. 31 (1993). If the trial judge finds that the plaintiff has failed to carry the shifted burden forward the motion to dismiss may be granted. 2024 IL App (2d) 230076-U at ¶25.
“The business judgment rule shields directors who have been diligent and careful in performing their duties from liability for honest errors or mistakes in judgment.” 2024 IL App (2d) 230076-U at ¶26, quoting Miller v. Thomas, 275 Ill.App.3d 779, 656 N.E.2d 89, 95, 211 Ill.Dec. 897 (1st Dist. 1995). As long as the defendants have exercised “due care, adequate information, and good faith in making business decisions,” the business-judgment rule protects corporate directors in how they address problem such as water leakage and window defects in a building. 2024 IL App (2d) 230076-U at ¶26. The appellate court held that the trial court was entirely proper in considering the business-judgment rule in the context of this action. Id.
“The business judgment rule acts to shield directors who have been diligent and careful in performing their duties from liability for honest errors or mistakes of judgment.” 2024 IL App (2d) 230076-U at ¶28, citing Stamp v. Touche Ross & Co., 263 Ill.App.3d 1010, 636 N.E.2d 616, 621, 201 Ill.Dec. 184 (1st Dist. 1993).
Under the business-judgment rule, the judgment of the corporate board enjoys the benefit of a presumption that it was formed in good faith and was designed to promote the best interests of the corporation it serves. Absent bad faith, fraud, illegality, or gross overreaching, courts will not interfere with the exercise of the business judgment by corporate directors. 2024 IL App (2d) 230076-U at ¶28, citing Henderson Square Condominium Ass’n v. LAB Townhomes, LLC, 2015 IL 118139, ¶77, 46 N.E.3d 706, 399 Ill.Dec. 387.
In this particular action, the appellate court affirmed that all of the plaintiff’s claims for breach of fiduciary duties against the defendants were focused on the failure to address water infiltration problems properly and the failure to establish a plan to keep enough financial reserves to fund future repairs to the building. 2024 IL App (2d) 230076-U at ¶29. Although the association argued that in 2009 Wiss had recommended that all the windows be replaced, the board at that time chose to proceed with the alternative of making sealant repairs to the windows. Id. The appellate court noted that the business-judgment rule was designed to preclude this kind of second guessing of the board’s decisions. Id.
The appellate court further rejected the association’s argument that its counteraffidavits sufficiently rebutted the defendants’ evidence that the business-judgment rule barred the breach of fiduciary duty claims. 2024 IL App (2d) 230076-U at ¶40. Relying on Supreme Court Rule 191(a), the appellate court concluded that the association’s affidavits failed to rebut the invocation of the business-judgment rule. 2024 IL App (2d) 230076-U at ¶¶41, 42. The plaintiffs’ affidavits failed to show any expertise or experience in handling water leaks, sealants, or other types of building maintenance and failed to provide a basis for conclusion that the 2009 sealant repairs were simply a “stop gap” measure. 2024 IL App (2d) 230076-U at ¶42.
The appellate court, after reviewing the prima facie case for a private cause of action of the Illinois Consumer Fraud Act or common-law fraud, noted that the record contained no evidence of any deceptive act or practice or any evidence of any statement made by the plaintiff's much less false statements. 2024 IL App (2d) 230076-U at ¶45.
Justice Kennedy of the Appellate Court’s Second District dissented finding that the association’s counteraffidavits were sufficient to minimally raise material facts that should have precluded dismissal of the action at the pleading stage. 2024 IL App (2d) 230076-U at ¶¶51 – 55.
For more information about condominium law, see CONDOMINIUM LAW: GOVERNANCE, AUTHORITY, AND CONTROLLING DOCUMENTS (IICLE®, 2024). Online Library subscribers can view it for free by clicking here. If you don’t currently subscribe to the Online Library, visit www.iicle.com/subscriptions.