A Newsletter of the Real Estate Law Committees
of the Association of the Bar of the City Of New York

COURT OF APPEALS LIMITS CO-OP BOARD INDEMNIFICATION
By Margaret E. Connor ^[1]

In April 2000, the New York Court of Appeals issued a decision which will cause cooperative board members to remember the seriousness of their responsibilities to the corporation and to the shareholders they serve.

In Biondi v. Beekman Hill House Apartment Corporation ^[2] , the Court of Appeals concluded that indemnification was not appropriate pursuant to public policy or pursuant to N.Y. BCL §721 when a director is assessed with punitive damages stemming from a jury finding that the director violated civil rights laws when denying a proposed sublease application on the basis of race and the director retaliated against the cooperative shareholder for opposing the denial.

This case involves the former president of the board of directors of Beekman Hill House Apartment Corporation, Nicholas Biondi.  In 1995, a shareholder of the corporation informed Mr. Biondi that she intended to sublease her apartment to a “financially eligible couple.” ^[3]   The shareholder was assured by Mr. Biondi that he would meet with the husband and that a full board interview would not be required, as was the board’s usual practice. ^[4]   However, after meeting the husband, who was African-American, the proposed subtenants were informed by the corporation’s managing agent that a full board interview would be necessary.  Prior to the interview, Mr. Biondi disclosed  the nature of the husband’s race to one board member and disclosed to another board member that he (Mr. Biondi) felt “uneasy” about the husband. ^[5]   The Board unanimously denied the sublease application and subsequently issued a notice of default to the shareholder for “objectionable conduct” arising from her claims of racism directed against Mr. Biondi and the Board. ^[6]

A series of lawsuits filed by each of the parties culminated in a trial in U.S. District Court.  At trial, the jury found that the corporation and its directors, including Mr. Biondi, “both personally and in his official capacity,” violated the Federal Fair Housing Act, 42 U.S.C. sections 1981 and 1982, and New York Human Rights Law section 296(5). ^[7]   The subtenants were awarded both compensatory and punitive damages.  Punitive damages of $125,000 were personally assessed against Mr. Biondi. ^[8]   As to the shareholder, the jury concluded that the corporation and its directors, including Mr. Biondi, violated her rights pursuant to the Federal Fair Housing Act and the New York Human Rights Law, breached their fiduciary duties to her and tortiously interfered with her sublease agreement.  The shareholder was also awarded both compensatory and punitive damages, $29,000.00 of which was assessed against Mr. Biondi personally. ^[9]

Mr. Biondi and the other Beekman board members moved, in part, for a new trial.  The District Court denied their motion and in doing so concluded that:

(1) the evidence supporting [the shareholder’s] breach of fiduciary duty claim established that “the Beekman board members acted in bad faith and with a purpose that was not in the best interests of the cooperative”; and (2) the evidence establishing that the Beekman defendants acted “willfully or maliciously when they rejected the...sublet application...and retaliated against [the shareholder] for trying to oppose the Board’s actions.” ^[10]

At a subsequent settlement conference, Mr. Biondi and the other Beekman directors agreed to limit liability to their respective punitive damage awards. ^[11]   When Mr. Biondi failed to comply with the settlement, a second conference took place, at which time the parties agreed to reduce Mr. Biondi’s punitive damage contribution to $124,000.00. ^[12]

Mr. Biondi then sued the Beekman cooperative in state Supreme Court for indemnification under Article VII of its by-laws.  The Supreme Court denied the cooperative’s motion to dismiss the complaint under CPLR §3211, holding that the cooperative’s by-laws permit indemnification for directors who act in good faith, and the “mere fact” that a federal jury found Mr. Biondi liable for violating the tenants’ civil rights  was not “dispositive” of that issue.  The Supreme Court also held that the public policy prohibition against indemnification for punitive damages did not apply because the settlement agreement did not clearly identify Mr. Biondi’s damages as punitive. ^[13]

The Appellate Division reversed and dismissed Mr. Biondi’s complaint against the cooperative holding that (1)Mr. Biondi’s settlement agreement limited his liability to punitive damages and that indemnification  for punitive damages is prohibited by public policy; and (2) BCL §721 barred indemnification where the jury in the underlying action found that Mr. Biondi had acted in bad faith with respect to both the shareholder and her tenants. ^[14]

The Court of Appeals upheld the decision of the Appellate Division on public policy grounds as well as pursuant to BCL §721.  The Court stated: “[t]he rule to be applied with respect to a punitive damage award made in a Civil Rights Act action is that coverage is proscribed as a matter of public policy.” ^[15]   Indemnification “defeats the purpose of punitive damages, which is to punish and deter others from acting similarly.” ^[16]

The Court concluded that the racial discriminatory and retaliatory acts perpetrated by Mr. Biondi are “precisely the type of conduct for which public policy should preclude indemnification.” ^[17]

The Court also concluded that Mr. Biondi was not entitled to indemnification by Beekman  under N.Y. BCL §721.

In its statutory analysis, the Court first reviewed BCL §§722(a) and (c) which allow corporations to indemnify directors against third-party actions and derivative suits.  Section 722(a) allows indemnification against judgments, fines, settlement payments and reasonable litigation expenses, while section 722(c) limits indemnification to settlement payments and litigation expenses. ^[18]   The standard of conduct under both sections is that indemnification is warranted for a director who has acted “in good faith, for a purpose which he reasonably believed to be in...the best interests of the corporation . . . ” ^[19]

The Court next reviewed BCL §721 which was amended by the legislature in 1986 to expand indemnification to include any additional rights conferred by a corporation in its certificate of incorporation or by-laws, provided that

no indemnification may be made...if a judgment or other final adjudication adverse to the director or officer establishes that his acts were committed in bad faith or were the result of active and deliberate dishonesty and were material to the cause of action so adjudicated. ^[20]  

The Court observed that the “bad faith” standard set forth in the BCL imposes a public policy limitation on indemnification, ^[21] and that the limitation is also imposed in the by-laws of the Beekman cooperative. ^[22]

Taking into account the BCL provisions and the Beekman by-laws, the Court turned its attention to the issue at hand which was “whether the adverse Federal judgment establishing Biondi’s bad faith toward [the tenants and the shareholder] precludes indemnification under [BCL] section 721.” ^[23]   The Court concluded that Mr. Biondi was not entitled to indemnification under BCL §721 because the federal jury trial judgment clearly established that Mr. Biondi’s acts were committed in bad faith.  The Court held that “the key to indemnification is a director’s good faith toward the corporation and that a judgment against the director, standing alone, may not be dispositive of whether the director acted in good faith.” ^[24]

However, the Court found nothing in Mr. Biondi’s conduct which could be construed as having been undertaken in good faith, for a purpose believed to be in the best interests of the cooperative (i.e., Mr. Biondi’s deliberate racial discrimination against the tenants, by which he blatantly exposed the Beekman cooperative to civil rights liability, and Mr. Biondi’s breach of fiduciary duty to the shareholder). ^[25]

CONCLUSION

This decision is one of import for the cooperative community.  It should alert directors and officers of co-ops that their actions are subject to scrutiny, and that not all of their decisions and actions will be protected by the cloak of indemnification.  Indeed, as in Biondi, directors can be held personally liable to the extent of having to pay thousands of dollars out of their own pockets; a prospect which could potentially bankrupt any individual.  While this decision should not deter well-qualified, caring people from serving on co-op boards, it should serve as a warning that a director’s primary responsibility is to promote the best interests of the cooperative corporation and its shareholders.  In other words, serving on a co-op board is a responsibility which should be taken seriously.

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