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Condominium Law FLASHPOINTS October 2019

October 15, 2019Print This Post Print This Post

Kenneth Michaels, Jr., Lakelaw, Chicago
312-588-5000 | E-Mail Kenneth Michaels, Jr.

Appellate Court Disregards Covenants with Land in Finding Fiduciary Duties Exist

It is said that bad facts make bad law. The appellate court’s recent opinion in Ruiz v. Cal-Ful Condominium Ass’n, 2019 IL App (1st) 181734, presents facts leaving one wondering what the parties could have been thinking. Additionally, there seems to be plenty of blame to share among all the parties. For years, the plaintiffs disregarded the condominium structure they created and then sued based on a course of events that they were responsible for setting in motion.

The Creation of Two Associations

In 1985, the plaintiffs purchased the subject real property that was improved with one building. In 1994, acting as developers, the plaintiffs recorded declarations to create and submit the improved property into two condominium associations, one to manage ten residential units and the other to manage three commercial units, for which they retained ownership. 2019 IL App (1st) 181734 at ¶5.

In 1991, the residential association was administratively dissolved by the Secretary of State for failing to file an annual report and pay fees. The plaintiffs incorporated a new residential association (2007 Association) with a different name. While two associations legally existed and were distinct on paper, the plaintiffs and other unit owners ran the residential and commercial associations together through this new 2007 Association. For example, one board of directors managed the 2007 Association; only the 2007 Association held meetings; the associations shared the same bank account and adopted the same budget; assessments were commingled; and one insurance policy covered the entire building. After 2006, neither plaintiff served on the board of directors composed of the three individual defendant residential unit owners, who served from 2007 through 2014. 2019 IL App (1st) 181734 at ¶¶6 – 7.

Two Associations Treated as One

In 2007, the plaintiffs took a copy of the residential association declaration, attached a new first page with the name of the new 2007 Association, representing it to now be composed of residential and commercial condominium units, and recorded it against the commercial units. The plaintiffs claimed that this action was taken to comply with HUD requirements to obtain mortgage loans for residential units. 2019 IL App (1st) 181734 at ¶8. (This writer’s inspection of the declaration recorded in 2007 shows a mixture of pages from the old associations’ declarations and added pages and an IRS notice of an FEIN, and someone recorded the same stating that it was prepared by the original attorney who prepared the declarations in 1994 and who had been disbarred for seven years by 2007.) Perhaps the plaintiffs were trying to merge two distinct condominium properties into one without incurring any legal costs for doing so, but the mortgage compliance explanation does not appear to have anything with the 2007 recording.

In 2007, the plaintiffs also asked one of the directors to distribute a notice to the unit owners that the 2007 Association was composed of ten residential units and three commercial units. The defendant individual directors managed and administered the condominium property for both the commercial and residential units from 2007 through 2014. 2019 IL App (1st) 181734 at ¶¶9 – 10.

In 2011, a fire damaged parts of the commercial and residential units. Travelers Insurance offered $51,500 to repair common elements of the commercial units, which the directors accepted. The directors then authorized demolition of the commercial units. 2019 IL App (1st) 181734 at ¶11.

Litigation Commenced

In 2013, one of the plaintiffs sued the 2007 Association seeking to compel production of books and records. In the plaintiff’s second amended complaint filed in 2015, he acknowledged the existence of two associations, although he argued that the two associations were treated as one. Additionally, the second amended complaint added the three individual directors and the original residential association as defendants. 2019 IL App (1st) 181734 at ¶12. At about this time the individual directors learned from their management company that two associations existed. They allowed the 2007 Association to dissolve and reinstated the original residential association as successor-in-interest to the 2007 Association. 2019 IL App (1st) 181734 at ¶13.

In the third amended complaint, in 2016, the original plaintiff added his wife as an additional plaintiff without leave of court. These plaintiffs asserted six counts, three of which were dismissed and not the subject of the appeal. Count II sought attorneys’ fees pursuant to §19 of the Condominium Property Act, 765 ILCS 605/1, et seq., from the 2007 Association and original residential association for failing to produce requested books and records. Counts III and IV alleged that the directors breached their fiduciary duties by accepting the settlement from Travelers, an amount that was grossly inadequate, and demolishing the commercial units without obtaining insurance proceeds to cover the cost of repair and replacement, and for demolishing the units without the plaintiffs’ authorization, or investigating whether demolition was necessary. 2019 IL App (1st) 181734 at ¶14.

On a motion to dismiss, the trial court dismissed Count II because the plaintiffs failed to plead bad faith to sustain an action for attorneys’ fees pursuant to §19 of the Act. 2019 IL App (1st) 181734 at ¶15.

Later, the trial court granted partial summary judgment for the directors on their equitable estoppel defense.

The court concluded that equitable estoppel applied as a matter of law, noting that the Ruizes knowingly and fraudulently misled the directors into believing there was one association governing the commercial and residential units and requiring them to act as fiduciaries for the commercial association. The court further found that the directors would be prejudiced if the Ruizes were allowed to deny the truth that there were two associations and that the directors had no obligation to assume fiduciary responsibilities for the commercial units. 2019 IL App (1st) 181734 at ¶16.

Appellate Court Reversed in Part and Affirmed in Part

The appellate court reversed summary judgment on the breach of fiduciary duty counts because the plaintiffs had not misled the defendants with regard to the fact that in practice the building was governed by one association. 2019 IL App (1st) 181734 at ¶22. “A basic precept of estoppel is that a party may not deny the effect of his conduct or representation if to do so would cause prejudice to the party claiming estoppel.” Id.

In order to raise a successful defense of equitable estoppel, the party claiming estoppel must show (1) the other party misrepresented or concealed material facts, (2) the other party knew, at the time the representations were made, that those representations were false, (3) the party claiming estoppel did not know of the falsity of the representations when they were made or when they were acted upon, (4) the other party intended or reasonably expected the representations to be acted upon by the party claiming estoppel, (5) the party claiming estoppel reasonably relied upon the representations in good faith to his detriment, and (6) the party claiming estoppel has been prejudiced by his reliance on the representations. 2019 IL App (1st) 181734 at ¶21, citing In re Parentage of Scarlett Z.-D., 2015 IL 117904, ¶25, 28 N.E.3d 776, 390 Ill.Dec. 123.

The appellate court was persuaded that equitable estoppel was not applicable because plaintiffs accepted and alleged in their pleadings that they induced to directors to act as fiduciaries. “Fundamentally, the Ruizes are not repudiating the fact that they told the directors that one association governed both the commercial and residential units in the building. They admit in their pleading that in practice, if not in fact, the building was governed by a single association.” 2019 IL App (1st) 181734 at ¶22. “Significantly, the Ruizes do not allege that the directors should not have exercised their fiduciary duty on behalf of the commercial units. . . . Their lawsuit is based on the allegation that the directors breached that duty.” [Emphasis in original.] 2019 IL App (1st) 181734 at ¶23. The court found that the directors’ reliance on any misstatements from the plaintiffs was not related to their alleged breach of duties and that the directors suffered no detriment merely from undertaking those fiduciary duties. Id.

The appellate court affirmed dismissal of Count II seeking attorneys’ fees from the associations because the plaintiffs failed to plead bad-faith conduct under §19 of the Act. The plaintiffs’ complaint alleged that the associations failed to produce “tax returns, financial statements, check ledgers, cancelled checks, a general ledger, a disbursement letter, or a cash receipts journal.” 2019 IL App (1st) 181734 at ¶32. The court held that these documents all fell within §19(a)(9) of the Act, namely the general catchall for books and records of account. Prior to the adoption of P.A. 100-292 (eff. 100-292), attorneys’ fees could be obtained only upon proof of bad faith by the association. The document requests and litigation preceded the effective date, so the question was whether the plaintiffs pled bad faith by the associations by pleading that the failure to provide access to the books and records was “willful, vexatious, and without a proper purpose.” 2019 IL App (1st) 181734 at ¶34. The court held that this was a conclusion of law. The plaintiffs argued that the failure to produce timely access to books and records was necessarily indicative of bad faith. The court rejected this argument as it would read the element of bad faith out of the statute. Id.

Takeaway. The opinion here left this writer confused because gaps appeared in the facts and questions were left unanswered. The appellate court’s rejection of equitable estoppel against the plaintiffs eschewed fundamental questions of whether the directors owed any fiduciary duties to the commercial unit owners. Can two condominium associations be merged by simply announcing such is the situation and recording defective documents to such extent? Did the unit owners vote for a merger? What about the mortgagees apparent lack of involvement? Did the directors themselves waive equitable estoppel by failing to conduct a reasonable investigation into the recorded documents underlying the land which they were responsible for managing? Obviously, the appellate court has a record from which to work and is much more knowledgeable about the cases before it than the court’s opinion may reflect. But as lawyers, we only have the court’s opinions from which to work.

The court’s reversal of summary judgment on the fiduciary duty claims was perplexing because the appellate court accepted that the directors were vested with fiduciary duties owed to the commercial unit owners — in disregard to the covenants running with the land. What prevails — the recorded covenants or what some unit owners tell other unit owners? To what extent should the law disregard recorded covenants running with the land when the parties appear to disregard those same covenants?

This writer conducted his own research into the land records and quickly found that in 1994, as a condominium lawyer would have expected, a third “operating declaration” was recorded (Cook County Recorder Document No. 04051121) on the parcels along with the two condominium declarations for the commercial and residential associations. The entire structure called for each association to have its own board of directors and the two associations of unit owners to work cooperatively as to certain matters, such as procuring insurance for the building. There is even a provision in this operating declaration addressing rebuilding after a fire causes damage to the building serving both associations.

However, as presented in this opinion, the appellate court disregarded the existence of this operating declaration and several questions regarding whether property owners can simply disregard covenants running with their land by their actions and orally create a new condominium association. If such is the situation, this author suggests that we have ushered in a different approach to condominium law, property law, and duties owed in corporate governance.

For more information about condominium law, see CONDOMINIUM LAW (ILLINOIS) — 2016 EDITION. 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.

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