A transcript of this podcast follows below.
Hi. This is Shep Atshuler, publisher of Timesharing Today. Welcome to this broadcast of Timesharing Today Radio featuring news and views of owners and industry professionals. Today we are being joined by John Funk, Shareholder/Director of New Hampshire based law firm Gallagher, Callahan & Gartrell. Today we will be taking a close look at the organization and responsibilities of the boards of directors of owner-controlled timeshare resorts.
SA: Hi John. Welcome to the broadcast.
WJF: Shep how are you? Nice to speak with you today.
SA: Very good. Thanks for joining us. This issue of board member responsibility that we’ll be talking about today is interesting because of the fact that so many of these boards are made up of timeshare owners and they are spread out – the resort may be in one area and the board members may reside in another state. This I think will be helpful for people who are maybe planning to run for a board and for those that are on the board to give them another perspective of what this whole relationship is all about between the board, the resort and the owners. Before we get into some of those details, provide our listeners with some details about your firm and how you became involved in the timeshare industry.
WJF: I’ve been practicing law since the early 1970s. In 1973 I was appointed to the Consumer Protection Division of the Attorney General’s office and ultimately became its head. In that capacity I regulated timeshare resorts. New Hampshire had a registration law that required all real estate projects be registered with the Attorney General’s office. In that time period, timeshares started arriving in New Hampshire and I had an opportunity to look at the business as a regulator. I left the firm in 1978 and went into private practice and have been in the same firm ever since. When I first joined the firm we had a number of real estate clients who expressed interest in timeshare and that’s when I got into it on the private side.
Interestingly, in my capacity in both the AG’s office and then ultimately in private practice I got to see the evolution of timeshare from the right-to-use that was the initial approach in the 70s to the deed based approach that became popular after the 70s. It was basically caused by a decision, the Windrifter decision, that had an adverse ruling with respect to right-to-use timeshare projects and as a result, after that decision, most resorts moved in the direction of deeded interests.
In the beginning when I was involved with timeshare, our clients had expressed interest in moving into deeded regimes but we very rapidly concluded that there were problems with the deeded approach. There were significant legal costs. If there was a default and you had to foreclose, the foreclosures were expensive. There were transfer taxes. There were title issues.
In the early 80s a number of our developer clients asked us to see if there was some other approach that could be utilized, and we pioneered the approach to trust timeshare resorts at that time. A trust timeshare resort is one where the title to the property is held by the trustee on behalf of all the timeshare owners. The timeshare owners get a beneficial interest in the trust. They have all the same rights to use the property as a deeded owner would have but we kept the title in one party, the trustee. That had the effect of making foreclosure issues go away. It prevented any problems with regard to the title going forward. It minimized legal costs and saved some transfer taxes. It turned out to be a very successful approach to timeshare. Trust regimes became pretty much the standard in New England as time went forward but it took a little while for it to catch on in the rest of the country. Now we find more and more resorts are moving in that direction. That was the background as to how I got into timeshare and how I’ve watched it evolve over the last 30 years.
SA: We’re probably at the beginning of a new trend towards the trust concept. Is that correct?
WJF: Yes we are. It’s been going on for quite some time. One of the things we’ve been dealing with recently with regard to the trust concept is the conversion of deeded projects into trust projects. It’s more complicated to do it midstream but it still has beneficial aspect to it. There are quite a few timeshare resorts that have made that leap and have converted over to the trust regime. It takes a while for all the inventory to migrate from a deeded ownership to the trust regime but for the long term future of the resort, it makes a great deal of sense.
SA: How does that specifically benefit the timeshare owner?
WJF: It benefits the timeshare owner because if the timeshare owner wants to transfer his or her interest in the future to a family member or to sell it, all he or she has to do is execute a document that transfers the beneficial interest in the trust and present that to the trustee. The trustee records it in the records of the trust and the transaction is completed. You don’t have to file anything in the registry. You don’t have to go to an attorney. It’s a pretty simple transaction.
SA: How is your firm made up in terms of the types of clients that you serve?
WJF: We’re very fortunate. We serve a broad range of clients in the timeshare area. We represent developers. We represent owners associations. We represent service providers, such as management companies or companies that provide financing to timeshare resorts. We also represent a very broad practice in the financial services area representing banks and other types of lenders. From that perspective, we have a very broad view of the timeshare industry and so we can bring that expertise to any given assignment with a client.
SA: What geographical areas do you provide services?
WJF: We’re based in New Hampshire and as you would imagine a substantial portion of our client base is in New England but we are able to practice law across the entire country by partnering with local attorneys in the different jurisdictions where resorts are located. Lawyers aren’t allowed to practice in areas where they’re not licensed and no lawyer can take the time or energy to get licensed in every state of the United States. What we typically do is work with the local counsel of a resort and bring our expertise into play and then get the benefits of the local knowledge that the resort’s lawyer has of the state law so that we can come up with a product that not only has all the latest attributes of timeshare but also is consistent with the laws of the state in which the resort is operated.
SA: So that provides you with the ability to have a national scope through these local partnerships.
WJF: Yes it does. That’s worked very well because frequently the local lawyer has a lot of background and expertise with respect to the resort but hasn’t had an opportunity to be involved with a trust-type project if that’s the direction the resort wants to go in. We bring our expertise and work collaboratively with that attorney to bring about the best result for the resort.
SA: Today we want to provide our listeners with some insights about the functions of the board of directors of the older legacy resorts. What defines a legacy resort?
WJF: There isn’t a dictionary definition of a legacy resort. What I typically have in mind is an owner-operated resort that is deed based and in most likelihood was established prior to 2000. Since 2000 many of the resorts have moved in the direction of trust regimes so that it’s unlikely that new resorts would have a deed-based ownership. Most of the resorts that we’re talking about are those that were created prior to 2000 and have the deed ownership as the base.
SA: My perception is that most owners pretty much go along with the situation. They pay their maintenance fees unless they have some issue. If the resort is well run, all they want to do is show up and have a carefree vacation. Why is it important for timeshare owners at these legacy resorts to understand how the board of directors are organized and governed?
WJF: You’re right. Many owners simply want to take advantage of the vacation that they’ve purchased and come every year and enjoy the amenities of it and then go home and not think about it again. With these owner-run resorts it’s very important that owners do have an understanding of how the resorts are intended to operate. Legacy resorts are run by the board of directors or in some cases they are called trustees or managers. They’re the board members and are elected by the owners. They may be elected annually or they may have a three-year term. They are elected by the owners at annual meetings. The Board is responsible for managing the resort. It’s responsible for the overall oversight of the resort. In that capacity what the board does is either hire a manager and staff or contract with a professional management company to operate the resort on a day-to-day basis.
The resorts are subject to the laws of the state where the resort is located. The resorts are also governed by the articles, bylaws and other resort documents. It’s important that the owners understand the process established by state law and the resort documents with respect to the election of the directors and how the resort is intended to operate. Ideally, what you want to have are qualified people serving on the board and that you have an owner base that is informed and participating so that you have everyone operating from a common information base. It’s important to emphasis that in these owner-operated resorts, the owners are in control. They elect the board members and they approve a budget. These two rights that they have enable the owners to be in control of the destiny of a resort.
SA: When we talk about board members who are qualified, maybe you could give some examples because in today’s economy, it’s a troubled economy. We’ll talk a little bit later on about the issues that are effecting resorts. What kind of qualifications should the owners be looking for and what qualifications should somebody consider before they decide to run for a board?
WJF: That’s a great question. What it does involve is owners to be active in both recruiting and participating in the process of electing board members. I think almost every articles and bylaws that I’ve looked at with respect to the requirements for the composition of a board of directors or trustees require that the member be an owner in the resort. What you have to look at basically is the pool of owners that you have and what type of expertise they have that might be useful to the board. One of the things that I would suggest that a resort do is canvas its owners and find out what type of background individual owners have. In my experience many owners don’t voluntarily step forward. They have to be recruited. It’s important to have an idea of what kind of skills your owners have so that you can target a particular owner and ask that owner whether or not he or she would be willing to serve. Sometimes the people who are overly eager to get on a board are not necessarily the best board members because they have an agenda rather than trying to look out for the good management of the resort.
Generally what you’re trying to look for are people on your board that collectively have some diverse experience. It’s good to have some members of the board that have some financial experience so that they can help explain to the other board members the financial statements of the resort. It’s good to have some with management background. That can be useful. It’s good to have people with communication skills. Teachers are well trained in that regard. In general what you’re trying to do is look for people that can make the best decisions on behalf of the resort and work well together as a group. I think the situations that have always been difficult are when you have some abrasive people on the board that have an agenda who become difficult to work with. Ultimately boards tend to break down when there’s that kind of divisiveness and confrontation at the board level.
SA: Would you say that’s a common thing to have this divisiveness? Would you say there are what might be conflicts of interest or self serving objectives of a board member? Is that very common from your experience?
WJF: I would say that “common” probably not but it does come up. I wouldn’t say every board gets plagued with that but some boards do have a board member who has an agenda or for one reason or another feels it’s important to serve on the board and throws his or her weight around. What’s really important is for the election of a board to be an open and fair process. It’s important to communicate to the owners how service on the board is critical to the proper decisions being made.
One of the things that would be important is to be consider term limits so that you get some turnover on the board and one or two people don’t become lodged on the board and have their perspective always reflected when there may be some other perspectives that are useful. It’s important to have diversity in the sense that I believe you should only have one member of a family serving on the board. You shouldn’t have groups of people that are related that can make decisions that may not be in the best interest of all the owners. It’s important to have different experience so that you can tap the abilities of your board members from their outside lives to help the resort.
Finally, you want to have a board that’s large enough so that you can spread the duties and functions around but you don’t want to have it be so large that it becomes unworkable. In my experience, a seven member board is pretty ideal. You get enough people on it with different backgrounds that can provide the proper perspective but it’s not so large that it becomes unworkable. It’s very important that any anyone who serves on a board member recognize that they do have responsibilities and have the willingness to put the time and energy into discharging those responsibilities.
SA: With that, why don’t you spend the next few minutes talking about the responsibilities of the board and principles behind those responsibilities.
WJF: A board is responsible for the oversight of the resort. It sets the policies and procedures and then works through the managers and the staff or in the case they’ve selected management company, the management company to execute on their decisions. In that oversight position, they’re looking at the big picture. They’re looking at the issues the resort should be dealing with and then they’re working with the management to make certain that their concerns and the priorities that they’ve identified have been dealt with by the staff. I would say the underlying principle of the board’s responsibilities is to act in the best interest of the owners. They have to be loyal to the association and not take advantages of opportunities to the association’s detriment, and they have to be free from conflicts of interest.
So with that as a background, what are the things that boards are required to do in discharging those responsibilities? They have to monitor the financial health of the association. They have to make certain that they’re aware of revenues and expenses. They have to be aware of trends so they can predict in future years what’s likely to happen. They have to be aware of the condition of the real estate and personal property that comprise the resort to make certain that there are maintenance programs is in place to preserve the quality of the those properties. They have to be aware of legal risks with regard to the property so that when visitors come to the property, they’re safe and protected. They also have to be aware of different laws relating to guests and the rights of guests so that the resort doesn’t inadvertently run afoul of some law that protects guests who are handicapped or have other impediments.
The board then, in order to accomplish all these goals, has the duty to establish an annual budget for the approval of the owners and to provide reserves to ensure that the resort will be viable. It also has the responsibility to make certain that the resort is in a position to maintain good relations with the exchange companies so that the value of the timeshare interests that the owners hold is preserved. It also has a duty to inform the owners as to what’s going on so that the owners can make meaningful decisions with regard to the budget and also for the election of the board at the regular meetings.
So depending on the condition of the resort, the board members have to look at these broad issues that are going on within the industry. They have to look at whether they should consider a trust conversion? What’s the status of the resort? Can it survive on its own or should it be considering merging with some other resort? Directors want to look at the numbers of use that are going on with respect to the property and address the question of whether or not the property is too large to accommodate the use and whether some downsizing would be appropriate. Unfortunately in some dire cases where a property has not been well managed or for one reason or another is no longer popular, perhaps because of the area in which the resort is located is no longer a hot destination place, then the board should consider whether or not the resort should be dissolved and sold and whatever value remains in it distributed to the owners. These are some major issues that they do have to keep on top of to make certain that in acting in the best interest of the owners. Directors must be aware of the future possibilities that may affect the resort.
SA: Any of these actions, as you said earlier, they do require some sometimes complicated legal maneuvers and they may take years to put into place. So it has to be carefully planning according to an effective strategic plan. This kind of ties into the topic of board member liability. How do all these situations, evolving issues, changing the way the resort is going to be organized or governed, whether it’s going to move from deeds to trusts, or just dealing with other very complicated situations, dissolving a resort, which is definitely major. Where does board member liability come into all of this?
WJF: A lot of board members before they decide that they’re going to serve on a board wrestle with the issue of liability because they want to know what they’re getting into to. First of all, board members are entitled to rely upon professionals in making decisions but they do have a responsibility to be diligent in making certain that they understand what the advice is that has been given to them and what the implications of it may be to the resort. They clearly have an obligation to attend meetings, to read the reports and to make informed decisions. In order to do that, a board has to be able to meet with competent counsel, accountants and other advisors.
The problem that I’ve seen especially with legacy resorts that have experienced some distress with declining revenues, especially as a result of these timeshare relief companies that have been predators on resorts, they find themselves in the position where they have limited funds and wrestle with the question can we afford to get the advice that we need to go forward or will our membership think that the assessments are too high and will that cause a further deterioration in our delinquencies so the resort in jeopardy.
That’s a very difficult question. What I would say is that a board has to have the knowledge in order to make informed decisions. Without the knowledge, the board can’t direct the future course of a resort. Therefore, I think it is important to get competent advisors who can help the board evaluate the result and guide it to a set of options that will be available to the board to consider and ultimately decide where they want to take a resort. I think that boards, in order to discharge their responsibility, need to find the funds in order to get the assistance that they need to make these very important decisions. Many legacy resorts are challenged by the issues we were just talking about, declining membership, rising delinquencies, questions as to whether or not the condition of the resort is sufficient to be competitive in the current timeshare industry. In order to make the right decisions for these very important decisions, they need to have competent advice.
Board members are protected by what we call the business judgment rule. As long as a board member is diligent and attends meetings and is informed and makes a judgment or makes a decision on a matter to the best of his or her knowledge, that board member is not going to be individually liable if that decision turned out to be a wrong one. In order to protect themselves from liability in the event that someone sues them for a breach of their fiduciary duty, then I think it’s important that board members have the comfort that they’re insured under directors and officers liability policy. I would insist that if a person is going to serve on a board that a minimum condition for service is that there be a D&O policy in place that protects him or her in event a lawsuit is brought.
SA: From your experience have there been a significant number of lawsuits in this area brought against the board members or is it a kind of rare occurrence?
WJF: I think it’s rare but the potential is always there especially if you’re making decisions that ultimately affect the fate of a resort. If, for example, a decision is made that a resort can’t survive and needs to be dissolved, I think it’s very important to make certain that if someone wants to second guess you on that decision that you’re not going to have to incur out-of-pocket expense to defend that decision. The reason why the suits tend to be rare is that most timeshare owners have a relatively small economic stake in a resort and in order to bring a lawsuit it means that they would have to spend their own personal resources to hire an attorney to go out and bring the suit. There have been cases brought in situations where you have insider dealing among board members taking advantage of their position on the board to their own personal benefit or acting in a fraudulent or corrupt manner. That’s where the most significant liability can attach. For board members who are serving on that board with someone who is engaged in that activity, then there’s a question as to whether or not they were properly discharging their responsibilities by not calling out that kind of conduct or governing it and preventing it from occurring. There are risks in serving on a board. I think the cost of D&O insurance is relatively minimal and every board member should insist that it be in place.
SA: How should owners stay on top of their resort’s governance?
WJF: It’s a persistent issue. Many owners enjoy the resort and all they want to do is go and take their vacation and not think about the other issues involved in terms of how the resort operates on a day-to-day basis. I think it’s a two-way street. I think the board of directors should be insistent that they have a website and other means of communicating what’s going on a making certain that the owners are given the opportunity to get as much meaningful information about the resort as possible. Vice versa, I think every owner needs to understand that because of the power that the owners hold to elect members of the board and to approve a budget, that in order to do so, they need to make every effort to be informed so that they can make intelligent decisions. Owners should constantly be reminded of the importance of their attending meetings. Owners should also be reminded that the resort needs to have their participation in order to operate and encourage owners to step forward and participate on the board or serve on committees that are set up to address a specific issues on which the board may need information. Another thing that board members should do is, as I was mentioning earlier, be aware of what kind of expertise exists in the ownership body and actively go out and recruit good people to serve on the board so that there is quality management at the oversight level with respect to the resort.
The other thing I’d mention is owners should visit the resort. They shouldn’t be exchanging out all the time and never go to the resort that’s their home base. Also, they should make certain that they pay their assessments in a timely manner so that they don’t put the resort in jeopardy from a financial standpoint. I think those are very important responsibilities of ownership.
SA: Now this of course is going to open up I think a lot of questions in our listeners’ minds, whether they’re on a board and if they’re considering running for a board or if they’re owners who want to get more actively involved in the governance of the resort and many of them may have additional questions. If our listeners would like to get in touch with you, how can they go about doing that?
WJF: There are several ways they can do it. They can email me at my office which is funk at gcglaw.com. They can also go on the website for my law firm Gallagher, Callahan & Gartrtell. The website address is www.gcglaw.com. They can also give me a call at 603-545-3607.
SA: Thank you John. This has been extremely helpful, extremely informative and probably raises a lot of questions as I said before. I appreciate your participating on this broadcast today.
WJF: It’s been my pleasure and look forward to working with your membership as they address these very important issues.
* W. John Funk is admitted in New Hampshire, Vermont and Massachusetts.