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August 23, 2006
Borrowing from Reserves - Is it Healthy?
There are a lot of complaints coming in about Boards borrowing from or using reserve funds for expenditures other than repairs or maintenance of components for which the funds are collected. In California, the laws are toughening up on reserve planning, borrowing and spending. Look for articles on this coming soon on my website http://www.californiacondoguru.com. I will be printing excerpts from a series of Legal Digests on this subject authored by me a few years ago covering expenditures, planning and investing guidelines. This subject never grows old. And it never resolves itself when a Board ignores inadequate funding.
Borrowing from homeowner association reserve accounts is rather like borrowing from your children's education investment accounts or from your own retirement investment accounts. If you have specific monies set aside for these things in IRAs or other investment accounts, you know there are controls against taking money out - very stringent controls ... more stringent controls than on an associations' reserve accounts. You just should not do it unless: (1) it's absolutely necessary; (2) you follow the legal requirements, and (3) you have a plan to pay it back. If you continue to borrow without regard to these factors, it will likely catch up with you.
The same goes for borrowing from the reserves. Sure, there are things that come up, like double or triple insurance premiums due on a short leash; however, when you as a Board Member find yourself on a "robbing-Peter-to-pay-Paul" syndrome, you can get into trouble both as an owner (who has to pick up the monetary slack) and as a Board Member (who could have personal liability as a fiduciary). Intentional raiding of reserves could expose a Board Member to serious losses. Negligence is accidental and carelessness may be forgivable, but continuing these practices after noting the resulting problems can cause you (if you are in the driver's seat) to cross over into the realm of punitive remedies (meaning a judgment against you that punishes that conduct, and rewards a victim beyond actual losses).
Check out the website and look for what's new in the next few weeks. The issue of reserves is a hot topic and its time to focus on that. For starters, if you are a Board member or owner in a community association (homeowners association) in California, you need to know that there are legal restrictions on borrowing (found in Civil Code Section 1356/1365.5), such as:
"The Board of Directors shall not expend reserve funds for any other purpose than the repair, restoration, replacement and maintenance of major components which are the obligation of the association, or related litigation. ... However, the board may authorize the temporary transfer of moneys from a reserve fund to the association's general operating fund to meet short-term cashflow requirements or other expenses, if the board has provided notice of the intent to consider the transfer in a notice of meeting, which shall be provided as specified in Section 1363.05. The notice shall include the reasons the transfer is needed, some of the options for repayment, and whether a special assessment may be considered. If the board authorizes the transfer, the board shall issue a written finding, recorded in the board's minutes, explaining the reasons that the transfer is needed, and describing when and how the moneys will be repaid to the reserve fund. The transferred funds shall be restored to the reserve fund within one year of the date of the initial transfer, except that the board may, after giving the same notice required for considering a transfer, and, upon making a finding supported by documentation that a temporary delay would be in the best interests of the common interest development, temporarily delay the restoration. The board shall exercise prudent fiscal management in maintaining the integrity of the reserve account, and shall, if necessary, levy a special assessment to recover the full amount of the expended funds within the time limits required by this section. This special assessment is subject to the limitation imposed by Section 1366. The board may, at its discretion, extend the date the payment on the special assessment is due. Any extension shall not prevent the board from pursuing any legal remedy to enforce the collection of an unpaid special assessment."
The intent of these sections is, of course, to establish legal limits on use of reserve monies and prevent borrowing unless the Board provides notice to the owners of the intent to borrow and discusses and takes action at an open meeting. Associations may borrow from the reserves to meet unanticipated operating shortfalls. (If the shortfall was anticipated, it should have been resolved in the budget process.)
Questions as to this statute arise as to what constitutes a legitimate borrowing including disagreements over the words "short-term cash-flow requirement”, and to what extent may funds be used for additional capital improvements (necessary or unnecessary). Professionals sometimes disagree on the exact intent embodied in the "one-year" payback time which changed in 1995 from the previous "three-year" payback deadline. Questions arise as to the effect of borrowing from reserves on the "disclosures" required by Section 1365 and 1365.2.5. Associations contemplating borrowing from reserves should consult knowledgeable professionals. This is an area where legal claims may arise.
Posted by Beth Grimm at August 23, 2006 9:53 PM