California Condo & HOA Law

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June 5, 2007

RESERVES - HOW DO YOU DETERMINE WHAT IS "HEALTHY" FINANCIAL PLANNING?

Your Association's financial strength should be of a number one concern. HOA regulatory documents commonly specify that the purpose of the homeowners association (HOA) is to protect the property values and sometimes even "enhance" property values. Other purposes commonly include maintenance of buildings and grounds, and collecting assessments to carry out the purposes and obligations of the Association.

That said, what exactly does that mean? Some associations can cope with shortfalls rather readily. I am talking about those whose members can withstand sizable assessments without blinking an eye. For the most part, that would require a membership of financially flush owners with the cash, equity or resources needed to step up to the plate and respond to any special assessment that might be imposed in lieu of having savings to pay the expenses and arrange for work to be done as the need arises. Know of any associations like this? I don't.

What I see are associations with financially strapped members, or associations with a variety of members, ranging from the financially flush to the ones who got in with creative financing and have no buffer available for the "surprise" special assessments. Many of these kind of members are first time buyers. These associations need healthy reserves. So what are "healthy" reserves. In California, studies accomplished by industry providers tend to show that the average association is about 60% funded per the current reserve study that was commissioned as required by Civil Code Section 1365. Yours may be more or less. 60% may or may not be considered "healthy" but sometimes average has to do. It is my belief that Boards should have a goal to reach 100% funding at the least. If not there yet, working reasonably with the members to improve the financial strength is better than ignoring or covering up financial woes.

And unfortunately the specific percentage funded shown in the financial statements is not a guarantee that the figure will not change drastically within any fiscal period. A matter of a $25,000 special assessment was recently brought to me by a new buyer who could not understand how the association went from 114% funded reserves to 2% funded with a $25,000 special assessment (from each owner) needed. The course of time between the reserve studies was only two years. I could not understand it either. The documentation provided to the new owner was not comprehensible.

Here are some questions from readers.

1. My association took out a loan a few months ago which was structured as an equity line the first year, that would be converted into a fixed period loan based upon the total amount used in the equity line. When the board makeup turned over in a recent election, we ended up with a new board that was vehemently opposed to the loan concept. This Board is completing rehab of buildings that will completely deplete the reserves, without tapping into the equity line. This board is on a course that will reduce the reserves to zero and then the Board says it will enact special assessments if they are needed. Do we have any recourse to this kind of activity?

Answer: The Board has considerable latitude in determining finances. This sounds like a difficult situation. There should be a plan in mind to assure that as reserves are used, they are replenished. Whether that should be a loan or special assessment or regular assessment increases is determined by the circumstances. The makeup of the membership should be kept in mind and if there is a way to structure the financials that the members can withstand, that is critical. Here are some important considerations in deciding what the best course of action is when the financial strength is seriously threatened:

**Without utilizing the loan in a scenario like this, are the members able to bear the special assessments needed to fund the remaining costs of the reconstruction, and bear the expenses in the future when they arise? If a loan would ease the pressure on members and help keep the reserves funded to a reasonable level even during a major construction project, it makes sense to utilize that option. Strapping the members beyond their means when there is another option will not be a win-win situation.

**An association with seriously depleted or underfunded reserves will be less enticing in the marketplace than a comparable association that shows stronger in financial strength. In past years this did not always make a difference as few could read and comprehend the financials and reserve studies and so few even tried. People tended to purchase based on what they saw when driving down the street, and entering through the front door. However, the California legislature, at the urging of the California Association of Realtors (one of the strongest lobby groups in the state) has over the past 5-6 years pushed for clarity and substance in the reserve disclosures and this has improved, in many cases, the ability to determine whether there are any "surprises" lurking in the background.

In trying to combat financial decisions made by your board, your best recourse is to run for the board, and try to get into the inner circle where the decisions are made. If that does not work for you, attending meetings, paying attention to financials, and communicating concerns to other owners might help. Some boards respond to membership pressure. Others do not. If you still are not satisfied and feel that you have losses caused by the action of the board, you can pursue legal action, either in small claims court (the upper limit for individual personal claims is now $7500.00) or superior court. Get legal advice first, though, because disagreeing with the Board, even strongly, is not cause for a lawsuit. One has to be able to prove that the Board members had a certain duty that was breached, and the losses which are identifiable were attributable to (caused by) that breach.

All this being said, there are still serious problems with some boards remaining "in denial" about what the law requires. See question 2.

2. My Board of Directors finally agreed to have our first reserve study prepared. They did not want one prepared because they knew that it would result in having to admit our association is severely underfunded. (As above) the board's mind set sseems to be "pay for it when it is absolutely necessary". We only pay for things via special assessment. We are not even covering our operating expenses. We will be bankrupt at the end of another 12 months if we do not raise the monthly dues.We have not had a contribution to funding the reserves for several years. What can I do as a homeowner to get not only the Board, but the other general members to vote for increases that will pay for normal operations as well as fund our reserves? Do I have legal recourse to threaten them with?

Answer: The answer is essentially the same as above. Getting your board to get the required reserve study done is easier than getting the board to adopt a realistic budget and the reserve study and funding it. Sometimes a board will simply refuse to adopt a reserve study prepared by an industry vendor versed in preparing such studies. They tend to be suspicious of anyone who puts in writing that the association is seriously underfunded. However, the reserve study preparers are finding in all too many situations that this is the case. Many studies contain a "recommended" level of funding (with a goal to get closer to 100% funded) and a "lowest threshhold" for funding and some boards do not even follow through with the threshhold level. However, if this is the case, at least there is an objective standard to be looked at if the Board is challenged on its decisions.

Getting the owners to approve assessments is the Board's job. It is the job of the Owners to run for the board and serve. And if Owners are not willing to get involved, but still want to challenge the Board's practices, proof of a duty, breach, causation and a loss would be necessary to prevail in a claim.

Here is another question.

3. After many years I finally purchased a condo. Before the purchase, I reviewed the CC&Rs as well as the total budget including reserves. My question what is the lowest acceptable reserve funding level for a condo complex? I am currently reviewing our condo's recent reserve study and we are at 62% and that seems unnecessary. Where do most CA condos place regarding reserve funding?

Answer: Here is a member who thinks 62% percent is too high. Go figure. It's average, and the question is, is average good enough? It's better than 50% but not as good as 75%. Wish I had a bettern answer. In the event any legal complaint is made that such a level is too high or too low, many factors would have to be considered. So, I have to give a lawyer opinion on these questions that ask if there is recourse for what are considered bad board decisions.

"It depends!"

Posted by Beth Grimm at June 5, 2007 8:36 PM