Reserves
Q.Our 10 year old clubhouse apparently has some settlement problems that started several years ago. No Boards had done any study of the cause until last Fall. It is going to cost about $35,000.00. They say we do not have money in reserve to take care of this expense. Is the board of directors responsible for failure to fund proper reserves? Is the Board liable to the other members?
A.It appears that something major is occurring with the Clubhouse the significance of which could not have been reasonably anticipated until a couple of years ago. Of course, an earlier study of the problem would have been appropriate and may have allowed for collection of funds over a period of a couple of years to remedy the problem.
The board of directors is responsible for properly preparing a budget each year and reviewing a reserve study which should be in the Association's file. By now most associations should have responded to the state law passed in 2002 requiring that a reserve study be prepared every five years. This involves an evaluation of all the common elements and limited common elements for which the association has maintenance responsibility and determining the remaining useful life and the cost of replacement at that point. If a professional is used for this purpose, you will likely have items brought to your attention that would otherwise go unnoticed, such as building settlement issues. Based on that information, a line item in the budget is created to fund this replacement reserve. In preparing the budget, the board should take the following steps:
*Review expenses from prior years;
*Consult experts regarding reserve requirements;
*Discuss with other professionals the requirements for, and cost of, insurance, pool operations and landscaping;
*Meet with owners to determine their desires for services in the community for the upcoming year; and
*Weigh all this information against the availability of funds and the likely reaction of the owners to an increase in the dues.
With all this completed, the board should adopt and publish a budget. It should always be remembered that a budget is not a guaranteed spending program, but rather a general guide as to how the board thinks things will go financially during the coming year. Unexpected events and changes will occur. When this happens, the board has three choices:
*They may reallocate money and decide not to do something that was in the original plan;
*They may take the money that is required from the reserve fund and replace it completely within the year by increasing the assessment for the following year; or
*They may have a special assessment of each owner based on the provisions in the condominium documents or the Condominium Act.
As to your statement about potential liability of the board, first of all you need to know that all board members are insulated by statute from liability for their actions as board members so long as they are not engaging in willful misconduct or a knowing violation of the criminal law. This is a public policy to encourage service by homeowners on boards of directors without exposing themselves to personal liability. Of course the board, as an entity, is subject to liability and is generally insured with Directors and Officers Liability Insurance, which policy will also pay the attorney's fees to defend the board against any actions brought against it. We are confident that most attorneys you would consult would encourage you to meet with the board and find out the details of the cause of any large special assessment before initiating a lawsuit. The board, of course, has an obligation to preserve and enhance the property values in the community. The board has a fiduciary obligation in this regard and must make special assessments when necessary to preserve the assets of the association. Keep in mind that the board members also have to pay the special assessment and would not be likely to make this special assessment without appropriate deliberation. Also keep in mind that service as a board member is a significant sacrifice of time for most of the members and most are doing so to assist their fellow homeowners by administering the affairs of the association without compensation.
You can learn more about this and other association topics at an all day event sponsored by the Community Associations Institute which will be held on Saturday, March 4, 2006 at the Chesapeake Conference Center. This one day event covers a variety of topics and a chance to meet with both vendors and other homeowners in community associations. More information can be obtained by calling the local chapter at 757-558-8128 or checking the CAI website at www.sevacai.org.
I own a unit in a 12-unit condominium. The condo is 15 years old. The Association has no reserves. We need a new asphalt parking lot, paint and replacement curbing around the units and center island. When I bought 5-years ago, it was in a "park-like" setting. I made substantial improvements to the interior. Now, the common areas are in shambles. We (the Board) are trying to pass a special assessment to repay a possible association loan. We are getting a great deal of resistence--particularly from one of the original owners who fought all those years to keep the monthly condo fee as low as possible. If we can't get the special assessment approved, what is our recourse--other than selling our units?
RESPONSE:
First and foremost, let it be stressed that our firm is located and licensed only in Virginia, so any advice we give on out-of-state issues are made without the benefit of knowing the law in your particular state, and you really should consult with an attorney in your state before relying on our general advice and observations.
That being said, your scenario involves many significant issues.....director liability, bank loans, special assessments, and reserve studies, to name a few. The specific questions you have asked us to respond to are (i) What if the loan gets rejected? What is the available recourse for those are in favor of spending the money to improve the common areas? What is the Board's exposure for negligence?
If the loan gets rejected, then the only alternative you will likely have is to pass a special assessment. I would urge you to look more closely at your condominium's governing documents (Declaration, Bylaws, Rules & Regs, Articles of Incorporation), as well as at Rhode Island's Condo Act to see what powers the Board of Directors has to borrow money or levy a special assessment. It may be the case that the Board has the ability to exercise these powers without the requirement of getting owner approval. In Virginia, a Board of Directors may borrow money on behalf of the Association or levy special assessments by majority vote of the Board, unless the Association's governing documents require something different.
At the meeting you plan to hold to help convince owners to approve of the loan, you should stress the point that special assessment may be the only alternative to the loan. This may be a good "selling point" because everyone knows how unpopular special assessments can be. With a loan, you have more flexibility on the pay-back terms, and owners can pay their share in one lump sum or pay a little bit at a time over the course of a few years. A special assessment may require payment in full within a short period of time, which would create unnecessary controversy, and greatly increases the chances of the Association having to place a lien on (and perhaps foreclose on) a unit. If you end up in the worst case scenario that loan and assessments cannot be made without owner approval which was not obtained, then those of you in favor of spending the money to protect your investment could theoretically put up the money yourselves, but you would do so knowing that some did not participate and that you have no way to make them contribute. This would accomplish the result of preserving the property, but it would be setting a very bad precedent and would cost you an unfair share.
Regarding the Board's liability for letting reserves become depleted or neglected, you may or may not have reason to be concerned. First, I would be curious to know whether or not the current Board members are relatively new, or are they the same directors who have historically depleted the reserve funds. An unreasonable failure to maintain adequate reserves is possible grounds for a finding of negligence. In Virginia, too many Boards were neglecting this important duty, and the legislature therefore recently added a requirement to the Condo Act requiring all Associations to perform a reserve study at least once every 5 years, and to act accordingly once the study has been completed.
If your documents (or your state's Condo Act) require you to get owner approval before a loan or special assessment is made, then I would think that you could defend yourself based on the fact that you tried to get both done but the owners simply did not approve, which would theoretically absolve you (and/or the Board) from culpability. An argument may be made that the previous Boards were negligent in allowing the situation to even get to this point, which may or may not involve current members of the Board.
The lesson to be learned for all Associations is that even though keeping dues as low as possible may make you temporarily popular with the other residents, but in the long run it hurts the Association and could arguably end up being grounds for director liability, depending on the circumstances.
Since it appears that you have several significant legal issues with serious consequences, I would urge you to get local counsel and good counsel is essential.
Gregory J. Montero, Esquire