By Tyler Berding, Esq.
There is a continuing debate in community associations over how much cash an association must set aside to adequately fund its operations and reserve accounts, and at what level the assessments must be set to obtain that cash from the members. Boards of directors frequently face the dilemma of whether to raise monthly assessments in the face of member resistance, or to defer funding certain budget line items--typically reserve funds--to a later time.
California has a mandatory funding statute for community associations. Civil Code Section 1366 says: "Except as provided in this section, the association shall levy regular and special assessments sufficient to perform its obligations under the governing documents and this title." It uses the term "shall" and that means assessments adequate to do the job are mandatory up to the limits of the board's authority. In California, the board has the authority to increase regular assessments up to 20% over the prior year and can impose a special assessment of up to 5% of the gross budget, all without a vote of the members. So the authority is there. But does the board have to use it?
Legislators use the word "shall" when they want to eliminate options. So as used in Civil Code Section 1366(a) it is the intention of the legislature that boards of directors of community associations are legally obligated to assess as necessary to fully meet the "obligations" of the association. But what, exactly, are those obligations? In terms of the association's operating expenses, it's a pretty easy call. Such expenses as water, garbage, management, pool maintenance, and insurance bills are current ongoing expenses. If you want the service, you have to pay the bill, usually monthly. The discussion of those obligations begins and ends during budget committee meetings each year, and once those expenses have been projected, there can be little argument but that they must be paid currently, from monthly assessments. If the board does not want to raise the amount of the assessments over the previous year, its only legal option is to insure that the expenses in the budget match the projected income. Obviously, directors can decide to cut certain expenses and make other adjustments designed to keep the overall cost of ownership low if they so choose. But once they agree on a budget, the obligations are clear and the law requires them to assess as necessary to meet those monthly obligations.
Reserve funding is another matter. Until it's time to put on a new roof or paint the buildings, expenditures from the reserve fund are not required, so the question that usually arises is: "Why is it necessary to fund these obligations now?" This question feeds into the debates mentioned above--should assessments be raised currently to save enough for future reserve obligations, or should we simply wait until it's needed and then look to the owners for a special assessment, or apply for a bank loan?
Recent surveys indicate that most associations are doing some of each--saving some money but relying on a special assessment or a loan to fund the balance. We say "relying" as if that were part of a conscious plan because these surveys also reveal that the average association has only 50% of the cash in reserves that its reserve study calls for. So if it is now time to replace the roof and the association only has 50% of the cash it needs, then some alternate sources of funding will have to be tapped, or the project will have to be deferred until the cash is available. Whether that is truly the plan or not is unknown.
The most commonly used alternatives are special assessments, bank loans, or deferral. Special assessments can work to fund a big construction project if the owners have the wherewithal to pay them. It also depends on the law of the state. In some states, there is no restriction on the amount that an association can specially assess. The only limitation is political resistance, but the basic authority is there if the association chooses to use it. In California, however, special assessments that exceed 5% of the "budgeted gross expenses for that fiscal year" require approval of the members of the association. This has the effect of taking control out of the hands of the board of directors and placing it in the hands of the members. And while this may be the Populist's choice, it complicates things immensely because self-interest, and not the community's interest, often influences the vote. If the board and management do an excellent job of explaining the need, if the members can afford the assessment, if all of their long-term interests are reasonably similar, and if they have been adequately warned, over the years, that this was indeed the plan, it might pass. But what if it doesn't? Given all of the hurdles above, that is always a distinct possibility.
The Future of Common Interest Developments:
Can they Survive the Current Economic Downturn?
On April 30, 2009, partner Tyler Berding will offer new insights to a topic he has been writing about for the last 10 years: the challenges faced by undercapitalized associations confronting large repair costs.
The topic remains as fresh and timely as ever and we hope our clients and friends can attend.
Private New Towns
A promising new concept saddled with
an old problem?
The City of Hercules, once known for The Hercules Powder Company, a manufacturer of dynamite, is redeveloping its old industrial properties into what has become one of the most explosive new ideas in housing and one of the finest communities of its type on the West coast.
Call it the anti-suburb plan; Hercules has employed smart growth and green planning concepts to create commuter and retail-friendly spaces among new housing, commercial and office space »
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