Berding | Weil Community Association ALERT Newsletter
Legal News and Comments for Community Association Boards and Managers Issue #95 • July 2012
Ponzi Scheme?
Cities are going bankrupt because they didn't adequately project their funding needs into the future—will community associations be next?
by Tyler P. Berding, Esq.
Vallejo, California declared bankruptcy in 2008. The city of Hercules defaulted on its bond debt repayments. Stockton, California filed for bankruptcy in June. Two days ago, on Tuesday, July 10, 2012, the city council of San Bernardino, California made the same decision. That makes two major California cities deciding to file Chapter 9 Bankruptcy proceedings in the last 30 days. Other U.S. cities and counties have either declared or are on the brink. Central Falls, R.I.; Harrisburg, Pa; Boise County, Idaho, and Jefferson County, Alabama all share that distinction. Stockton is, so far, the biggest city in the nation to declare bankruptcy.
Each of these public entities has a unique reason for its financial problems. Base closings. Industry shutdowns. A gradual financial decline. But Stockton's case is somewhat different and perhaps presages more accurately the fate of many other municipalities—they spent money they didn't have and failed to determine if they ever would have it.
“The city's fiscal history "has eerie similarities to a Ponzi scheme," says Bob Deis, the city manager Stockton hired in 2010. Over the years, the city promised employees huge—and unfunded—salaries and benefits...”
Essentially, the Stockton City Council approved ever-higher salaries and pension benefits for public employees without the slightest idea of how these benefits would be funded.
“Perched precariously atop this mountain of obligations are retiree health benefits. Stockton officials awarded these to city employees in a series of votes in the 1990s but made no effort to fund them, intending simply to pay costs out of their budget as workers retired…Stockton Mayor Ann Johnston voted for these expensive measures when she served on the city council. 'We didn't have projections into the future what the costs might be…I learned that you don't make decisions without looking into the future'… 'Nobody gave thought to how it was eventually going to be paid for,' says Mr. Deis, the city manager.“
Berding|Weil Q&A
by Lucas J. Olona, Esq.
Our Association, which is only a few years old, has several developer representatives sitting on its Board of Directors. Given their relationship with the developer, we are concerned that they might not have the Association's best interests at heart. When developer representatives sit on an Association's Board of Directors, what is their fiduciary obligation to the Association?
Although developer representatives should not always be viewed with a suspicious eye, there is an obvious potential for a conflict of interest given their relationship with the developer. That developer may still be selling units and, in an effort to make the units more appealing to buyers, may be opposed to a necessary increase in assessments; that developer may also be opposed to the Association's investigation of potential construction-related deficiencies that could ultimately trigger litigation against it.
Developer representatives sitting on Boards of Directors have the same fiduciary duties to the Association as any non-developer representatives. As described by the California Corporations Code, that fiduciary duty is as follows: "a director shall perform the duties of a director, including duties as a member of any committee of the board upon which the director may serve, in good faith, in a manner such director believes to be in the best interest of the [association] and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances." This fiduciary duty trumps any obligations that developer representatives feel that they may owe to the developer. For example, one California Court of Appeal determined that a developer breached its fiduciary duty to the Association when, in the Association's infancy, its developer representatives failed to adequately assess the condominium owners to create a sufficient reserve fund for maintenance of the common areas. Although the delay in implementing assessments likely helped the developer sell additional units, the best interests of the Association required that the developer representatives approve the increase to ensure that the Association maintained adequate reserves.
Just like any other board member, developer representatives can be held personally liable for a breach of fiduciary duty if their actions result in mismanagement of the Association or if a decision was the result of fraud, bad faith (such as putting the developer's interest ahead of the Association's), or negligence.


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