CAN YOUR ASSOCIATION AFFORD NEEDED CAPITAL IMPROVEMENTS?

Community Association Law - Association Improvements
CAN YOUR ASSOCIATION AFFORD NEEDED CAPITAL IMPROVEMENTS?
Townhome Association, Minnesota Townhouse Association
The decks are falling apart, the siding needs paint, and the roof is due to be replaced. Does your community association have enough in its reserve fund to pay for these necessary projects? Unfortunately, many associations do not have adequate reserve funds for capital improvements. There are generally three primary solutions to this problem: increase annual assessments, impose a special assessment, and/or finance the project(s) with a bank loan. This article provides legal guidelines for addressing the problem of inadequate reserve funds.
Community associations suffering from inadequate reserve funds are put in that situation for a number of reasons, including the following:
Increased assessment delinquencies causing a budget shortfall;
Increased maintenance costs due to pricing increases or demand for improved maintenance;
Construction defects;
Inadequate initial assessments by developer;
Inadequate assessment increases by prior boards of directors;
Reserve requirements imposed by the Declaration or Bylaws;
Reserve study implementation requirements;
IRS reserve allocation requirements;
FHA Recertification; and
Minnesota Common Interest Ownership Act ("MCIOA") reserve requirements under Minnesota Statutes section 515B.3-114).
While other reasons exist, the above lists some of the most common reasons for inadequate reserve funds - all of which require action by the association's board of directors.
The board of directors has a duty to maintain the financial viability of the community association. The first step in meeting this duty is to understand the current financial situation by evaluating current and future financial needs to meet the obligations imposed on the community association by the declaration. Community associations often analyze their current financial situation by conducting a reserve study, which provides an analysis of the current capital items, determining each capital item's age and expected useful life, and then estimating the timing and amount of future capital improvement expenditures. The reserve study further analyzes current and future financial resources to determine whether any inadequacies exist now or in the future when capital improvement expenditures come due. Reserve studies are available from a variety of sources including management companies, independent consultants, accounting firms, certified public accountants, and through software packages.
If the board of directors determines that a reserve fund shortfall exists (or will exist in the future), it must take action to meet its fiduciary duty by using reasonable and good faith efforts to implement a financially sound plan for the growth and use of the association's financial resources. In short, the board of directors must take affirmative action to correct the inadequate reserve fund situation.
The first method for increasing reserve funds is to increase annual assessments and the amount of those assessments being deposited into the community association's reserve fund. While governing documents generally allow the board of directors to make increases to the annual assessments without homeowner approval, most place a limit on such increases without homeowner approval. Assuming that the association can increase annual assessments by a sufficient amount with or without homeowner approval, and the association has sufficient time to increase its reserve funds before capital improvements become necessary, an annual assessment increase is an effective solution to the inadequate reserve fund problem.
The legal method for implementing an assessment increase is primarily determined by the governing documents, including the declaration, bylaws and articles of incorporation. Although many associations have similar provisions concerning assessment increases, specific provisions must be carefully reviewed prior to increasing the annual assessment.
The same principles are generally applicable whether or not the community is a planned unit development (townhouse) or condominium. However, there are some important differences between planned unit development (townhouse) and condominium documents. For example, there is generally no homeowner vote required to increase annual assessments or impose a special assessment in a condominium association, but there may be limits on the amount of the increase. In any case, the association and its counsel should carefully review the governing documents prior to proceeding with the annual assessment increase.
If capital improvement items are required now or in the near future, the association must look at alternative solutions, usually a special assessment or bank loan financing. A special assessment is a one-time assessment to the affected units, which is used to pay for the necessary capital improvement project. While a special assessment may be an effective solution, many governing documents require homeowner approval of any special assessments, and the homeowners may not support the proposed special assessment. In these situations, a board of directors cannot force homeowners to approve the special assessment, even if there is a recognized need. Nevertheless, the board of directors must undertake efforts to correct the inadequate reserve fund issue by affirmative action to meet its duty to the association.
If an annual assessment increase or a special assessment is not possible or feasible under the circumstances, an association facing inadequate reserve funds for capital improvements may attempt to finance the capital improvements with a bank loan. Again, the governing documents must be analyzed to determine whether the board of directors has the power to obtain financing - either with or without homeowner approval. In situations where the other alternatives are not available, bank loan financing provides the community association with a means to accomplish the required capital improvement projects, and the bank loan is paid out of future annual assessment revenue. Since additional revenue will be required to meet the loan payment requirements, the association must have sufficient revenues in its budget to repay the loan, or the association must be able to increase its annual assessments to meet these new obligations.
Whenever an annual assessment increase or special assessment becomes necessary, there are many commonly applicable legal principles involved in the process. The declaration creates a lien for annual assessments (usually payable in equal monthly installments) and special assessments (usually for capital improvements in the year imposed). The declaration fixes an initial annual assessment and sets forth method of increasing the assessment. The declaration typically allows discretionary increases by the board of directors without consent by the owners. The most common discretionary increase is limited to five percent (5%). The board of directors is required fix any annual assessment increase at least thirty (30) days prior to calendar year end by resolution, and written notice to the homeowners is commonly required.
Annual assessment increases in excess of the discretionary amount or special assessments usually require consent by vote of the homeowners. Whenever homeowner consent is required to increase annual assessments or to impose a special assessment, the first step in the process is to call a meeting of the homeowners. Notice of the homeowner meeting are typically controlled by the bylaws, requiring written notice a specific number of days prior to meeting date, and including a statement of proposed meeting action. At the homeowner meeting, a quorum (the required percentage of all homeowners) must be present in person or by proxy to conduct business at that meeting. Once a quorum is established, the homeowners may vote on the annual assessment increase or the special assessment, but approval of the requested action must comply with the approval requirements of the association�s governing documents, regardless of meeting the quorum requirements.
The above information should prove helpful in analyzing your community association's assessment rights in dealing with inadequate reserve funds. However, it is important to note that each association's documents are unique, and the board of directors must look to the governing documents to determine the applicable legal requirements for dealing with the inadequate reserve fund issue. If the board of directors is uncertain as to the association's assessment rights and procedure, it should seek competent legal counsel prior to implementing an annual assessment increase, special assessment or bank financing.
Deepest gratitude to: Liz Hersey at 952-746-2158
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