Poor Documents and Insufficient Reserves = A Big Problem

Poor Documents and Insufficient Reserves = A Big Problem

The era of community associations really began to flourish in the late 1970s. The legal documents for those early homeowner associations and condominiums reflected the best thinking and analysis of the time regarding the future financial and operational needs of the individual communities. Actually, it is a tribute to the attorneys who crafted some of those fledgling documents with foresight to include flexibility for future boards with regard to assessment levels. However, in most cases, that flexibility was not included and community associations were limited to a small percentage annual increase – or none at all — without a high percentage of membership approval. Those communities face a serious economic challenge today.

Let me describe an actual situation involving a townhome community in a suburb of a large metropolitan area that was built in the early 1970s. The community has private streets and parking lots, a clubhouse, and a swimming pool, in addition to wood perimeter fencing, two retaining walls, and some decorative brick walls. Their documents specify that the annual assessments can only be increased by a maximum of three percent per year.

The community is now nearly 35 years old, and although they have been diligent about doing preventive maintenance on their amenities and common areas, the board members are now faced with having to do extensive repairs to their private streets and parking lots. Through the years, the boards have increased the assessments the maximum amount allowed. However, because of the three-percent limitation, they have never been able to fund their repair/replacement reserves to the full amount mandated by their reserve studies. Because of the rapidly accelerating rate of repair and replacement expenses, the three-percent increases were not even adequate to cover their rising operating costs.

The options available for this community were: (1) impose a special assessment to cover the cost of the asphalt repairs as well as to catch up on other replacement reserve funding; (2) obtain a loan to cover the cost of the current repairs, fund the reserve account and then impose a special assessment (with homeowner approval) to repay the loan; (3) continue to make only necessary repairs and hope that the asphalt and other capital components will last many more years; (4) revise their legal documents to allow assessments to be increased at a more flexible rate; or (5) some combination of the above.

In general, the process for revising association documents is not easy, and rightly so, since revisions may impact an owner’s ability to continue owning his or her home. The documents themselves contain a provision that specifies the percentage of owners required to approve the amendments, and the actual approval process may be cumbersome, sometimes requiring witness signatures and notarization. Approval of a special assessment may also have unique provisions with regard to required percentage approval.

In the case of this particular community, the board of directors took the bold approach of proposing rewriting the governing documents and imposing a special assessment at the same time. Obviously, this scenario necessitated a lot of thought and careful planning. The first step was to subject the legal documents to a section-by-section scrutiny to ensure that any and all items that needed to be modified, deleted, or added were addressed. The board sought the input of the community at large by appointing several residents to an ad hoc Document Review Committee, believing that more resident involvement might lead to greater acceptance of the revisions.

When the board was comfortable that it had workable, enlightened documents, it requested a review by the association’s legal counsel. Counsel was asked to verify the appropriateness and legality of the language used, and to make sure that it conformed to any new federal, state, or local statutes enacted since the original documents were created.

In parallel with this lengthy process, the board-hired consultant identified the asphalt needing repair, created specifications, solicited bids and submitted his recommendation. The board then selected a potential contractor.

Also in parallel, the board began to communicate with the owners about the lack of sufficient funds to bring the reserve accounts to the appropriate level and to make the necessary repairs to the current most pressing problem, the streets and parking lots. Several articles on the importance of reserves and on the board’s fiduciary responsibility to protect and enhance the value of the property were placed in the community’s newsletter. Updates on the progress of the document revisions were provided at the monthly board meetings, and the members of the ad hoc committee were encouraged to speak to their neighbors about the critical nature of these efforts.

The board distributed to all the members the draft of the revised documents with explanations of the revisions that might be problematic. The board also distributed the details about the proposed special assessment including the updated reserve study and cost of the asphalt repair as well as payment plan options. Two town hall meetings were held at which homeowners were invited to raise any concerns about the special assessment and governing documents rewrite. The association’s Document Review Committee members, attorney, Reserve Specialist® and auditor attended both meetings to ensure that all questions would be answered.

The time came to pull this huge endeavor together. A special meeting was held at which the owners were asked to approve the revised documents and the special assessment to cover the cost of the asphalt repairs and fund the reserve account. The board again arranged for the association’s legal counsel, Reserve Specialist® and auditor to be present to answer any final questions the owners had.

Did the board succeed in educating the owners about the need to both rewrite the governing documents and approve a special assessment? Was this two-pronged approach the right thing to do? Did the owners approve both of the issues presented to them?

Yes!

When confronting a complex issue like the above, seek out industry professionals to guide you in the process. They are invaluable and can provide you with their expertise gleaned not only from facts of law but also from association clients with similar issues. Focus on the issue, not the emotions, and you, too, can overcome impediments created by governing documents created long ago, before the detrimental impact of too-restrictive wording was recognized.

Published in Association Times – June 2008  

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