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Minnesota Legal

Daniel B. Greenstein, Esq.

Daniel B. Greenstein, Esq.

Greenstein & Sellers, PLLC

The Declaration

April 4, 2019

How are the elements of a community defined? What determines the components of the common areas versus homeowner-owned areas? Where is it written that certain elements are the responsibility of the homeowner and others are the responsibility of the association? How does one even know if their property is a part of an association? These issues and more are established in what’s commonly called an association’s “declaration.” Declarations Attorney Daniel B. Greenstein with Bernick Lifson, P.A. in Minneapolis, Minnesota spoke with us at length and explained the nuances of declarations as well as many other important common interest community topics.

One important note — in some states, statutes vary for condominiums, homeowner associations (HOAs) and cooperatives. Additionally, Greenstein noted that the historical phrase “Covenants, Conditions and Restrictions” is rarely used in modern association declarations; most developers now simply refer to the document as the declaration.

Declarations are recorded with the county in which the particular association is located. In Minnesota, Greenstein said, they can be found using a conventional title search. In some counties they are even accessible via a governmental internet system. “When a property becomes subject to a recorded declaration, that property becomes a part of the association,” he said. A declaration should also not be confused with the rules and regulations of an association.

Rules and regulations are something entirely different. Most notably, boards can generally change rules and regulations without holding a vote of the association’s members. Declarations cannot usually be changed in this manner, Greenstein noted. They usually require an owner vote – specifically, a super majority – to amend. The ability for boards to change the declaration by vote is limited to certain circumstances, such as addressing errors and omissions, and may not be done to make substantial changes. Voting regulations can vary by state and association type as well.

In cases where it is required by the declaration, he said, mortgagee approval may be needed to pass amendments. Sometimes this approval can occur by default if the mortgagee does not respond to the amendment approval request within a certain time period, which is usually sixty days.

A declaration is the document that governs the community from its outset, and it is generally rather broad and covers a wide variety of issues. It is created by the developer, sometimes known legally as the “declarant.” Rules and regulations, Greenstein said, are created by the board, typically over the course of time and to the extent to which they are allowed as outlined by the declaration. Rules and regulations are more easily created and more easily revised. Occasionally, however, they are not as easily enforced. Rules and regulations work in conjunction with the declaration, and they are used to supplement the governing documents. “A good analogy would be that the declaration is like the U.S. Constitution and the rules and regulations are like the laws that Congress enacts. Rules and regulations are used to supplement or address issues that are not specifi- cally covered in the declaration and may not contradict them,” Greenstein explained.

As an example, the declaration may say that no commercial vehicles shall be parked within the confines of the community without board approval. That implies, he noted, that the board can theoretically approve some commercial vehicles. The board can then come up with rules and regulations that specify which commercial vehicles are approved and how that restriction will be enforced.

The initial declaration carries the most weight amongst an association’s governing documents. They are the most fundamental, and they are usually harder to amend. The declaration requires an incredibly large su- per majority to amend—a super majority that flows from the total number of interests in the community, and not just a special few. Some states specify the exact majority needed to amend a declaration. “In Minnesota, an amendment to the declaration usually requires approval of 67% of the ownership interests in the association,” Greenstein said. Bylaws, however, can often be amended by a smaller super majority. They can be amended by a super majority of owners who are in good standing or owners who are present at a meeting which, he noted, is significantly lower than the total number of owners who exist throughout the community as a whole.

How detailed does the declaration need to be in the governing documents? And what role does vague language play in drafting the “supreme law” of the community? Vague language can make declarations more difficult to enforce, but it can also give board members flexibility, Greenstein said. Certain issues may need to be very detailed, such as members’ easement rights. Specificity is always best, but not to the extent that it lim- its the flexibility of the board. For example, he explained, the declaration could include the board’s power to levy a fine or penalty against an owner for some infraction. A very specific way to define that power would be that the board has the power to fine, that fine can be no more than “X” dollars and it has to be administered in a certain way. This provides flexibility in terms of the amount, the way in which the fine gets levied, the way in which it gets waived, and the mechanism by which fines are ad- ministered; it gives the board the ability to function. “Contrary to popular belief, in Minnesota a board is not required to publish a schedule of fines before enforcing violations of the declaration or rules. The board has the authority to determine the fine amount based upon the exact violation in question,” Greenstein said.

More specific language does not necessarily lend greater ability to enforce. Discretionary language, on the other hand, allows for more rights to create. That’s especially important as boards are charged with the responsibility of creating and revising rules and regulations over the course of time to supplement the existing declaration, Greenstein said. Conventional wisdom holds that boards are looking to enforce and control things, but that is quite often not the case. In fact, boards are often looking for ways to avoid controlling things and are sometimes limited in their discretion if the specificity of the language in the declaration man- dates that they do something. Boards often want to be flexible and look to the declaration for ways to prevent a lawsuit, rather than having those governing documents held over their heads. “However, if there are violations of provisions of the declaration or rules, it is the duty of the board to ensure compliance and to enforce the provisions of its documents,” he explained.

Even if boards follow their rules and governing documents, the potential still exists for them to be challenged successfully. Declarations are presumed to be valid unless they are shown to be completely unnecessary or violate state or federal law, Greenstein said. A board that is adhering to its governing documents is either doing something it is authorized to do or refusing to do something it doesn’t have to do.

Take for example an association’s ability to restrict or prohibit the installation of energy efficient systems for aesthetic purposes. There are modern-day, state-by-state regulations that have tried to limit the powers of community associations to regulate these systems. According to some state laws, Greenstein said, associations may only be allowed to limit where these systems can be placed and how they are installed. By contrast, some states allow associations to outright ban systems like solar panels for aesthetic reasons, although with the rising popularity of green technology it is becoming harder to do so. Even regardless of any such laws, Greenstein noted that owners could still successfully challenge a board’s attempts to regulate or prohibit energy efficient systems.

Another example would be an association trying to ban satellite dish- es, even though the FCC Rules and Orders explicitly outline which dishes and installation locations associations are allowed to restrict.

According to Greenstein, other rules that would be tested are those that violate the Fair Housing Act, which protects individuals who are in certain classifications from discrimination. One most often sees these rules successfully challenged by disabled residents, typically requesting that the association modify its practices in such a way as to accommodate their disability. Those issues often fall into two areas: parking and pets. One may see challenges regarding how close parking spaces must be to certain buildings, or if an association can ban all pets or certain types. In these situations, the individual may opt to challenge the association privately or through the government. These matters are often delicate as well, with potential for substantial damages, Greenstein noted, so it is usually best for associations to seek legal counsel.

Another potential Fair Housing Act violation would be trying to en- force single-family use restrictions, especially if the association requires residents to be related. “There is no good reason to include restrictions on the number of occupants allowed, moreover, every city will have occupancy regulations,” Greenstein explained. In sum, any potential violation of the Fair Housing Act or state discrimination law is easy enough for residents to file complaints about, but expensive for associations to deal with. “Be sure to talk with your insurance agent about coverage for these potential trouble spots,” he said.

An association may have an appeals process in place, based on the governing documents. There may be specific language in the declaration about an appeals process, how rules are enforced and how penalties are administered. But absent that language, the board must decide the manner in which an appeal would take place.

“In Minnesota, most associations provide for the board of directors to enforce the rule violations,” Greenstein noted. Some governing documents allow for the association to form a committee specifically for rules and violations. Committees are typically created and staffed by volunteers appointed by the board. Some governing documents, however, allow for the formation of what’s known as committees of the membership; although not very common in Minnesota, Greenstein said, these commit- tees are staffed through the voting in of members, and they are granted authority and autonomy by the governing documents. Committees of the membership may have their own authority to resolve issues separate the board.

Is a committee’s decision final when penalizing a resident rule-breaker, or can a resident appeal to their association’s board? As explained above, Greenstein said it depends on the association’s governing documents. A resident could certainly appeal to the board, but that doesn’t guarantee anything can or will be done. A board may have no power to change the decision of a committee of the membership, for example, depending on the governing documents. Ultimately, it may prove more worthwhile for residents to appeal to a court of law, rather than to the same people who issued the penalty.

In some states, a person does not have the right to appeal to the board. “Minnesota, however, provides that every owner who has violated the governing documents or rules is entitled to a due process hearing before the board,” Greenstein said. Where there is disagreement, however, associations may make alternative dispute resolution available as an alternative to litigation, he noted. An alternative dispute resolution is when a neutral third-party is brought on to look at all the facts of the case and determine the outcome. The cost of an alternative dispute resolution is either paid evenly by those involved or negotiated beforehand. The mediator of the alternative dispute resolution and manner in which it is conducted must also be agreed upon beforehand between all parties. If a party is dissatisfied with the arbitration award (the ruling), they can only reject the award and litigate the case if there was a showing of impropriety during the arbitration process.

Alternative dispute resolution is a popular, and often more affordable, alternative to litigation. The mediator of the resolution is agreed upon be- forehand and may be chosen according to their knowledge of the issue at hand, which cannot be done with a judge prior to litigation.

How does an association determine fine amounts? Common sense and reasonableness should always prevail. Fining someone $5,000 because they failed to take their Christmas wreath off the door by the deadline is very inane and is just going to attract bad publicity. “It would inevitably be struck down by a court reviewing the action. A fine must be reason- ably related to the infraction,” Greenstein said.

“Minnesota does not place restrictions on fine amounts; however, our laws do state that after notice and an opportunity to be heard before the board or a committee appointed by it, the board may levy reasonable fines for violations of the declaration, bylaws, and rules and regulations of the association,” he explained. Fines may be specified in the association’s enforcement policy, though, which is part of its rules and regulations.

In some policies, there are specific fines for certain types of violations. “However, if a board relies on a schedule of fines, it may not vary from that schedule. This often limits the board’s fining authority and compels the board to follow the schedule. This is not always in the association’s best interest,” Greenstein said. In addition to traditional fines, an association may also seek to recover costs it has incurred because a violation has taken place. These costs and expenses are often more enforceable and more reasonable than traditional fines. For example, if an owner violates a parking rule and parks their car in a prohibited place during a snowstorm, the association can likely recoup the cost of having that car towed in order to get the road plowed.

It is common for associations to use an escalating fine schedule, especially for relatively harmless violations, such as putting out trash at the wrong time. Some states even outline these fine schedules for condos and HOAs, making it easier and more enforceable for associations. In Minnesota, where Greenstein said that is not the case, associations may choose to dole out fines at their discretion, where each fine is determined by the body that is performing the hearing and then confirmed by the board. However, the more discretion you put into the system, the more you are required to keep good records of the circumstances surrounding the violation and the fine that was levied.

Speeding tickets may be another way associations can levy fines. For the most part, associations may issue them unless the state or local government has ownership of the road or has been assigned the right to exclusively enforce speed restrictions via state law or some other mechanism. “However, consider how you would effectively determine if someone is speeding. It will be difficult to establish,” Greenstein said. In addition, it’s ill-advised to issue tickets to visitors because the association would likely have difficulty enforcing them. Instead, associations may choose to issue fines to the owners associated with those visitors. In rare instances, associations could also have the right to pull residents over, but that would largely depend on the community’s way of living. For example, if allowed by the local government, a large community association may choose to hire a private security company to hand out speeding tickets.

According to Greenstein, fines should never be simply punitive in nature, and they are not to be considered a true form of revenue. Any fines that are enacted are done so to alleviate the harm or financial cost brought upon the association by violations or simply to obtain compliance. Regardless, fines should be enforced equally throughout the community. Not doing so could be considered a form of discrimination.

The concept of due process is found in the United States Constitution. Due process requires that the person who is being accused is given knowledge of that which they are being accused. There is a certain amount of specificity needed to inform the person of what they did, when they did it and that it was in violation of an identified restriction. After the suspected offender has been notified, they must be given an opportunity to defend themselves of the violation. “In Minnesota, an association board must give someone a right to a hearing before the board, before a fine is placed on a violator’s account. The board must determine whether or not it is likely the person violated a provision of the governing documents or rules,” Greenstein said.

If it can be determined that a violation has actually occurred af- ter following those steps, and the association has the right to fine to begin with, then it can be said that due process has been satisfied and the fine may be levied.

How does the governing body make knowledge of its actions available to residents, and what is meant by transparency? Some people who talk about transparency are talking about governing by the whole. To them, transparency means everything gets voted on by the members and the vast majority must agree upon everything that is enacted. While that may be theoretically ideal, it is not a practical application of transparency in a community association. This is why members of an association vote for people to serve on the board — to represent them when making decisions.

In its realistic application, transparency is when decisions are made known to all owners. Meetings may or may not be open to all owners, for it depends on the meeting location and the topics at hand. But as a general rule, Greenstein said, decisions made by the board must be made during open meetings. Meetings held in a board member’s home will most likely not be made public. There may also be certain topics that are sensitive in nature that require discretion, or demand legal privilege or privacy, and those meetings may not be open to the public. Such private executive sessions do not necessarily make for a lack of transparency. However, all owners are allowed access to meeting minutes and outcomes from open meetings, but not from closed executive sessions, he noted.

“In Minnesota, the board is allowed to close a meeting to the pub- lic when discussing (1) personnel matters; (2) pending or potential litigation, arbitration or other potentially adversarial proceedings, between unit owners, between the board or association and unit owners, or other matters in which any unit owner may have an adversarial interest, if the board determines that closing the meeting is necessary to discuss strategy or to otherwise protect the position of the board or association or the privacy of a unit owner or occupant of a unit; or (3) criminal activity arising within the common interest community if the board determines that closing the meeting is necessary to protect the privacy of the victim or that opening the meeting would jeopardize investigation of the activity,”
Greenstein explained.

Furthermore, open meetings do not give owners the right to interject themselves into the conversation whenever they see fit. There are appropriate times for open homeowner feedback during meetings, and owners must remember that the board was elected to make such decisions. “Unless allowed by the board, non-board members should not be speak- ing at a board meeting,” he noted.

What kind of notice is required to inform residents that a new rule is in effect? The law does not usually outline how an association must give notice of a new rule, but they are generally responsible for doing so in some manner. Once a resolution is signed and adopted, the board could then send it to members. Sometimes an association’s governing documents may specify how and when the board gives notice of new rules. Some associations may give little to no notice, but doing so risks the possibility of members challenging those rules. “Minnesota requires reasonable notice; most attorneys read this to mean 7-10 days advance notice,” Greenstein said.

How do associations define “reasonable”? Reasonableness is hard to strictly define, but it’s often simple to pinpoint in any given situation. According to Greenstein, anything that leads to ridicule or widespread criticism is most likely unreasonable. Anything that is easily defendable is most likely reasonable. For example, it would be reasonable for associa- tions to require that renovation work be permitted and specify that con- tractors be licensed and bonded.

Can associations place restrictions that would affect the sale of properties in their communities? Greenstein said that every restriction has the potential to impact the sale of properties in either a negative or positive way. Restrictions provide the stability of maintaining things that residents do not want changed. The premise of the entire restrictive property scheme is that the rules are desired by the people who will buy the property and are designed to uphold a certain community standard. Given this, it’s difficult to argue that a restriction actually hurts the value of the property. Classic examples of restrictions that come into question here would be pet policies and leasing restrictions. One prospective buyer might be turned away by such restrictions, while others might find them ideal. “Use restrictions in Minnesota cannot be simply voted on as a rule. Use restrictions, such as leasing and no-smoking in units, must be in the association’s declaration in order to be enforceable,” Greenstein said.

Can an association grant a variance to any type of rule? According to Greenstein, an association can grant a variance if its governing documents first allow it, and even then only under certain limited conditions. Reasons for granting a variance should not be subjective or favor-based and dependent on who the owner knows on the board; reasons should al- ways be objective, he said. Those objective standards should always show that the owner did not self-create the cause for their variance request.

What are considered reasonable architectural controls? The declaration can contain a wide array of architectural controls detailing specifically how a home can and cannot be built and what can be added to the property. Reasonability largely depends on what is written in the govern- ing documents, Greenstein explained. Beyond that, any other architectural control would be deemed reasonable as long as it doesn’t violate the law.

“If a board believes that a rule is important enough to remain in the association’s set of rules, the board must enforce the rule,” Greenstein noted. What are some of the negative consequences for associations that don’t enforce their own rules? If a board fails to enforce the association’s rules and regulations, the association can be sued. Individual board members can also be sued. Additionally, associations may not be able to get away with re-enforcing an old rule that has not be used in a while, he said, especially without first notifying the residents. If a board has no intention of enforcing a certain rule, Greenstein advised it would be in their best interest to have it removed.

Associations should also proceed with caution when attempting to restrict certain visual elements, such as holiday displays and political signs. In some states, those types of regulations are not necessarily legal because the state regulates an association’s powers in a free speech con- text. Greenstein explained that associations are viewed by some states as quasi-governmental in the application of free speech, assembly and religion; so they should handle these subjects accordingly, much like any other government entity. Instead of prohibiting certain types of holiday displays, the association should attempt to only regulate their size and extent, including how long they are allowed to remain visible in the community. “In Minnesota, the associations are given discretion in allowing holiday displays and political signs,” Greenstein noted. As for political signs, they may be easier to restrict in a condo association due to more common property being shared between residents, while HOA residents may have their own lawns for displaying signs. “However, if an association’s declaration prohibits signs, even political signs can be restricted,” he said.

Reasonableness should also govern other exterior issues, such as light- ing. For example, an association may be sued if a member is injured while passing through an area with insufficient lighting. In that case, one could say that the amount of lighting was unreasonable and that the association knew of its dangerous potential ahead of time. But ultimately, boards should base their decisions on reasonableness and not the likelihood of being sued. It is the board’s fiduciary responsibility to act in the best interest of the community — not their own — anyway.

Declarations establish the components of the common areas versus the homeowner-owned areas. The governing documents contain those delineations, which typically include boundaries, easement rights, and where units, lots and common elements begin and end. An encroachment, Greenstein said, is when an individual member builds or puts something on a common element or area.

How do associations deal with encroachments in common areas? There are a few ways of dealing with this, Greenstein said. Using the ex- ample of a resident who planted shrubbery in the common area, one meth- od would simply involve the forced removal of the item. The association can send notice to the owner that the item in question will be removed by the association at the owner’s expense. If the encroachment might actually harm the common property or cause drainage or other problems, he said, removal may be the only way to remedy the situation. However, absent such a threat or other factors, it’s advised that associations simply render the encroachment harmless and come to an agreement with the owner. In some cases, the association may need to go to court.

Occasionally, a developer may construct something that encroaches on a common element or area. In such a situation, nothing can usually be done. Most Minnesota association declarations allow waivers for encroachments caused by the developer, Greenstein noted.
Like plant life, play sets can sometimes encroach on common areas. Before they are forcibly removed or made the subject of an agreement between the association and owner, it should first be determined if they are a temporary structure. Play sets that are simple enough to remove may not even be considered an issue.

Collection of Delinquent Dues

April 3, 2019

Delinquent homeowners can affect a community in a variety of negative ways. Obviously, the association needs homeowner dues to be paid, preferably on time, in order to operate. However, there are many residual, undesirable consequences of having too many delinquent ac- counts. A community with an abundance of homeowners in arrears could be declined for a capital improvement loan when needed, therefore preventing the community from performing necessary major repairs or replacements. The Federal Housing Administration (FHA) also looks at the number of delinquent homeowners in a community in its approval process and will not approve communities with past-due accounts over a certain percentage. If an association can’t obtain FHA approval, which allows potential purchasers to obtain FHA mortgages for homes in the community, owners will have a smaller pool of available buyers. Cleaning up past-due accounts in an expeditious manner will not only benefit the association itself but also all the home- owners who have a stake in the community. How, then, should this be done?


According to attorney Daniel B. Greenstein, the first step in the process of collecting delinquent dues from a unit owner, generally, is a letter from the association. This is a formal notice demanding that the unit owner pay his or her outstanding assessments, which are detailed within the document. This notice also warns of impending legal action if the debt is not paid by the specified deadline. Depending on the situation, the association’s letter may have a variety of other contents. Association counsel may thereafter send such a notice.

There are usually two options an association can pursue, he said, if the demand letter was unsuccessful in recovering the assessments owed. Generally, those two options are filing for a money judgment lawsuit or a foreclosure of the lien against the delinquent unit.
Some states give associations the option of evicting delinquent owners prior to going through the foreclosure process. However, this option is not allowed in Minnesota. In some states, the association also has to re- cord a lien before it can foreclose on it. “Under the statutes in Minnesota governing most associations, a paper lien is not required to be filed; rather, any association with a delinquent account has an automatic statutory lien against the delinquent unit. There are two ways that a Minnesota association can collect delinquent sums due it. The first is to bring a suit for a personal money judgment against the record owner. Once a judgment is obtained, the association is entitled to attempt to execute on the person’s assets, such as wages and bank accounts. If the delinquent party (judgment debtor) has no non-exempt assets, such as wages or savings, it is extremely difficult to collect from that judgment debtor,” Greenstein explained.

A second method of collecting on delinquent accounts is to initiate a foreclosure. Most association lien foreclosures are performed by advertisement; this means that there is no court involvement, he noted. The lien foreclosure process takes about eight months to complete and requires the association to spend money on costs and expenses. “All of these costs and expenses are recoverable from the delinquent owner if he or she redeems the unit from the sheriff’s sale by paying the association the total sums due,” Greenstein said.

He continued, “The foreclosure process looks like this: after many required notices are sent to the delinquent owner, the sheriff of the county where the property is located actually auctions off the unit to the highest bidder. The association with the lien can bid its full lien amount without posting any payments to the sheriff. If successful, the association takes title to the unit subject to the owner’s six month redemption period and any first mortgage or tax lien on the property. The association does not need to make payments on the mortgage or tax lien but must satisfy them upon selling the property.” After the foreclosure process, the purchaser of the property will become responsible for those.

When should an association pursue collecting delinquent assessments? It depends on the association, and perhaps even the state, Greenstein said, but most pursue collections after three payments have been missed or after $500 has accrued, whichever comes first. This is an effort to make sure that fees do not immediately overshadow the assessments to be collected. Additionally, it is often easier for an owner to catch up and pay a lower balance quickly, which is important for getting back on track and staying current on upcoming assessments. “We often recommend starting the process much sooner,” said Greenstein. “The reason is that our first step must be a thirty-day demand letter that complies with the Fair Debt Collections Practices Act. So, it is important to keep in mind that there will initially be another thirty-day period in which the delinquent owner can pay their account balance.”

Can associations embarrass their residents by publicly disclosing their delinquencies? Associations cannot make it a point to embarrass residents on purpose in order to motivate them to pay overdue assessments, Greenstein said. Doing so in order to punish a delinquent owner could constitute a breach of fiduciary duty. However, some associations can disclose to residents the breakdown of an assessment, including specific amounts owed by specific owners, because homeowners have the right to know everything that goes into calculating assessments. Some states even require associations to do that regardless. “In Minnesota, most attorneys recommend that associations not disclose which homeowners are delinquent; rather, delinquencies may be discussed at closed meetings,” he ex- plained. Moreover, when disclosing balances, it is crucial for associations to be confident in their accuracy, as stating incorrect amounts may make them liable of defamation.

As for keeping records throughout a collections process, associations should already have previously adopted policies regarding the collections process and what records need to be kept. It should also make sure that all accounting is correct.

How can an association determine if an account is likely to be collectible? One way to determine this is to look at the equity of the house and the balance on the mortgage. If the house is worth more than the mortgage, it’s most likely collectible. “In Minnesota, we cannot obtain a current mortgage balance from public records; however, we can see when the mortgage loan was given and the original amount. Often, this gives us clues as to the current amount owed to the lender,” Greenstein explained.

On the other hand, if the house is worth less than the balance of the mortgage, the house is empty, or the owner is missing and/or judgement- proof, then there is not much likelihood of the account being collectible, at least from the owner. The association could then use the empty unit to try to generate revenue by renting it out, which is a common solution.

Depending on the state, there may be two options for foreclosure: foreclosure by advertisement and judicial foreclosure. As mentioned above, foreclosure by advertisement is a way of serving a foreclosure if the owner proves hard to find, moreover, it is a quick and efficient process without court involvement.

“A judicial foreclosure, sometimes called a foreclosure by action, re- quires the court to approve each step of the process and typically takes much longer than a foreclosure by action,” Greenstein said. A judicial foreclosure must be performed by the court, and a court must enter judgement and authorize the home’s sale. Once the foreclosure complaint is served, there is a period of time during which the owner can file an answer. If the owner does not respond in time, the association can proceed with the foreclosure process. A sheriff’s sale is then scheduled and held, with the buyer from that sale becoming the unit’s new owner. “In both types of foreclosure, advertisement and action, the delinquent owner has a six month period to redeem the property by paying off the balance due,” he noted.

Debt collectors have a variety of obligations in regard to communication with debtors. But most debt collection laws, such as the United States Fair Debt Collections Practice Act (FDCPA), are only applicable to third- party collectors and not the party to whom the debt is owed, such as an association. According to Greenstein, any rules on communication are to be followed by the association’s attorney, who should be the association’s main form of contact with the debtor. The association’s attorney should be kept informed of anything relating to that unit, to make sure everyone is on the same page. This includes informing the attorney every time a payment is made.

With regard to associations themselves, communications should be undertaken in the best way possible to help ensure the recovery of money owed and to get owners to pay assessments moving forward. “However, once the association’s attorney is involved, all communication should go through the legal counsel,” Greenstein, advised.

The Fair Debt Collection Practices Act (FDCPA) is a federal law that regulates the collections practices of third-party debt collectors in order to protect debtors. If the FDCPA is applicable with regard to a given debt, then there are a variety of controls on the debt collector pursuing that debt. “Associations are not governed by the statute, as the association itself is not a third-party debt collector, because it is collecting its own debt,” Greenstein said. However, he noted, collection agencies and attorneys are third party debt collectors. Therefore, associations do not have to comply with the FDCPA when setting up payment plans or pursuing debtors.

If a delinquent owner is willing to cooperate and sign paperwork, Greenstein advised that the association should draw up a repayment plan, especially if the balance is relatively small. This is often the best way for associations to recover delinquent fees.

With regard to setting up a repayment plan, the plan should first be put in writing to protect the association. According to Greenstein, the agreement should focus on not only the amount of money owed as of the date of the agreement, but also on the amount that has not yet accrued. The length of the repayment period should be reasonable for both the owner and the association—neither too long for the association to ever recover the money, nor too short for the owner to feasibly repay the debt while staying current.

The plan should hold the owner accountable for staying current on future assessments, while still repaying delinquent ones. If the owner fails to stay current on future assessments, the agreement should allow the association to take action and take a judgment on the balance due. “This is typically done by having the owner sign a confession of judgment at the same time as the settlement agreement,” Greenstein said. This gives the association a way to address the debt if the owner doesn’t follow through with the agreement.

Payment plans may vary by owner, but the association should remain mindful that they should not vary by much. Plans should be drawn ac- cording to an owner’s ability to pay, and deviations should not be so great as to make the association liable of discrimination. Associations also have the option of outlining repayment plans in their governing documents, he said, “But such plans customarily are in the rules so that the future directors can make changes to the repayment plans as times change.”

Are new owners responsible for paying assessments owed on fore- closed properties? “Technically, a new owner is not personally liable for the debts which came due before the new owner took title. However, the association will still have a lien against the new owner’s unit for unpaid assessments. If not paid, the association can foreclose the lien. This means it is critical for every new owner to receive a ‘dues current’ letter from the association before closing,” Greenstein explained. “This is necessary to ensure that a new owner is not stuck with a lien from the previous owners’ failure to pay all sums due to the association.”

In some instances, small claims court may be a viable option when pursuing delinquent fees. It could be a smart and affordable option for an association because using an attorney is often not necessary.

When an owner fails to pay assessments, the association can bring them to small claims court and file a standard breach of contract case. This is because the declaration of the association is considered a form of contract, and the owners are expected to pay the assessments as described therein, Greenstein explained. However, going about it in this way does not necessarily ensure that the association will recover anything. “A conciliation court referee has the discretion to compromise the amount and give the owner a discount. Any decision made in small claims court can be appealed by either party to district court, where the process starts over,” he said.

To “execute” an asset means to take or seize it. An execution is the physical act of enforcing a judgment, and garnishments and levies are types of executions. Typically, common language provides that a garnishment is a wage execution, while a levy is a bank account execution.

A wage garnishment is when the owner’s employer withholds a certain portion of the owner’s nonexempt wages (wages above the poverty line). According to Greenstein, before the association can request a garnishment it must first obtain a judgment against the owner. “A wage garnishment and a bank levy should be handled by your legal counsel,” he advised.

If an owner fails to pay assessments, the association will have a lien. “In all Minnesota associations formed since 1994, every association has an automatic lien by statute against any owner that is delinquent in his or her account with the association. It is automatic. In older associations, a paper lien may have to be drafted and recorded against the delinquent owner’s unit. Check with your legal counsel on which process will apply to your association,” Greenstein explained.

According to Greenstein, the point in the debt collection process at which a lien is actually recorded depends on the association and its governing documents. It is recommended that associations do not hesitate to record a lien as it is a way of protecting the association in the event of an owner’s bankruptcy or attempt to sell or refinance their property. Some associations may issue their demand letter to the delinquent owner prior to filing a lien, while other associations may file the lien first. As stated earlier, some states also require associations to record a lien prior to going through the foreclosure process.

It is not advisable to pursue delinquent owners who decide to walk away from their properties. Instead, Greenstein said, it is typically more worthwhile for an association to foreclose its lien and take ownership of the unit. This will allow the association to sell the unit or to rent it out to recover money. It is very unlikely that an association would recover payment if they personally sued an owner who has abandoned their unit. When an owner “walks away from” their property, they are essentially giving the property to the bank in exchange for not owing the remaining mortgage.

If the association tries to pursue a delinquent owner who has abandoned their property, it can only really pursue that owner’s personal as- sets, as the property is no longer theirs. Pursuing the owner’s personal assets would require a money judgment from the court. “But it is highly unlikely the recovery will work. If a person walks away from their home, they are normally in dire straights financially,” Greenstein said.

The association’s options for pursuing personal assets after receiving a money judgment would be to execute a garnishment or levy. However, Greenstein noted that seeking recovery of debt through personal assets is never a sure thing. For example, if the owner declares bankruptcy, and depending on the kind of bankruptcy, the association may never recover that money directly from the owner.

Once an owner files for bankruptcy, all creditors must cease collections against the owner, including the association. This is required by the bankruptcy code. There are usually two types of bankruptcy seen in a situation like this: Chapter Seven bankruptcy and Chapter Thirteen bankruptcy.

A Chapter Seven bankruptcy entails a liquidation of the owner’s assets. In this situation, once an owner is discharged from bankruptcy court, the association can no longer collect from the owner personally, though it is still entitled to collect on its lien. The association is still entitled to collect future assessments if they are not paid as well.

A Chapter Thirteen bankruptcy involves a creating a repayment plan for the owner in which they must pay the bankruptcy trustee a monthly amount to be distributed to the creditors, including the association. This plan is usually completed between three to five years. In this situation, the association should recover at least most of the money owed, if not all.

A judicial foreclosure is a foreclosure via the court system. It involves recording a lien and filing a foreclosure complaint in a civil lawsuit. “Minnesota does not require a judicial foreclosure but allows foreclosures by advertisement,” Greenstein noted. Some states require that all foreclosures be judicial ones. A judicial foreclosure must be performed by the court, and a court must enter judgement and authorize the home’s sale. Once the foreclosure sale goes through in a judicial foreclosure, it is final.

Minnesota allows for foreclosure by advertisement in which the fore- closure notice is published publicly in some manner, including a foreclosure notice on the front door of the property. According to Greenstein, “Foreclosure by advertisement is faster and less expensive than a judicial foreclosure, and it is most often used when foreclosing an association’s lien in Minnesota.”

“In both a judicial foreclosure and a foreclosure by advertisement, the owner will have six months following the sale to redeem the unit. A redemption occurs when the owner pays the association in full, including its foreclosure costs and legal fees, and retires the entire balance of sums due on his or her account with the association,” he said.

f the unit’s lender comes in once the association has already started the foreclosure, can the association discontinue it? The association can discontinue the foreclosure process at any time, Greenstein said, “But there is a risk in doing so.” There is no guarantee, or law, that requires the lender to finish their foreclosure process. “They may stop the process for any number of reasons and should that happen, the association will have to start its foreclosure process over from the beginning,” he said.

Should an association move forward with its own foreclosure once the lender begins their foreclosure process? “Typically, no. If a first mortgage holder is foreclosing, it most often makes sense to let the lender finish its foreclosure and not start the process. This saves the association the money needed to pursue a foreclosure. In most cases, if the owner does not redeem the unit from his or her lender, the lender will be required to pay the association six months’ of assessments at the end of the six month redemption period,” Greenstein explained.

When must a lender pay delinquent assessments? In Minnesota, a purchaser via a sheriff’s sale is not required to pay any assessments that accrued prior to that sale. “But the lender must pay the association six months’ worth of assessments at the end of the redemption period if the lender becomes the property owner,” he repeated.

When is the bank held responsible for the property? The bank be- comes responsible for a property once the sheriff’s deed has been issued to it during a foreclosure or if it receives a deed-in-lieu of foreclosure, which is when the owner is allowed to walk away from their property and ownership in exchange for not being held responsible for the remaining mortgage. Once the bank receives a deed for the property in its name, it must send a copy to the association. “In Minnesota, the lender is not responsible for past assessments, except that it must pay the association six months’ of assessments when the redemption period expires,” Greenstein said. It does, however, become responsible for paying that property’s future assessments until it is sold. If the bank becomes delinquent on the assessments, the association is then allowed to pursue collections from the bank.

The bank may also be held responsible for not maintaining whatever that unit is responsible for, such as certain repairs and perhaps mowing the lawn, he noted. If the governing documents state that the units are individually responsible for such things, the association may hold the bank responsible and may also pursue it in court for unaddressed maintenance issues. Alternatively, the association may have the ability to maintain parts of the unit on the owner’s behalf and may bill the owner or bank for that upkeep.

What are the pros and cons of foreclosing on a delinquent owner with the intent to rent out the unit to recoup association fees? In general, Greenstein said, there are no negative consequences to renting out an empty unit that is under the association’s control. Doing so allows the association to both recover debt and potentially secure upcoming assessments from that unit, while ensuring that the unit stays fit for habitation.

According to Greenstein, in most cases short sales are not in the association’s best interest. Short sales occur with properties that have little to no equity. While a short sale may ensure paid assessments from a new owner going forward, it will also usually result in the association not recouping those delinquent assessments. Associations are better off going through the foreclosure process and renting out that unit in the meantime to recover at least some money. A short sale is acceptable, however, if it results in a full recovery of debt for the association, even if the lender is at a loss.

After the association has foreclosed its lien for assessments, it becomes the owner of the unit and subject to any first mortgage of record. This means the association owns the unit and has the right of use and pos- session of the unit in any manner it sees fit. “Often, it takes a mortgage company anywhere from nine months to a year or longer to initiate a foreclosure. Due to this, after the association takes title to a unit, there is a window for the association to generate rental income from the property,” Greenstein said.

The association then has the right to rent out a property to generate monthly rental income and can apply that rental income to the delinquent amount it is owed due to the previous owner’s nonpayment of assessments. “If the association intends on doing this, there are several things which should be kept in mind. First, tenants are protected and will have the right to possession of the unit if a valid lease is entered into with the association. The lease must contain language that informs the tenant the unit is subject to a first mortgage but the tenants are adequately protected be- cause Minnesota law requires any mortgage company to honor an existing lease that is in place or provide at minimum 90 days’ notice for the tenant to vacate,” Greenstein explained. In most circumstances, a one-year lease will expire well before the mortgage company forecloses and takes title. This is because it usually takes over six months for a mortgage to foreclose and sell the property at sheriff’s sale; after the sale, the mortgage company does not take title to the property until the expiration of the redemption period, which is an additional six months.

“Even if there happened to be several months left on the lease when the mortgage company takes title, the mortgage company will then con- tact the tenant, direct them to make rent payments to them, rather than to the association, and either honor the lease until the remainder of the term or provide a 90 days’ notice to vacate, which will likely extend beyond the lease term anyway,” he said. In some circumstances, the bank will even offer the tenant “cash for keys” which is a lump sum payment to the tenant in exchange for them agreeing to vacate the property prior to the expiration of the lease term.

Another consideration is the condition of the unit. Minnesota law re- quires that anyone renting a property ensure the unit is “habitable.” “This means the unit must have heat, be free from pests and not having any conditions which could adversely affect the health, safety or welfare of any occupants. Therefore, the unit should be inspected prior to renting to make sure it is in adequate condition. If significant money must be spent to put the unit in rentable shape, you may want to rethink your plan,” Greenstein advised. The association can provide language in the lease to avoid being responsible for appliances or fixtures.

Finally, the association should consider the rental value of similar property in the area. “Typically, an association that is going to rent a fore- closed property will charge less for rent than the fair market rental value of similar property in the area. This is because the property is subject to a first mortgage, and the association generally will not warrant appliances or make any repairs which are not necessary to maintain the property in habitable conditions,” Greenstein explained. The association should con- sider what it could rent for and discuss what costs may be involved in cleaning the unit and preparing it to be rented.

Once a unit is rented, the income can be applied to the previous owner’s delinquent balance. “Make sure to apply monies received to the oldest debt first,” he said. In many cases, the rental income will exceed the amount which was owed on the unit prior to the assessment lien fore- closure. “If or when the first mortgage steps in and forecloses there is still a delinquent amount owed, the association can collect the previous six months of assessments from the bank when it takes title. This is true whether the unit is rented or not,” Greenstein said.

If an association decides to rent out an empty, delinquent unit in order to recover unpaid fees, it will then find itself in the position of being a landlord. An association’s best practice when it comes to its landlord du- ties is to follow the law. Many states have detailed laws governing the ob- ligations of landlords, so associations should become familiar with those laws and follow them. Regardless, Greenstein advised that it is best for associations to hire a professional to ensure compliance with all relevant laws.

“As foreclosures have increased since 2008, many investors look for association foreclosure sales and offer to pay the association in full on such account and take over the association’s position by way of assignment. In other words, in exchange for payment in full of a delinquent account, the association assigns its lien rights to a third party. The third party looks to negotiate with the owner’s lender to buy out the mortgage and own the unit, usually for resale. This has many benefits for the association,” Greenstein explained.

If repairs must be made to the unit, then the third party is responsible for making them, as they are responsible at that point for making sure the unit remains habitable, much like a traditional landlord. “If a renter is found for the unit, the third party must deal with the renter. During this time period, the third party is responsible for all assessments due the association, just like any other owner,” he said.

As for security deposits, associations typically have to follow the same regulations that other landlords must follow. In most states, landlords are required to give the tenant a receipt as proof that the security deposit is in a secure bank account, separate from the landlord’s personal assets. They may also be required to pay interest on the security deposit. Not follow- ing the proper procedures for handling a tenant’s security deposit could subject the association to damages and attorney’s fees for that tenant. Given this, it’s best to have leases reviewed by the association’s attorney.

If a lender comes in when the association is renting a unit, can it argue that there are no delinquent assessments that it must pay? That is possible if everything that has accrued after the sheriff’s sale has been paid, or if the association is obligated to apply the rental income to current assessments first, Greenstein said. However, it may be the case that the rental income was put towards repairs, past assessments and other costs, and there was no income left to put toward current and future assessments. Depending on the priority of the different costs associated with the unit, as outlined by the governing documents and state laws, the bank may still be responsible for current and upcoming assessments, even if there is rental income coming in.

To sum up the collections options available to associations, it generally comes down to foreclosure or a money judgment.

A foreclosure is an in rem proceeding, which is an action that focuses simply on the property and does not seek any personal judgment against the homeowner. A foreclosure judgment does not allow asset execution, Greenstein noted. It is only used to take possession of the delinquent property. The process begins by recording a lien, though a foreclosure may not necessarily follow from a lien. However, there is no foreclosure without a lien.

A money judgment, on the other hand, allows the creditor to take an individual’s non-exempt personal assets, including money. “However, as a general rule, if the owner is not working it may be difficult to find any non-exempt assets from which the association can get paid,” he said.

The Association’s Records

April 2, 2019

Knowing which association records should be kept, where to keep them, and how to store them can help an association maintain ac- cess to important historical data. Association records should contain information that the board can use as a reference for future projects or possible evidence in a lawsuit or audit. Records are useful when the board is negotiating contracts for landscaping or snow removal. Boards can re-fer to work records, financial records, or even minutes from the meeting where a contractor was chosen to weigh future decisions.

Should associations keep records, and if so, what records should be kept? Most associations keep records, and some states have statutes that outline which records are required and for how long they must be kept. According to Greenstein, Minnesota does not have such a statute. An association’s gov-erning documents may also describe which records are supposed to be kept. Records that are commonly kept include financial records, tax records, unit files, meeting minutes and work records (including contracts with vendors, employee records, warranty documents, etc.).

Financial records and the manner in which they are kept are typically based on recommendations by an auditor or standard accounting principles. Tax returns and records should be kept for at least seven years, per the Internal Revenue Service, as that is how far back an association may be audited. It is recommended that the association keep it’s corporate re- cords indefinitely, as that is the association’s corporate history. Apart from government statutes and requirements from the governing documents, associations should use their own reasonable discretion as to how long to hold on to various records.

According to Greenstein, associations in Minnesota are generally required to keep meeting minutes. The details of the minutes are determined by their relevance and importance for future decisions and any potential problems. Decisions made by the board must be recorded and perhaps even the deliberations that led to those decisions as well. Certain facts and circumstances relating to decisions may be included in the minutes. Essentially, anything that may prove useful in upholding decisions in the future should be recorded, in case a decision is challenged, Greenstein advised. Meeting minutes should not usually be full transcripts of board meetings. The length of time for which minutes must be kept varies by state law and the community’s governing documents. “However, it is a best practice to always keep association minutes,” he said.

The location and manner of storage of the records depends on the association and any regulations from the state or the community’s governing documents, Greenstein said. An association with a clubhouse will usually store its records there, and one with a management company will usually store its records with them. If an association has neither of these things, it may choose to store its records in the home of a board member or the board president. If the information is stored at someone’s home, Greenstein said that person must make it available to other members on request. Many associations are now choosing to keep electronic records. When doing so, it is important to keep a backup and to make sure they can be reproduced on paper if needed.

Currently, there are no restrictions against making records available online for members to view. However, Greenstein advised, associations do need to be careful about posting the personal information of owners and other private information online.

Who has access to records and can some records remain private? Individual owners should have access to records, including financial ones. “Minnesota law provides that all owners in an association have access to the association’s financial documents,” Greenstein said. Associations may try to set a limit on the number of records an owner may review, but that ultimately depends on its governing documents and state statutes. Any process put in place by the association must be reasonable and lawful, and access to records will likely be allowed within reason.

What is an association’s responsibility regarding members’ personal information? Access to members’ personal information depends on the community’s governing documents and state law. “Minnesota’s laws are fairly silent on this issue,” Greenstein noted. Access over other privacy concerns also varies. For example, if an owner decided to build an addition to their house, such as a deck, community members would be able to see the paperwork for that in that owner’s file. In reality though, knowledge of the deck wouldn’t be kept private anyway as it would be quite obvious to neighbors. The only information that may truly be kept private would be anything connected with the community’s attorney-client privilege, he said, “or certain types of board meetings which can be closed to the owners.”

Association Board Member Elections

April 1, 2019

Cultivating, nominating and electing board members is something that should always be on the minds of current board members. Politics in any arena can be tricky, but in associations it can also sometimes be difficult to find people willing to serve. Many people feel unqualified or even afraid to volunteer due to fears of being taunted by potentially disgruntled residents. While these fears are not wholly un- founded, current board members should encourage volunteerism by running fair elections, showing that residents with different types of views and knowledge are needed and desired, and letting potential candidates know that their service will be valued, even if all residents don’t agree with every decision they make. Minnesota associations have safeguards in place to indemnify board members from potential liability, so if a resident has the time and desire to serve, they shouldn’t be afraid to run for the board.

Associations are not generally required to have written election procedures, and it is unusual for associations to have them. Some states, though, heavily regulate an association’s election process.

Is there any legal obligation to provide members notice of an election? According to Greenstein, notice of an election is governed by Minnesota statutes and/or the community’s governing documents. Both would include details such as the date, timeliness of the notice, and to some extent, even the content of it. State law and/or the governing documents also dictate the frequency of elections for an association. The same applies for requiring annual meetings. An annual meeting is typically required, but again, it ultimately depends upon the state law and the governing documents. If proper notice is not given, Greenstein noted, it could be said the election is invalid.

Can associations install term limits for their board members? Associations can install term limits for their board members if the bylaws or the declaration are amended to include term limitation. “Minnesota bylaws do typically contain term limit provisions,” Greenstein said.

What is the distinction between directors and officers? Directors are those who are elected by the members to the board, and officers are elected by directors or the membership to perform specific duties. There are usually only a few officers on a board. For example, on a seven-member board, there may only be three officers, such as a president, vice president and treasurer. Officers are usually also directors. In Minnesota, he noted, officers must be directors and must be elected by the board, not the membership.

How is the nominating committee chosen and what is its role? Most associations do not have a nominating committee. For associations whose bylaws require one, the committee is created by the community members or the board. A nominating committee’s purpose is to nominate candidates who are suitable for running for the board.

This process may be set by law, depending on the state. “In Minnesota, most governing documents allow the board or a nominating committee to select candidates for the board,” Greenstein said. Regardless of what an association’s governing documents provide, any member is empowered to nominate any member in “good standing,” whether it be the owner themselves or another. In Minnesota, “good standing” is often taken to be when someone is not delinquent on any assessments or other fees and has no outstanding association judgments to fulfill.

Are nominations from the floor or ‘write-ins’ allowed? In some states, associations may have flexibility regarding nominations from the floor and/or write-in candidates. In that regard, it is best to approach each situation carefully, and decide it on a case-by-case basis within the association’s reasonable authority. An association should not ban floor nominations or write-in candidates, Greenstein advised, otherwise it may find itself without enough candidates. In some cases, an association’s govern- ing documents may allow for a closed slate prior to a meeting, in which case nominations from the floor would not be allowed.

Can an association ban self-nomination? Greenstein said it depends on state law and the governing documents, though a court, even aside from any law, would be very skeptical of an association banning self-nomination.

What is the procedure for a member who is not nominated by the nominating committee to be listed on the ballot? It depends on the situation of that particular association and whether such a thing is even permit- ted by the association’s governing documents.

Can an association’s board endorse a single candidate or a slate of candidates? According to Greenstein, an association or board disseminating materials endorsing someone is frowned upon, even if it was allowed by state law. If board members are endorsing a candidate, it should only be personally, and endorsements should not appear on the ballot or election materials. Some states have, though, declared an official association endorsement or ‘audit’ of the various candidacies to be outside the bounds of the board’s authority.

Can associations adopt a rule that restricts certain people from be- coming board members? Generally speaking, Greenstein noted, in order to enforce something like that, it would have to be made part of the by- laws or declaration. However, situations could be taken on a case-by-case basis. For example, if a community had evidence that someone was steal- ing money, a court could validate a board’s decision prohibiting that per- son from running. Outside of that, associations are generally unable to prohibit people from running. “However, members of the association can distribute public information concerning any candidate,” he said.

Can an association request a background check on potential board members? Generally, Greenstein said, a board does not have the authority to request background checks.

How far can an association go in vetting applicants? According to Greenstein, if the bylaws specify that the only qualification to be on the board is that one must be an owner of a home within the community, then the association does not have the authority to vet anything other than a person’s status as a homeowner. In order to make it legal to vet candidates for other reasons, it may be acceptable to amend one’s bylaws to provide for that, as long as a state statute doesn’t prohibit it.

During the actual campaign phase of an election, do associations need to provide equal access to association media for candidates to campaign? “Minnesota does not govern this type of a situation; however, if an association is providing one candidate with a certain platform or access to association facilities, it should really do so with all other candidates,” Greenstein explained.

If someone believes that a candidate is making false claims, can the association notify members of this? An association would need to be very careful in addressing so-called false claims. It is really up to individual members to use their discretion in differentiating between true and false claims, Greenstein said. The only false claims an association should ad- dress are those related to the manner and location of the election, in order to maintain the integrity of the election.

Can associations require members to register in order to vote in a board election? Most governing documents would state that everyone who owns a unit and is in good standing can vote. A board could require owners to register in order to vote if that stipulation is put into the by- laws. “Some bylaws require that owners sign in at any meeting where a vote will take place. The voting process is most often left to the board’s discretion provided the board does not violate the governing documents,” Greenstein said.

How does the ballot process work and what does it involve? The ballot process differs from state to state and community to community, Greenstein noted. In general, nominations are received and candidates are announced. Then, owners receive their ballot, fill it out, and submit it according to the methods allowed by the association. Usually, ballots can be submitted in person, by mail, by proxy, or through electronic means. The votes are collected at the end of voting and are counted by the election judges. Election judges are selected prior to voting, and they must not be a candidate in the election or related to someone who is. Furthermore, an association cannot prevent anyone from voting by electronic means if the association already allows it. “Note that in Minnesota, even if provided for in the governing documents, an association cannot prevent an owner from voting simply because that owner is delinquent on his or her account with the association,” he said.

Who has access to election results? According to Greenstein, there may be governing document provisions or statutes that address access to election results, but they are usually accessible by the election judges, the board and the property manager. The candidates and their representatives may also be present for the counting of the votes. If other members are interested in re- viewing the ballots and proxies, they may submit a request to the association. Ballots and proxies are kept for a certain period of time after the election, ac- cording to an association’s governing documents or state law, but they are not usually kept in the association’s records indefinitely.


A proxy is a document that allows for someone to legally vote on another person’s behalf. For example, if an owner is out of town during the election, they may authorize someone they know to serve as their proxy holder and vote on their behalf according to the proxy. According to Greenstein, the proxy could be general and allow the proxy holder to vote according to how they see fit, or it could be specific and direct the holder to vote in a specific way. The proxy must be filled out, signed and dated by the owner, not the proxy holder. Some associations require owners to use a form specified by the association, but otherwise the owner could submit their own proxy form.

What’s the process for validating a proxy vote? “Minnesota does not require any specific process for validating a proxy,” he said. However, there are other states that limit proxy voting and make it more difficult to establish a valid proxy. Proxies can always be revoked if the owner decides to vote in person.

Is the use of proxies limited at all? “Usually not, but any restriction would need to be in the association’s governing documents,” Greenstein said.

Cumulative voting allows for a member to cast their number of allot- ted votes for a single candidate. For example, if there are three seats up for election and four candidates, a member could vote for one candidate up to three times or for one candidate twice and another candidate once, etc. Cumulative voting may or may not be allowed according to an association’s governing documents. State law may also regulate or otherwise pro- hibit such voting. “Most Minnesota governing documents do not allow cumulative voting,” Greenstein noted.

When an election results in a tie, how should the association proceed? The board would have to come up with some reasonable way to deter- mine a winner in the event of a tie, especially if it isn’t addressed in the governing documents, Greenstein explained. If candidates refuse to with- draw, options include having a run-off election, or even flipping a coin, as long as the parties in the election agree to the method beforehand.

What’s the process for an election challenge or recount? Many associations are not required to have any set process, but members may generally ask for a recount or send a notice challenging the results. Associations are advised to grant a recount and respond to challenges. If the recount results are the same, a member may then choose to file a lawsuit, though that is rare.

The Fair Housing Act and Civil Rights

March 28, 2019

Violations of the United States Fair Housing Act (FHA) can result in severe penalties for associations. Knowing how to govern your community responsibly in this regard is highly important. What is a common sense approach to staying in compliance with the FHA?


There are generally two subsets to the FHA and community associations: age-restricted, adult communities and residents with disabilities. Age-restricted communities, also known as adult communities, are ex- empt from part of the FHA, as they are allowed to discriminate towards residents based on age and sometimes familial status. These communities, though, must keep certain records in order to preserve this exemption.

The second subset is in relation to disabled people or people who claim to be disabled. When an owner or resident with a disability requests an accommodation (a modification of the rules) he or she feels is necessary to facilitate his or her use of the property, the most proactive approach the association could take would be to seek legal counsel. An association should never say “no” to a request until it’s absolutely necessary and appropriate.

Regardless, Greenstein advised, it’s best for associations to try to treat everyone the same, or accordingly under similar circumstances. Doing so limits the possibility of discrimination.

What are some problems with, pitfalls of and penalties for non-compliance with the FHA? According to Greenstein, the act provides for the recovery of legal fees and penalties, which means an association needs to be very careful and completely certain that it is making the correct deci- sion before it denies any request. Even if it hasn’t denied a request, it is also important for an association to address a request in a timely manner. Prolonging action on a request could be just as bad as denying it. Many associations also fall into the pitfall of discrimination through seemingly harmless regulations, he noted, such as pool restrictions, wherein they may be discriminating against a protected class without even realizing it.

Associations need to be very careful and certain when denying these kinds of requests. If an association is found to have unreasonably denied a request or discriminated against someone, they will be responsible for not only damages but the attorney’s fees and costs of the injured party as well. Because of this, penalties for violating the FHA are substantial.


The Department of Housing and Urban Development (HUD) is responsible for enforcing the aspects of the FHA related to associations. Each state has its own enforcement mechanism as well. A resident who believes their association has committed a violation could file a charge with either their state mechanism or the HUD, Greenstein advised. If dis- crimination is found, they will proceed with a lawsuit against the association on behalf of the resident. If not, the resident may still file a lawsuit against the association on their own.

What are some civil rights, and how do they apply to associations? The FHA makes it illegal for an association to discriminate in certain fashions in the provision of services. Some prohibited discriminatory bases include, but are not limited to, race, creed, religion, color, national origin, age, ancestry, nationality, marital/domestic partnership/ civil union status, sex, gender identity, sexual orientation, disability and familial status.

Could FHA violations be considered civil violations or criminal penalties? According to Greenstein, FHA violations are almost always considered civil violations, not criminal. In very rare situations, FHA violations could also be criminal violations if they violate the civil rights amendments or otherwise violate a federal criminal statute.

What constitutes problematic wording in a covenant or rule made up by the association? A rule made by an association may prove problematic if it contains anything that differentiates between residents based on one of the protected classifications, Greenstein explained.

In and of itself, an act of discrimination is not necessarily illegal. People discriminate all the time; for example, we discriminate when we purchase one type of car over another or hire one person instead of another. It is only when it is directed at a protected class that is becomes problematic. A clear example of such a violation would be a rule that prohibits children from riding the elevator. Furthermore, Greenstein noted, an association could be held responsible if it does not address discrimination between residents if it becomes aware of the issue.

As stated earlier, protected classes may include race, creed, religion, color, national origin, age, ancestry, nationality, marital/domestic partner- ship/civil union status, sex, gender identity, sexual orientation, disability and familial status.

What is discrimination based on protected classes? According to Greenstein, illegal discrimination would be an association’s actions that discriminate on the basis of one of the identified classes. For example, an association can regulate a lounge in regard to use, but not in regard to the type of person using it. He explained that a rule that prohibits families with children from using the lounge would be illegal discrimination based on age and familial status. Essentially, whenever a decision or rule by the board singles out or unfairly burdens a protected class, that board has discriminated based on a protected class.

What are considered reasonable accommodations for people with disabilities? For example, one would think it reasonable for a wheelchair-bound resident to request the addition of a ramp to one of the common area buildings. However, Greenstein explained, if an engineer determines that the desired ramp would not be safe or feasible, that same request might not be reasonable. Otherwise, associations are required to give dis- abled residents reasonable accommodations that are necessary to afford them equal use and enjoyment of their home and the services provided by the association, especially if it does not impose an undue burden on the association.

According to Greenstein, religion is absolutely a potential legal con- cern in the area of civil rights. For example, an association may ban residents displaying anything in a common element hallway, while someone’s religion may require a religious display in such a location, like a mezuzah.

How are religious displays treated in the FHA? They are treated the same way as any other matter related to reasonable accommodations. If the association allows a display for one religion, Greenstein noted, they must then allow similar displays for others so as not to discriminate. Banning all religious displays, though, may prove problematic, since residents could present that as a violation of the FHA. Furthermore, such a restriction may even be seen as a violation of free speech.

Can associations prohibit religious services in common areas? The association would have to decide if that regulation is reasonable under the circumstances. “Common areas are used by residents all the time. When it comes to regulating such a thing, the association should focus more on the time, place and manner of assembly, not the type,” Greenstein said. Associations should ideally avoid becoming involved in issues of religion, if at all possible.

Can an association place any restrictions against sex offenders? Sex offenders and felons are not listed as protected classes by the FHA, Greenstein noted, so an association may be able to discriminate against them. However, the HUD has stated that if restricting them appears to have an impact on an actual protected class, such as race, then the association could potentially be found liable of discrimination.

Can an association prevent a sex offender from renting a unit? Greenstein said that individual owners decide how they handle their private homes, including to whom they rent. It is feasible, then, for those owners to choose to not rent to sex offenders, without the association being held liable for such a discrimination.

But, according to Greenstein, it is very difficult otherwise for an association to regulate who is allowed to rent. If a community amends its bylaws to provide for the association having more of a stake or interest in the rental of units, perhaps there would be some right. However, he said, owners often realize that such a restriction affects the marketability and value of their units.

Are associations allowed to have any bias for or against families with children? The only associations that could regulate such a thing would be lawfully established adult communities, whose purpose is to do just that.

In other associations, any rule meant to impact children should be based on conduct. As an example, if the community has a gym, children should not be banned outright. Instead, Greenstein noted, rules should prohibit the type of conduct that people typically associate with children.

“In recent years, a Minnesota condominium had a rule which restricted children from riding bikes in a certain green area of common space. Because HUD believed this rule unfairly impacted families with children, it was found to be in violation of fair housing laws and the association paid a significant penalty. The rule could easily have just prohibited bicycle riding in the common space by everyone instead of limiting the rule to children,” Greenstein explained.

Is an association required to allow residents to keep animals if they have a prescription from their doctor for a comfort or service animal? According to Greenstein, this should be addressed on a case-by-case basis, but if the resident requires the animal in order to have equal use and enjoyment of the property, then the association should really allow it. Regardless, an association should present all requests to their attorney to ensure it acts appropriately, especially in regard to the FHA.

Can an association question a resident about the prescription or medical note for that animal? The association can indeed question a resident about the prescription or medical note, Greenstein said, unless their dis- ability is obvious. Such medical notes need to meet the specifications required by law, and the association can require residents to provide acceptable notes. The association cannot question the severity of the disability, but they are allowed to ask about the relationship between the disability and the required accommodation. “Because of the complexity of this area of the law, it is prudent to obtain advice from your attorney whenever a new situation arises,” Greenstein said.

What is the difference between a comfort animal and a service animal? A service animal performs a tangible service for a person with a disability, such as a guide dog guiding someone who is blind. On the other hand, a comfort animal’s purpose is to provide psychological support.

Can associations restrict the size of these animals? According to Greenstein, they cannot. It is difficult for associations to impose size and height restrictions on service and comfort animals. Some states even deem it unreasonable for associations to regulate it. For example, an owner’s guide dog might be above the acceptable height, so the association may need to allow it. The association needs to show a legitimate reason for these restrictions if they do want to try to enforce them, Greenstein explained. Again, many of these decisions must be made on a case-by-case basis, and it is often better to simply allow such accommodations.

Does the Americans with Disabilities Act (ADA) affect how an association makes up its rules for service animals? The Americans with Disabilities Act does not apply to this type of situation, Greenstein said. Instead, the ADA applies to public accommodations and physical constructions, i.e. whether or not an association is required to modify a door- way, stairwell, etc.

Can an association ever restrict the areas where the comfort or service animals are allowed? Placing restrictions on the areas where the comfort or service animals are allowed depends on the situation, Greenstein noted. Limiting the number of comfort or service animals a resident can have also varies by situation, but it largely depends on how it impacts the resident’s condition. Associations may also be able to limit the areas where animals are allowed in order to comply with health regulations.

Is it common or even permissible for associations to require that the animals are photographed when they are first brought onto the property? If, for instance, a disabled person’s service animal won’t sit for a picture, does the association then prevent that person from having the animal? Associations must handle each case with care, Greenstein said, erring on the side of caution when making decisions. If an association requires pets to be photographed, then all pets within the community must be photographed, not just certain ones. “If an assistance animal will not sit for a photograph, the disabled person should not be penalized,” Greenstein stated.

Transitions

March 27, 2019

A transition occurs when control of the association transfers from the developer, sometimes known as the declarant, to the members of the association. Many states mandate a point at which the developer must transfer control, such as a number of years after the establishment of the first board of directors, or once a certain majority of properties are sold. It can also occur sooner if the developer chooses to transfer control. Before transferring responsibility, however, it is important for the association to confirm that the developer complied with the standard practices for construction, property management, operating the board of directors, etc.


The first step is to present the nature of the defects to the developer and see what they say. One would then hope that the developer would address it. But it’s possible that the developer is no longer in business or outright refuses to take action. If either is the case, and if the defects prove to be substantial, it’s likely that the association will need to file a lawsuit. “However, it is critical to notify the developer in writing as soon as you even suspect a defect. Any delay may seriously lessen the association’s rights and remedies,” Greenstein said.

Oftentimes, when an association facing construction defects is not working with one of the larger development companies, Greenstein ex- plained, its recourse may not necessarily come from the developer or the contractors the developer used. Instead, the problem may be resolved through the insurance carriers and insurance policies that were taken out and maintained by the developer and contractors throughout the course of the construction. This is important for associations to remember, especially if they are dealing with substantial defects.

Prior to transition, the members of the developer’s board each have a fiduciary responsibility to address any defects discovered. In fact, the developer’s board has the same fiduciary responsibilities as the post-transition board. When members of a developer’s board are sued after a transition, Greenstein said, it is often for failing to resolve any defects or other such concerns. Thus, it is advisable to document how any problems were ad- dressed. Individual owners do not have much say in the matter prior to transition, as the board is still under the control of the developer.

Yes, Greenstein noted, and that is almost always the case. However, case law exists at the national level which states that it is in violation of the board’s—developer and non-developer both—fiduciary duty to keep assessments artificially low. Furthermore, he said, it is usually required that the developer fund an association’s operations in a certain way through- out the course of the development, and to make disclosures regarding the same.

According to Greenstein, homeowners do not have the right to inspect a developer’s financial records, though they do have access to their association’s records. A developer is also required by the state to file certain documents pertaining to the approvals for building and selling units. Those records are presumed to be available to the public.

Is the association held responsible for that contract? Perhaps, Greenstein said, but it would depend on with whom the contract is made and their relationship with the developer. Ideally, these kinds of contracts are addressed on an individual basis. “Contracts instated prior to the transition may be terminated by the owner controlled board of directors typically for up to two years from the time owner control of the board took place,” he said. It is recommended that all active contracts be reviewed by the new board after the transition. Contracts involving the association are not typically considered valid if the developer enters into them after the transition.

Construction Defects

March 26, 2019

A construction defect is a constructed item with a condition that deviates from the accepted architectural plans, building codes, and/or industry standards. One example would be walls that are missing vapor barriers.

According to Greenstein, the first thing an association should do if a construction defect is found is to evaluate the concern and determine if it is in fact a defect. This is done by contacting an expert for a professional opinion. The next steps would be to determine the full nature of the deviation, the cost associated with its repair, and whether or not any consequential damages exist or will later result because of it. Once the defect has been fully assessed, it may then be necessary to contact the developer. The developer should be contacted and advised of the problem if the association believes the developer may be able to remedy it, and if it is in the best interest of the community for the developer to do so, Greenstein explained. Giving notice gives the developer a chance to fix the defect, or at least witness the defect firsthand. Notice is often given through certified mail, or however stated in the sales contract. Some states may have a statute of limitation outlining at what point an association may still request repairs from the developer. If there is a much larger problem, Greenstein said, and it is one that the developer cannot fix, the association will most likely have to file suit or make the repairs itself.

“Like most issues under contract law, the longer an association waits to notify the developer in writing of the defect and then bring a law suit, the better the chances that the developer will prevail. It is critical to give the developer a written notice of the defect as soon as it is determined and then to speak with your attorney, even before hearing back from the developer. Many developers are known to push off any complaints of defects until the association loses its rights to pursue a claim,” Greenstein explained.

Defects found in any of the common property elements are to be handled by the association, and they are determined to be either the responsibility of the association or the developer. Though the association does not have a contract regarding this with the developer, Greenstein noted, it can often claim the implied warranty of habitability, which requires the constructions to be defect-free and suitable for habitation. In some cases, the association or developer may even be responsible for defects in individual units if the defects are part of the original construction. However, unit owners are usually responsible for addressing any defects over which they have exclusive ownership, such as within the general bounds of their unit; this would include everything from the paint on the drywall and inward.

“Both the association and the individual unit owners have implied warranties and often express warranties. In addition, Minnesota has some of the most liberal implied warranties of any other states,” Greenstein said. The implied warranties, however, tend to greatly outlast the period of any express warranty. Furthermore, he stated that Minnesota has statutes limiting the period of time in which a claim can be reported after the defect has become known.

According to Greenstein, an association has the fiduciary responsibility to maintain, repair and protect the common elements of the community, even if some are found to have been built incorrectly. Emergency repairs must be made, if necessary. The association needs to be able to collect the cost of repairs from the responsible parties, yet they must not allow the defects to worsen. Allowing defects to worsen would both breach the association’s fiduciary duty and increase the amount of damages that need to be recovered, Greenstein said. If the developer outright refuses to fix the defect, then the association will have to act to the extent that it is responsible for the defect. Besides that, a lawsuit against a developer may take a few years to resolve.

The key for pursuing damages is to document everything. Greenstein advised that the association should give prior notice to the contractors and/or developer if it hopes to recover the full amount of the cost of re- pairing the defect. Again, giving notice through certified mail or written means goes back to the importance of proper documentation. Giving notice allows the developer to view the defect firsthand before it is fixed, not necessarily to make repairs. The association could pay its expert to photograph the defect so as to provide more detailed and accurate reports, otherwise, the contractor fixing the defect should be required to provide these items. Regardless, the repair should be thoroughly documented throughout the entire process.

Furthermore, even if the developer claims that a warranty has expired, it is still not definitive. Greenstein said the association should still have its attorney look into all potential implied warranties. The post-transition board also has full authority to make changes to the rules and regulations set in place by the developer’s board.

Arbitration in construction defect claims may or may not be mandatory and varies by state, Greenstein noted. Though it may not be mandatory, it is allowed if all parties involved in the claim agree to arbitration. The arbitration process is similar to that of a court proceeding, except without a jury. Arbitration is also a way for a company to try to reduce its losses, so it is often a developer’s preferred method for settling a claim. Sometimes they even go so far as to mandate arbitration, instead of litigation, by putting it in the bylaws or the owners’ purchase agreements, Greenstein explained. Because of this, some states have made it difficult for developers to force associations on this matter. Arbitration can be just as expensive as litigation, so many associations would rather just go to court.

Even if a construction claim goes to court, some courts may refer the case to arbitration, knowing that extensive expertise will be needed. Some states may even require arbitration from the outset in certain situations, he said, depending on the parties involved and the amount of damages at hand.

Contact Info:

Daniel B. Greenstein, Esq.
Greenstein & Sellers, PLLC
825 Nicollet Mall, Suite 1648
Minneapolis, MN 55402
Phone: (612) 816-5804
dan@greensteinsellers.com
greensteinsellers.com

Minnesota Accounting

Michael P. Mullen, CPA

Michael P. Mullen, CPA

Michael P. Mullen, CPA, PLLC

Association Accounting and Budgets

April 4, 2019

Where should the board begin when creating budgets? What are the reporting requirements and rules for handling association funds? What are the proper accounting methods? How can an association be assured they don’t be- come the victims of theft or fraud when it comes to their funds? We spoke with Michael P. Mullen, CPA, who is the owner of Michael P. Mullen, CPA, PLLC, of Minneapolis, Minnesota, to answer these questions and enlighten readers on other important accounting topics.

There are two different accounting methods, cash and accrual. Which is the best one for associations? According to Mullen, the accrual basis of accounting would be best, if implemented properly. It follows generally accepted accounting principles (GAAP). He said that the reason for this is that it presents a more accurate picture of the financial statements for the association. Mullen explained that the cash basis of accounting only recognizes revenue when the money is received and expenses when the money is paid. But the accrual basis of accounting recognizes revenue when earned (when assessments are made) and expenses when incurred (when the service has been performed). Also, the accrual basis accounting recognizes revenue in the year it was supposed to be collected, whether it’s collected or not. This method gives the association a true picture of what the revenue and expenses were for a particular fiscal year.

Mullen said this is, in fact, a professional requirement for how the financial statements for an audit or review must be presented by a CPA firm. In Minnesota, if a Certified Public Accountant (CPA) is performing audits or reviews, they are required to follow the professional standards as set forth by the American Institute of Certified Public Accountants (AICPA) and be enrolled in the Peer Review program. This mandates that reports be done on an accrual basis.

When creating the association’s operating fund budget, of course it makes sense to categorize expenses. The objective of the association is to have a zero-based operating fund budget (revenues = expenses). What is the best way to categorize these expenses, and how detailed should the categories be?

Mullen explained that there are certain categories that are commonly used, and within those are sub-categories, which break the main category into greater detail. One of the main categories that associations typically list is the “Administrative” section. Within that section there will be sub-groupings such as office, paper, postage, etc. Another category that would appear on a typical association budget is “Utilities”— which includes things such as electricity, gas, water/sewer, etc. A typical association budget would also include a category for “Repairs & Maintenance.” This category can be as detailed as needed and can include anything having to do with interior or exterior common area maintenance and repairs. “Sometimes it’s better to be very detailed,” Mullen said. Other typical categories include “Professional Fees” and “Management Fees.” If an association has a clubhouse that they rent for events, for example, they can have a category of expenses specifically for that. “An association should keep the clubhouse as a separate category, so the association knows the exact costs pertaining to that common element,” Mullen recommended. Other categories include insurance, taxes, lawn care, snow removal, etc. Lastly, Minnesota state statute requires that associations have a separate category for reserve expenses. This is where the association records their reserve expenses, also referred to by the AICPA as the major future repair and replacement costs, for Common Interest Realty Associations (CIRAs). These are the main categories Mullen recommends for boards creating budgets.

The advantage of having detailed sub-categories is that they allow an association to see the exact costs compared to the budget each month. “For example, in the Repairs & Maintenance category, you would not record an expense for something like major siding, roof or asphalt repair or replacement, because those would go in the reserve category. You’re not going to have big ticket items that go through the operating expenses, because they don’t necessarily occur every year,” Mullen explained. The more detailed the budget is, the more you will see what you are paying for. “You’re always going to have some fixed expenses, such as management fees, but you are going to have variable costs that come up,” he said. Mullen also noted that associations should not make too many categories so as to make it impractical, and that it largely depends on the size of the association.

How often should the budget be analyzed and by whom? The budget is the responsibility of the board of directors. There is usually a lot of support from the association’s manager, but the board is ultimately responsible. Mullen recommended reviewing the budget to actual comparison each month. “They should be gathering data and trying to figure out what assessment level they need for the next fiscal year. An association will usually finalize its budget for the upcoming year toward the end of their current year.

Does the association’s CPA firm typically review the budget prior to it being approved by the board? “We typically see it after it’s approved,” Mullen said. Although, sometimes boards will consult with their CPA firm prior to approving their budgets, to see if they have any recommendations. “It’s generally a good idea,” he said, “because your auditors pro- vide a second set of eyes.”

It’s the fund that accounts for all of the association’s operating revenue and expenses. Your operating fund balance, at the end of the year, is like the retained earnings in the business world (a for- profit entity). It’s the net of the profits and losses for all the operating years since the association’s inception.that the reserve account will never fall into a deficit position or below a set minimum amount.

What are an association’s annual reporting requirements for financial statements? According to Mullen, under the AICPA rules, the association’s CPA firm is required to follow GAAP for financial statement presentations for community associations. He warned that if you use a CPA firm that is not familiar with accounting for CIRAs, their reporting will most likely not conform with the rules on financial statement presentation for a community association.

Unlike a budget, which is the board of director’s projection for revenue and expenses for the fiscal year, the internal financial statements consist of the balance sheet and statement of revenues and expenses. The board and manager should analyze these reports when preparing the budget for the next year and look for items they think may be variable in the upcoming year. For example, if the association knows that water rates will be going up in their city or municipality, they should incorporate the increase into their upcoming budget.

Minnesota statutes require that the association maintain an adequate reserve fund and that those monies be kept separate from operating fund monies activity. Additionally, associations are required to reevaluate the adequacy of their reserve funds at least once every three years. “They should also do a physical inspection of the property each year,” Mullen said. “This is important to make sure that the correct amount designated towards major future repair and replacement expenses are incorporated into the reserve portion of the budget.”

As mentioned earlier, associations in Minnesota are required to reevaluate their reserves at least once every three years. But are there any other requirements when it comes to reserves for associations in Minnesota?

According to Mullen, there are several other requirements. In general, replacement reserves must be included in the annual budget, and the amount allocated should be enough to reasonably replace the association’s aging components over their estimated remaining useful lives and their estimated future replacement costs. The exception to this is that associations are not required by, Minnesota law, to annually fund reserves for components that, at that time, are estimated to last longer than 30 years.

Mullen noted that associations are also required to keep their reserves separate from their operating account, and that the re- serves may not be used for operating expenses. An association can, however, use their reserves as security when seeking a loan.
Lastly, if the association finds itself with surplus funds after providing for common expenses and its budgeted reserves, it can either credit it to reserves or use it to reduce future assessments for the unit owners. This is typically determined by the board, unless the association’s declaration addresses it.

What types of tax returns can an association file? With rare exceptions, there are two types of federal tax returns a CIRA can choose from: Form 1120 (regular corporation), or Form 1120-H (homeowner association). “The calculation of income for both of these types of returns are basically the same. One difference is that laundry income is taxable on the 1120-H, but not on the 1120,” Mullen explained.

For Form 1120, the association must separate the membership income from nonmembership income, because membership income is not subject to tax under Internal Revenue Code (IRC) 277. The membership income is the income received from the members, such as assessments and late charges. The taxable income is the portion received from nonmembers, such as interest income, dividends and capital gains.

Meanwhile, for Form 1120-H, the association must separate the exempt function income from nonexempt function income, because exempt function income is not subject to tax under Internal Revenue Code (IRC) 528. The exempt function income is the income received from the members, such as assessments and late charges. The taxable income is the portion received from nonmembers, such as interest income, dividends and capital gains.

According to Mullen, the calculation for the expenses is the same on both types of returns. “An association can allocate expenses that relate to the taxable income, thus creating a deduction,” he stated. Examples of this includes management fees, accounting, audits, tax preparation, insurance and administrative expenses.

So what are the differences between filing the 1120 versus the 1120- H? “One of the biggest differences is that on Form 1120, the net taxable income is subject to a flat tax rate of 21% (IRS rule change effective beginning in 2018), while Form 1120-H has a flat tax rate of 30%, after a $100 specific deduction,” said Mullen.

In Minnesota, as well as certain other states, associations still need to file a state tax return, and depending on which type of federal return is selected, it dictates which state form is required. Minnesota’s tax rate is 9.8% regardless of which form is filed, Mullen noted.
A word of caution should be taken into consideration when filing as a regular corporation (Form 1120) where there is a net membership income. Mullen explained that that excess can be exempt or deferred under the Internal Revenue Rule 70-604, which states that if there are excess assessments over expenses, the excess should either be refunded to the members (not recommended) or applied to the following year’s assessments (recommended). The election must be made by the membership and before the tax return is filed.

Since June 1, 1994, Minnesota law requires community associations to have an independent CPA perform a review, at a minimum, of their financial statements at the end of the fiscal year. Many associations elect to to have a higher level of service, which is an audit. However, Mullen noted, an association can waive the review requirement if at least 30% of the association’s voting interest elects to do so.

This vote to opt out of the review, though, needs to take place within 60 days after the end of the fiscal year, through a meeting of unit owners or by mailing a ballot. Furthermore, if the association votes to waive the review, the waiver only counts towards the fiscal year that was voted upon, and not additional years as well. If a review does occur, every member of the association must receive the reviewed financial statements within 180 days of that fiscal year’s end.

According to Mullen, Minnesota law requires a review to be per- formed by a CPA who is licensed according to the AICPA requirements. The CPA must also be independent of the association and cannot be a member of the association, or employed by the association’s declarant or those affiliated with the declarant.

According to Mullen, an audit is the highest level of financial statement service that only a CPA can perform. It provides the expression of an opinion as to whether the financial statements are fairly presented in all material respects. The work preformed includes, but is not limited to: the inspection of invoices, canceled checks, bank statements and the general ledger to determine that transactions were properly recorded — that monies were properly collected and deposited and that checks to vendors were supported by an invoice. “We evaluate the internal control structure of the association to determine whether weaknesses exist. In an audit, we also perform all of the procedures that are part of a review engagement,” Mullen explained.

A review, Mullen noted, is the second highest level of financial statement service that, again, only a CPA can perform. It provides limited assurance as to whether the financial statements require any material modification. The work performed includes, but is not limited to: analytical procedures such as comparing current year actual revenue and expense balances to the budgeted amounts, comparing current year actual to prior year actual, and analyzing material fluctuations to determine if the explanation is reasonable. “We reconcile account balances to the corresponding subsidiary ledger, but we do not look into the detail as this would be an audit procedure,” he said.

In summary, an audit requires many more procedures than a review. An audit also provides an opinion versus a limited level of assurance and, as a result, audits cost more than reviews. “Most associations will have an audit every three years, at a minimum,” Mullen said. Associations may also elect to have an audit instead of a review in the event that any of the following situations occur during the year:

• Documents require audit
• Change in management company
• Turnover from developer
• Significant change of board members
• Large insurance claim
• Lawsuit
• Large reserve expenses
• Special assessment
• Association has a loan payable
• Association has investments that fluctuate on market value
• Association sold property

How can associations protect themselves from fraud? The most common scenario of theft of association funds occurs when a self-managed association allows their treasurer to physically make deposits of the association’s money and also approves invoices, pay bills, signs checks, reconciles the bank statements and prepares financial statements. “There are no segregation of duties in that scenario,” said Mullen. “That’s the biggest threat of fraud to a self-managed association.”

Another common threat is when a board allows for only one signer on a bank account. Most management companies pay all of the bills for the association, since that is what they are hired to do. Mullen suggests boards set a dollar amount threshold based on the size of their budget so that all non-contractual or extraordinary invoices needing to be paid, that exceed that amount, require two signatures — one from the management company, and one from the board. Just allowing one board member to be the signer on a reserve savings, certificate of deposit, or checking ac- count, without requiring two signatures, gives the signer the opportunity to commit fraud. “With a second signer on a bank account, you would need to have the collusion of two individuals in order to commit fraud, like paying fictitious bills, for example. It could happen, but it’s less likely if you have more than one signer on the bank account,” he said. Mullen recommended having either two board members as signers, or a board member and someone from the association’s management company.

What are some of the warning signs that theft or fraud is occurring? One warning sign is when a board member or a management company, who is the only signer on the bank account, prevents online access to the bank statements. “That is a fraud indicator,” Mullen said. “They’re con- trolling the bank account as the only signer, and no one else is privy to those bank statements. That’s your biggest problem right there.”

Another indicator is if you have board members that have altered their lifestyle. “You see them purchasing more than usual, or living beyond their means,” he said. He also warns about board members who express they have financial concerns of their own, or for a family member. A per- son experiencing a desperate financial situation could be a potential threat for committing fraud against the association.

Mullen said that the most important thing to look for in a Certified Public Accounting firm is if they are a member of the Minnesota Society of Certified Public Accountants and the AICPA. If the firm is a member of the AICPA and they perform audits or reviews, they’re mandated to belong to the Peer Review Program. So the association needs to find out if the firm is a part of the AICPA, and if they are, that the CPA firm is having their mandated Peer Reviews done every three years. Also, what types of reports are they getting on these Peer Reviews?

If an association is bringing someone in to perform an audit, Mullen strongly recommended asking if they are in compliance with the AICPA’s Peer Review Program. He said further that you should ask to see a copy of their latest Peer Review acceptance letter. Mullen stressed that, in Minnesota, CPAs are not allowed to perform audits or reviews unless they are part of the Peer Review Program.

Firms are reviewed on how they prepare financial statements, how they audit and review, how they focus their work papers, if they’re keep- ing up with the standards of the AICPA, and the rules on how to do financial statements for community associations, and more. “Those are very important things to consider,” he said.

Mullen also recommended asking about the firm’s expertise in work- ing with community associations. Find out if they are preparing financials using the guidelines for a CIRA. What are the qualifications of the CPA firm’s staff that will be doing the association’s audit? Which continuing education classes do the firm’s accountants take to maintain their CPA licenses? Are any of those classes taken for condominium and homeowner associations? What type of continuing education keeps them up to date with condominium associations? “These are all very important questions to consider,” Mullen said.

The cost for accounting services will vary based on several factors, such as if an association has a lot of reserve activity, if they’re bringing in monthly dues versus annual dues, the size of the association in terms of the number of cash receipts and cash disbursements per month, the number of units in the association and whether they are legally organized as a condominium association or a homeowner association. “Those items are what indicates to a CPA firm what to charge an association,” Mullen explained.

He also said the majority of associations are billed on an agreed upon fixed fee listed in the engagement letter. “They pay one fee for an audit and a lesser fee if a review is selected. Fees typically include preparation of the association’s federal and state corporate tax returns,” he said.

One last piece of advice Mullen gives is not to select a firm based solely on price. “Instead, look to a CPA firm that is a specialist who understands the unique and complex financial, accounting, and tax issues facing community associations today,” he said.

Contact Info:

Michael P. Mullen, CPA
Michael P. Mullen, CPA, PLLC
5912 West 35th Street
Minneapolis, MN 55416
Phone: (952) 928-3011
mike@cpamullen.com
www.cpamullen.com

Minnesota Construction

Ryan Arvola, CMCA

Ryan Arvola, CMCA

Hoffman Weber Construction

Association Property Maintenance — Working With a Building Contractor

Property maintenance is one of the most important responsibilities community association managers and board members must assume. Keeping the association’s physical components up to date and free of flaws not only ensures the safety of its residents, but maintains the value of the community and each unit as well. Given this, it is critical for community managers to possess good general knowledge of structural components and, more importantly, to establish trusted, ongoing relationships with reliable construction industry specialists. To gain insight into choosing contractors and addressing common property issues, we spoke with Ryan Arvola, Multi-Family Director of Hoffman Weber Construction in Minneapolis, Minnesota.

Associations vary in shape and size, but many often face the same construction problems. Roofs in particular may prove susceptible to problems throughout the year, and Arvola stated that roof leak repairs are one of the most common types of repairs association contractors have to make.

How can associations stay on top of roof problems? According to Arvola, a quality asphalt shingle roof—the most common type in North America—should last about 20 to 25 years. “Roof leaks typically only re- veal themselves when there is a wet spot on the ceiling. This can be avoided by having the roofs inspected annually by a trusted contractor,” he said. During the annual inspection, the contractor should look for damaged or loose shingles, failed vent boots and chimney flashing, cracked caulk- ing, soft decking, and pooling water. If a roofing problem is discovered, Arvola recommended addressing it right away. Serious structural damage, mold growth and insect infestation can develop long before a problem is noticed. Associations should address small problems immediately and begin to budget for replacement well before the end of the roof’s lifespan approaches.

According to Arvola, other additional common repairs include win- dow and siding flashing improvements, deck repairs and attic vent cor-rections. Attic ventilation is particularly important. “When an attic lacks proper insulation and balanced ventilation, it heats the roof deck and can cause premature shingle failure and ice dams. Meanwhile, if moisture is allowed to rise into the attic from the living space below, it can freeze and rain down when it melts, and cause wood rot,” he said. Ideally, attic ventilation is balanced with equal amounts of fresh air intake at the eaves and warm air exhaust at the ridge.

What exactly is an ice dam? Arvola explained that ice dams occur when snow melts on the roof, over the relatively warmer attic, and refreezes over the cooler soffit at the eaves. This creates a ridge (or dam) that causes water to pool above it. If the water backs up beyond the ice and water shield membrane under the shingles, it can soak through the roof deck and down into the home. “It’s important to understand that leaks of- ten do not originate directly above the area where the water spot appears. Water can follow framing and appear some distance from where the roof or flashing require repair,” Arvola noted.

How should associations deal with ice dams? Arvola advised that ice dams should always be removed by a professional. “It is extremely important that anyone who gets up on a roof in the winter time is properly insured, has the knowledge and equipment to deal with the dangers of an icy, sloped roof and understands how to properly remove the ice dam without damaging the roof,” he said. Arvola noted that associations can take certain preventative steps that may help deter ice dams from forming, such as having proper attic insulation and ventilation, and having a professional remove excessive snow from the roof.

Lastly, all of these items could be addressed with a properly created Preventative Maintenance Plan (PMP), which most Minnesota community associations have been required to have since 2019. “Each association has many differences including size, age, types of materials and so on, so the PMP should be customized to each association’s needs,” Arvola noted. A comprehensive and well executed PMP should greatly help an association be more proactive than reactive. Reactive repairs are inherently more costly, time consuming and stressful for the contractor, the manager and the association.

It is very important for an association to select the appropriate con- tractors for their community. Arvola discussed what managers and board members should look for in a contractor: “Contractors that are knowledgeable on a particular issue will typically discuss the topic with confidence, can speak about past experiences and can also provide references of associations that they have done this type of work for in the past.”

Contractors should also have any insurance that may be required. A reputable contractor will keep his contractor’s insurance renewed and will even look into special insurance requirements for the project.
What are some recommendations for managers and board members to ensure proper quotes from contractors? Arvola explained that those handling the project should figure out which details are the most important to the association and to convey that to the contractors. Are drawings or renderings necessary or useful? What about the materials used? “What are the main reasons for doing this project, and what are your short term and long term goals? What are your concerns with the project?” Arvola stated. Other important details may include the timeframe, the budget, installation practices, references and the possibility of financing.

Detailed specifications are always important in a Request for Proposal (RFP), and Arvola said that given such details, an experienced contractor can often provide valuable insight on a project, instead of just providing a cost estimate. “Providing detailed specifications and expectations will also allow the board to get apples-to-apples bids,” he said. Doing so may help the association to avoid hiring a contractor at a lower price, only to discover that their proposal did not include critical components, which would then require change orders (additions to the contract). “They can often end up costing more in the long run, with much more hassle and frustration, than just selecting a contractor that was more up front and realistic with the proposal price,” Arvola said.

Once you have chosen a contractor, it is very important to have a contract that includes detailed project specifications, drawings and renderings (when necessary), timeframes, communication protocol, pricing and warranty information, and the logistics of deliveries and staging areas. To avoid conflicts, the association should try to address all expectations in writing beforehand. “However, none of this matters if the association is not 100% confident that the contractor will follow through with all these details and stand behind their work. Having worked with a contractor in the past, or getting solid references from other associations, is just as important as the contract itself,” Arvola stated.

While an association is addressing a repair or an ongoing project, it goes without saying that each project may come with a certain set of expectations. What standards should be expected from a contractor’s personnel while they are on the premises? “Any tradesman or supplier, or anyone else at a job site hired by the contractor for a project, represents the contractor and is expected to be respectful of the property and the owners,” Arvola stated.

What are some common reasons for delays on projects? While the contractor should reasonably commit to meet the agreed upon production schedule, even the most prepared contractor will run into delays. Arvola explained that reasons for delays may include the weather, material shortages, labor shortages or backups, delayed selections or changes made by the owners or association, miscommunication and additional work that could not have been anticipated, such as deteriorated wall sheath- ing. Regardless, the contractor should keep the association well informed about delays at every stage of the project.

What are some unreasonable expectations from a contractor’s perspective? Arvola explained that a homeowner’s or client’s expectations for project timing can sometimes be unrealistic and that he has learned how important it is to set proper expectations regarding this. “We find it much more beneficial to take the extra time to ensure all decisions and plans are ironed out before the start of the project, to help avoid complications and delays mid-project. With some projects there can be a lot of selections and specifications to make, and with association communities there are typi- cally quite a few more decision makers involved than with a single-family project. So this process can take quite a bit longer than most homeowners might think,” he said. There can be many moving parts to any given proj- ect, and allowing enough time before and after contract signing is vital for a project to run smoothly.

Lastly, safety is always important to consider during a project, for both the association’s residents and the contractor’s personnel. “The contractor holds the responsibility of ensuring a safe work environment throughout the project. This could include ensuring the job site is set up with proper scaffolding, having the crews dressed in required safety gear and following OSHA requirements in general,” Arvola said. Many reputable contractors also choose to partner with a professional safety consultant, to ensure that they are meeting all safety requirements.

Throughout the course of any project, proper communication should be maintained between the contractor, managers, board members, and residents. Since every situation is different, Arvola explained that the con- tractor should create a communication plan that’s based on what works best for everyone involved.

According to Arvola, the contractor may communicate various project details to the residents prior to beginning work, so that they know what to expect. “Before the project begins, it is vital to provide all home- owners with project information, such as the project timeline, when their home will be affected and a detailed list of homeowner expectations,” he noted. Doing so allows homeowners an opportunity to give feedback about the project before it occurs. Arvola finds that homeowners will also often provide any other pertinent information or requests that the contractor should know about, such as not using the outdoor electrical outlets on their unit. The project manager can then retain such details for future reference, if needed, and to make sure they plan accordingly for every unit they work on.

Once a project is underway, Arvola said that the contractor should assign an accessible and responsive central point of contact for the project and share that contact’s information with homeowners before work begins. “Since the contractor has the most up to date project information, they are best suited to respond to homeowner questions. We are then able to copy the board members and community managers, as desired,” he ex- plained. Doing so takes some of the burden off of the manager and board members. This also establishes one point of contact for the project, which allows for efficient communication while keeping the association managers and board members informed.

How often and in what format can managers, board members, and residents expect to be updated on the status of their projects? Arvola not- ed that contractors often use a variety of methods to keep everyone in the association well informed and updated on a project and communicate using everything from phone calls and emails, to social media and posting flyers to doors. “Homeowners typically feel very informed when they are provided project updates every day, or every other day, for the entire community via social media,” he stated. When working on specific units, Arvola said that the contractor may choose to communicate with those homeowners directly, often via email and phone calls. Not everyone communicates online, so prior to beginning a project, the residents of every unit should also receive a notice posted to their door.

Board members and managers, on the other hand, are typically very involved in the project from the start, during the planning phase. Once the project has begun, any urgent updates or items requiring board direction may be communicated to the board daily. Otherwise, updates on the project’s status should be expected weekly, at minimum.

What are common reasons for conflicts between board members, managers and contractors? Throughout Arvola’s years in the industry, he has heard plenty of homeowner construction stories. Conflicts often arise due to “not setting forth the right expectations, poor communication, poor quality of work, varying design or color opinions and timeline conflicts,” he said. But many such conflicts can be prevented with sufficient planning and proper communication.

Lastly, associations may encounter what’s known as a cost overrun during a project. It is not uncommon for contractors to miss something during the initial proposal, and it is also not uncommon for unexpected setbacks to occur. Prior to beginning a project, the contractor should edu- cate the association about the possibility of unknown expenses.
“If a cost overrun happens due to the contractor failing to properly figure all the details for a project, a reputable contractor would typically take responsibility for the error, absorb the expense and learn from the mistake,” Arvola said. Overruns can also be due to unanticipated work discovered after starting the project, such as rotted wood under roofing underlayment. The contractor should contact the association as soon as they become aware of potential additional expenses and even provide evidence of the necessary change, such as before and after pictures. Both par- ties would then sign a change order to confirm the additional work, the additional expense and the new contract total. This change order approval process, Arvola noted, should be outlined in the contract as well.

According to Arvola, it is necessary to confirm that the association either has the financial ability to cover the additional expense or the flexibility to make a change elsewhere within the project that would offset it. If the project is being financed, the lender typically needs to approve a change order as well. Because of the potential for change orders, it is wise for associations to maintain a contingency fund for cost overruns.

It is important that the association fully understand the reasons for a cost overrun so that the additional cost does not come as a surprise later on, and also to ensure that there are no payment delays. These unexpected change orders should be tracked and recorded so that the final invoice refers to those changes, and so that the association understands the final amount owed.

Contact Info:

Ryan Arvola, CMCA
Multi-Family Director
Hoffman Weber Construction
3515 48th Ave N Minneapolis, MN 55429
Cell: 763-248-6768
rarvola@hwconstruction.com
www.hwconstruction.com

Minnesota Insurance

Joel Davis, CPCU, CIC, CIRMS

Joel Davis, CPCU, CIC, CIRMS

Community Association Underwriters of America

Association Insurance: Ensuring You’re Protected

December 8, 2020

Insurance is a complex subject in any context, and in the realm of community associations — condominiums and homeowners associations (HOAs) — there are many bases to cover when it comes to ensuring the association, its board, manager and residents are all appropriately protected. We spoke with Robert A. Travis, CIRMS, CPIA who is the Managing Partner of Risk Management Matters, LLC from Bartonsville, Pennsylvania. Risk Management Matters, LLC is a consulting company which specializes exclusively in Risk Management and Insurance for community associations and other common interest properties.

So how does a community determine how much and what types of insurance are needed? While an association’s governing documents offer meticulous details about the governance of a community, they don’t typically, and shouldn’t according to Travis, specify exact amounts of insurance needed. However, they usually lay the groundwork for building the proper mix of coverage. “They’re going to have an impact in setting minimal standards of insurance for every line of insurance the association needs to have,” he said. The types of insurance needed by associations are Property, Directors & Officers (D&O) Liability, Fidelity (otherwise known as Employee Dishonesty), Commercial General Liability, Workers’ Compensation and Commercial Umbrella. “The governing documents can have a lot to say and have a strong demand about what the minimal level of insurance will be,” he said.

The association also needs to be comfortable that they’re fulfilling all the insurance requirements of federal and state statutes, and any contractual or lenders’ requirements. Above that, boards need to fulfill their business judgment — that is, ensure they’re fulfilling their fiduciary duty and exercising due care in their decisions — to make sure they have adequate coverage. But Travis noted there is no definitive answer as to how much is too much when discussing insurance. “No one can know what the future could bring in terms of losses,” he said.

Homeowners should note that there is different insurance needed depending on whether their community is a condominium association or an HOA.

In covering the properties in condominium associations, there is a master insurance policy for the association, then individual unit owners have their own insurance — commonly called HO-6 policies — which cover their individual unit’s contents as well as any upgrades made to the unit by the owner or previous owner. These policies also cover things such as loss of use, special assessments caused by a loss to the association, as well as giving General Liability coverage to the owner.

What should an association know about how its master policy interacts with the coverage residents have on their individual units? The first thing people need to understand is that, when it comes to insuring the unit in a condominium, the association’s insurance is always primary. When a loss occurs, the unit owner’s insurer is always going to look and see how the master policy dispenses of the claim, and then their HO-6 policy — the unit’s policy — will step in and cover what it can pick up after the association’s master policy applies to the claim first.

Here is an example of how this works. Let’s say there is a storm and a medium-sized tree falls on the roof of a two-story condominium building. While no major damage is done to the structure, the roof is torn causing water to leak into the kitchen of the unit below. The unit’s ceiling collects water and the sheetrock eventually breaches, causing a hole in the unit’s ceiling and water damage to the custom wood cabinetry the owner had installed after the original purchase of the unit from the developer. The condominium’s master policy pays to repair the roof and the ceiling inside the condo unit. Then the unit owner’s HO-6 policy picks up the cost to replace the custom cabinetry that was not part of the original unit sold by the developer.

Another example of how the HO-6 policy kicks in is when there is minor damage that is under the amount of the deductible of the association’s master policy. Then the HO-6 policy picks up the repair cost, making the unit owner whole again subject to the HO-6 deductible.

Travis emphasized that having an overlap of coverage in these cases is better than having a gap in coverage. “Don’t think of this adding up to 100% of the value. Having a little bit of overlapping coverage is a far better scenario than putting yourself in a position where you may have a gap,” he said.

With HOAs, on the other hand, sometimes the association is covering the unit and sometimes it’s not. That would depend on the association’s governing documents. In townhome communities, even where there are common roofs, it is not always the case that the association’s master policy will cover the townhome building. Homeowners should have their insurance professionals make sure they have reviewed the Governing Documents and offer the proper coverage for their particular situation.

When insuring a property, it is best to be covered for the Replacement Cost Valuation (RCV) of what is insured. What is meant by Replacement Cost Valuation as opposed to an item’s Actual Cash Value (ACV)? When evaluating a loss, Actual Cash Value takes depreciation into consideration. Travis gave an example of someone who has a seventeen-year-old Plymouth Neon. Let’s say this person has Comprehensive and Collision Coverage on this car and has a total loss of the car in an accident. The insurance company will pay an amount to purchase another seventeen-year-old Plymouth Neon. That is Actual Cash Value. Inversely, Replacement Cost Valuation does not take depreciation into consideration. So a policy that is written to cover Replacement Cost Valuation will pay an amount for this person to buy a brand-new Neon. “So Actual Cash Value is a valuation where it is replacement cost, minus depreciation,” he said. “It does not give you enough money to rebuild a building, it gives you the depreciated value of that building.”

Associations need to make sure they regularly check their insurer’s estimate of the replacement value for their property to ensure they have enough coverage. How often should this be done? “In my opinion,” said Travis, “annually.” He recommended the association get a Replacement Cost Valuation from an actual replacement cost construction valuation company, and enter into a contract for the company to come back on a regular basis, such as every three years. Then on the in-between years, Travis said that you should get an automated increase based on construction cost increases at the time in that geographic area. He said that the valuation company can provide you with this as well.

Associations should also be knowledgeable of their property’s replacement value in connection with its property insurance policy’s co-insurance clause. Otherwise they could be subject to a co-insurance penalty should a loss occur. The co-insurance clause basically puts a condition upon the insured that they are properly insuring the premises to its true replacement value. The actual percentage of insurance required varies from company to company. “The co-insurance clause basically will state that if an insured does not properly insure the building or buildings to the proper percentage of the true replacement value, that they will then be penalized on any and all claims on the property,” he said.

For example, let’s say someone has a building worth $100,000 from a replacement cost standpoint, and their insurance policy has an eighty-percent co-insurance clause — it’s saying that this person or association should at least be insuring the building for $80,000 on a replacement cost basis. If they choose to insure it for an RCV of $70,000, the insurance company is then going to do an evaluation at the time of the loss and discover that the building is worth $100,000 and is only insured for $70,000. Therefore, the building is only insured for 7/8ths of what the co-insurance clause specifies. Consequently, the insurer can rightly say they’re only going to pay 7/8ths of any loss.

Travis explained if the person or association in the above example had a total loss, they would only be paid 7/8ths of the policy limit of $70,000. “That’s how the co-insurance penalty works,” he said.

Associations need to have special insurance to cover themselves and their board members in case they’re sued in relation to their actions in running the community. Board members can be sued for any wrongful acts or breach of their fiduciary duties to the association. A breach of fiduciary duty happens whenever a board member or any other person of authority in a community association does not properly exercise the proper controls or procedures in handling and utilizing the community association funds. “If I’m a board member and I am putting the association into contracts that they don’t really need to be in, I’m forcing money to be spent that doesn’t need to be spent, or I’m mishandling funds , that is a breach of my fiduciary duty. I have a fiduciary duty to protect the association’s funds,” said Travis.

 A breach of fiduciary duty can also include when board members, or the manager, do not properly protect the assets of the association, including the resale value of the lots, units and homes in the association. “When you have a breach of fiduciary duty, you’re not fulfilling the fiduciary duty that you have to protect the money of the community association and its membership,” he said. 

This is where Directors & Officers (D&O) liability insurance comes in. A D&O liability policy is designed to protect the association from various wrongful acts of its board members and association leadership. These wrongful acts can come in two categories. One is monetary losses — where someone sues an association for a wrongful act which has cost the claimant a dollar amount. Or, someone can sue a board of directors for a non-monetary claim. This is where they’re suing not for a dollar amount, but for injunctive relief. “It’s easy to say that most D&O claims are of the non-monetary variety,” said Travis. In cases seeking injunctive relief, it is when someone sues the board because they feel the board is enforcing a rule that is working unfairly against them. They want to go to court and have the court tell the board they must stop enforcing the rule in question. The opposite could also be the case. An individual can take the board to court saying that they’re not properly enforcing a rule. “They’re trying to get the court to make the board actually enforce the rule,” he said. So in these cases, the board is not being sued for a monetary amount, but in order to make them take some action, or to stop them from taking an action they are taking. In the non-monetary suits, the costs that need to be covered are all for legal defense.

Obviously, lawsuits can arise even when board members are fulfilling their fiduciary duties and following the rules of their associations to the letter.  Travis explained that boards are faced with many difficult decisions, of which, whatever choice is made, could have some undesired effect for some residents. “Every day goes by where a situation is posed to a community association insurance professional, and we look at it and we know that the board was between a rock and a hard place. That either decision, you could back up as being a prudent decision, but either way you made a decision you’re setting yourself up for detractors and a possible lawsuit from those who think it’s the wrong decision,” said Travis.  So even if every step of the way you’re trying to do the best you can do, many decisions that need to be made have no ideal choice that will satisfy everyone in the community. Even if there are two desirable choices in a decision, someone could say you chose the wrong one.  “Even if you have the very best risk-management program on earth, you still do not eliminate all potential exposure to loss,” said Travis.

Are there things the D&O policy won’t cover? Travis said yes. One example is if someone is making a decision as a board member that helps them put money in their own pocket — such as if they sway jobs to a company the board member has a financial interest in, thereby profiting themself. Certain events are going to be excluded from D&O coverage. “If it’s criminal, if it is lining your own pockets, or something similar to these acts, there are just certain things that are not covered and certain types of wrongful acts that are not going to be covered,” he said. 

Another item that possibly may not be covered by a D&O policy is when the board is accused of a wrongful act that is considered to be discriminatory toward someone in a protected class. According to Travis, there are some D&O policies that provide no protection for discrimination whatsoever. Alternatively, some D&O policies provide defense costs only, and then there are some that will not only provide defense costs but will also pay judgments made against the association for a discrimination claim. Travis said that there are different types of coverage available to boards and they should be sure they choose the D&O policy that protects their exposures to loss. 

A somewhat gray area of coverage is the mismanagement or improper investment of funds. In terms of mismanagement or improper investment of the association’s funds, Travis noted this is a very broad topic. “For the most part, most D&O policies are not going to provide any coverage for mismanagement or improper investment of funds,” he said, “but some do.” He explained further that if you’re getting into areas where the FDIC is not providing insurance for your monies while they’re sitting in an investment fund, the D&O policy might not provide coverage either. 

One thing board members should be aware of is that D&O is not there for Bodily Injury or Property Damage losses. That’s what General Liability insurance is for. “If I’m going to sue a board because I got hurt, or I’m going to sue them because my property or my car was damaged, and I blame the board for my injury or my damage, that is not a D&O lawsuit, that is going to be a General Liability lawsuit,” he said. D&O does not get into the Bodily Injury, Property Damage arena.

How do board members determine how much D&O insurance they require? First, most states have something about this in their statutes. After referring to state guidelines, the next place to look is their own governing documents — the declaration, CC&Rs, articles of incorporation and the bylaws. “Someplace within the declaration, the articles of incorporation or the bylaws, there may be some minimal standards set out as to what limits the board should have as far as directors and officers liability,” said Travis. He added that there also may be lenders, such as Fannie Mae, Freddie Mac, or the FHA and HUD that require certain limits in order to comply with those lending institutions. There could be another type of contract also demanding a certain amount of coverage, such as that with a local municipality or neighboring property whereby there may be a cooperative venture. “After that,” he said, “then it becomes a business judgment.” So an association may evaluate their assets and decide to have additional insurance based on that value, rather than going with the minimum required by other entities.

Board members should make sure they’re named as an additional insured on the association’s D&O liability policy. “The community association is going to be what’s called the first named insured. The first named insured is the party that’s on the policy’s declaration page,” he said. All the other insureds, such as the board members, committee members and managers, are named in the body of the policy. “Those are the folks who are additional insureds,” he said. This ensures that if there is a lawsuit, and these board members are named along with the association, that they will be covered by the policy.

Board members should verify that they are, in fact, insured under the association’s D&O policy by asking to see a copy of the policy. “If I’m a board member and I have someone whose opinion I value, such as my insurance agent or attorney, I’m getting a copy of the association’s D&O policy and asking what they think about it.  Quite frankly, I’m also reading it myself,” he said. Other than doing that, a board member would be relying on certificates of insurance and proposals, and Travis said that not even the most comprehensive proposal explains every exclusion or definition on a policy. For example, every D&O policy covers for wrongful acts, however, every policy also has its own definition of what a wrongful act is. “That’s the definition that the entire policy is hitched up to,” he said, “so I would want to see that definition of wrongful acts.” 

Aside from the D&O policy, the board members should expect to have protection for their General Liability coverage. This would be for scenarios where they might get individually sued for a Bodily Injury or Property Damage to a third party that may find them individually responsible. “As an example, if I’m the head of the social committee and somebody gets hurt at one of the social events, they may sue the community association, but then sue me. As an individual I need to make sure that I have that kind of protection from my community association as a volunteer,” he said. Board members should expect to have coverage if they’re individually sued in this manner.   

Property managers should follow a similar procedure in ensuring they’re insured in this manner. Travis recommended the manager make sure they are a named insured on all the General Liability and D&O liability policies that are written for all the community associations that they manage. Managers should also make sure that their management company, the site managers themselves and other management company employees are insureds on the policy as well.

This brings us to protecting associations, boards and managers in cases of theft of association funds. Fidelity insurance, which covers things such as employee theft, should be in place for this purpose. Travis explained that, for the most part, this is purchased to protect the association from something an employee could potentially steal. Travis explained that a contractor would buy this type of coverage because they’re worried about an employee stealing their tools and equipment. A retailer could be worried about employees stealing their goods. Community Associations, however, are primarily concerned with people stealing the association’s funds. “The average community association really doesn’t have what you and I would define as an employee. So in a community association environment we need to expand the definition of an employee so that it not only includes the kind of employee the IRS defines as an employee, but it also includes committee members and volunteers operating within the scope of the direction of the association,” he said. He added that if the association is professionally managed, they need to make sure the site manager, the management company and all its employees are included in the definition of employee on the Fidelity policy as well.  The policy is intended to protect for potential internal theft of community association monies. 

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3/10/23 – Note from Jeffrey E. Kaman, Esq., Kaman & Cusimano, LLC:

Ohio law now requires that community associations have sufficient fidelity insurance on all individuals with access to association funds, in an amount not less than everything in the association’s accounts, plus three months worth of income.

As you can see the mix of policies procured by an association work together in a variety of ways. We’ve touched a bit on the General Liability insurance policy. So, what is General Liability insurance?

General Liability, like D&O, responds to what are called third party claims. These are when a third party, someone other than the community association or the Insurer, makes a claim or lawsuit against a community association claiming that the third party has somehow been injured or suffered damage because of the community association’s actions or lack thereof. 

The first of these four is Bodily Injury. Bodily Injury is when someone has a physical injury to their person and claims the association is at fault. 

The next item covered under General Liability is Property Damage. This is when someone has property that has been damaged, and they either have direct physical damage, or indirect damage, meaning loss of use of a property, and that direct or indirect damage or loss is claimed to be the community association’s fault.

Then there is Personal Injury. Not to be confused with Bodily Injury, this is when the community association is sued for something the association has said or done, which has hurt someone’s reputation or self-worth.  Personal injury in this context is not when someone is physically injured.

Advertising Injury, said Travis, is the same as Personal Injury, except it’s in the written or published form. “So when we say things about people in board minutes or on the association’s website, we are talking about two classic examples of Advertising Injury exposure,” he said. 

Under the General Liability policy, associations should include Host Liquor Liability insurance. This is for the Liquor Liability exposure an association has when hosting a party or event, since they are not in the business of selling alcohol. This is for those situations where a liquor license is not needed, because liquor won’t be sold, but it is being served at no charge or given away. These situations include wine and cheese parties, picnic type parties, cocktail parties — or any event where liquor will be provided in this manner. This type of insurance needs to be added to the General Liability policy. 

Not every association has employees, however, every association should have Workers’ Compensation insurance coverage. Is this to cover volunteers? Travis said every community association should have Workers’ Compensation coverage, whether or not it has employees, to cover contractors who are sole proprietors or partnerships. Travis explained that in most states, sole proprietors and partnerships are unable to purchase Workers’ Compensation insurance to cover themselves.  They are required to purchase it to cover their employees, and they will produce an insurance certificate to show the association they have the coverage for those employees. However the sole proprietor or partner in most states cannot cover himself under that policy. The reason being is that sole proprietors or partner are not considered employees of themselves.  So if the sole proprietor or partner himself were to be injured on the job site, his Workers’ Compensation coverage would not cover him. What often will happen in the Workers’ Compensation courts is that since the sole proprietor or partner isn’t covered under his own policy, they will look at whom he was working for on the day he was injured. If they determine that the sole proprietor or partner was working for the community association that day as an employee, the association now owes Workers’ Compensation benefits for that sole proprietor or partner. 

Another reason to have Workers’ Compensation coverage is to provide coverage in case one of their contractors provides a false certificate of insurance. If one of these contractor employees is injured on the job and the contractor has no Workers’ Compensation Insurance, the Workers’ Compensation courts would likely deem the association responsible for the Workers’ Compensation claim. Again, they would look at whom the individual was working for the day he was injured much like the scenario described in the previous paragraph.

Travis said that yet another reason why it is needed is to provide coverage for casual labor. The association could casually pay a teen to clean up a small area around the association’s pond on a Saturday, for example, and pay him or her $50 out of petty cash. The association’s Workers’ Compensation coverage would apply here if that teen were injured while performing this casual labor. “The Workers’ Compensation courts are going to look at this as an employee/employer relationship,” he said.

So for these reasons, even if a community association has no payroll, they should have Workers’ Compensation coverage. 

As for associations that do have employees, they should carry a type of coverage to protect board members and association assets against employee claims.

There are three types of employee coverage and claims that would come up here. 

There is Employment Practices Liability, which is when the association or the board can get sued for how they practice being an employer. This includes hiring and firing, as well as how employees are treated on the job, raises, promotions and more. “Generally we get that coverage from our D&O liability policy,” said Travis. He explained that the D&O policy’s Part B is usually Employment Practices Liability when the D&O policy does provide this coverage. 

Next is Workers’ Compensation coverage, discussed previously, which covers the association should an employee get hurt during a work-related incident. These benefits are required and determined by the state. 

Then there is a second part of the Workers’ Compensation policy, called Employer’s Liability, which is for when an injured employee waives their rights to be taken care of by the Workers’ Compensation system, and they want to sue their employer for some additional funds. “That would be Part B of the Workers’ Compensation policy,” said Travis. He further explained that when an employee sues in this manner, waiving Workers’ Compensation coverage, not only does the employee have to prove that they were injured on the job, but that their injury was the result of their employer’s negligence.

As I’m sure you all know, an Commercial Umbrella policy is not a special policy to cover the umbrellas around your community’s swimming pool.  This is an important liability policy that covers above and beyond other liability policies. “If you had a General Liability policy that had $1 million per occurrence and $2 million in the aggregate, and you had a $10 million Commercial Umbrella and you were to suffer a $5 million loss, then the General Liability policy is going to basically take the first $1 million. Then the Commercial Umbrella policy is going to cover the next $4 million above that,” Travis explained.

The Commercial Umbrella policy sits on top of your General Liability policy.  It will also go over your D&O policy and any other liability coverage the association purchases.  The Commercial Umbrella would help in case a claim goes over the limits of any of these policies. “It basically provides excess coverage to the limits that are shown in all of the underlying liability policies that are listed on the Commercial Umbrella policy’s declaration page,” he said.

Self-insurance is any scenario where an entity or community association could buy insurance, but decides not to. In these cases, the entity or community retains the risk, and if anything comes up, they would be the ones to pay for the loss and/or legal defense. Travis explained that to be self-insured is a two-step process. First, there needs to be insurance that can be purchased for that exposure.  Then if there’s insurance that can be purchased for that exposure, the association makes the choice not to buy that insurance. They choose instead to take financial responsibility if something happens. 

“If it was an uninsurable event,” he said, “then you’re not self-insuring and it’s just a business expense.” Events that are not insurable would include things like repairing the roads after a bad winter. Since there is no insurance that covers this, an association cannot be self-insured for it, and must absorb the cost as a business expense. “Self-insurance is when you could have bought insurance, and made the decision not to buy insurance,” he said. That is the act of self-insurance

One special type of coverage that may be needed by some associations would be Garage Keepers insurance. Garage Keepers insurance covers when an association has someone else’s automobile in their care, custody and control. This could be if an association has unit-owners’ automobiles kept in an area under the care, custody and control of the association. For example, lots of community associations, especially in urban areas, have valet parking only. So residents and guests pull up to the building, give the valet their keys and they park the car in the garage for you. “That is the ultimate example of your car being in the care, custody and control of the community association, not you. That is a classic example of when you need what they call Garage Keepers insurance,” said Travis. This type of policy enables associations to insure vehicles they don’t own for when they are in their custody.

Associations can check an insurance company’s ratings in order to gauge the strength of the company and their ability to pay claims. Checking the AM Best Rating of the company is the best way to do this. It is an independent party’s evaluation of what position they are in financially to pay a claim. Travis said you can refer to other sources for the ratings as well, such as Moody’s or Standard & Poors. “There are several companies that evaluate an insurance company’s ability to pay future claims,” said Travis.

To learn more about cyber insurance, we spoke with Joel Davis, CPCU, CIC, CIRMS, Marketing Manager for the Hoffman Estates, Illinois office of Community Association Underwriters of America, Inc.

Cyber security is an often overlooked but increasingly essential part of community associations. Every association should develop their own strategy for minimizing the threat of a cyber attack, including keeping their security software up to date, keeping sensitive information secure and educating employees and board members on safe cyber practices.

Even if cyber security is being addressed by an association, Davis explained, “Most commercial insurance policies do not cover cyber, and if they do, it’s usually on a very limited basis.” If those preventative measures aren’t enough, and a cyber attack proves successful, that’s where cyber insurance comes in. “When a cyber attack occurs, community association operations may be interrupted. Cyber insurance helps to recover losses due to downtime,” Davis said. Cyber insurance also covers the association’s liability in the event of a data breach, such as theft of residents’ personal identifiable information. Thus, it is important for community associations to purchase a cyber liability policy, to ensure they are fully protected in that regard. 

What is a waiver of subrogation? Most states have this written into their statutes or their condominium acts. In the world of community associations, the waiver of subrogation basically means that the association waives its right to subrogate — that is, specifically to go after a unit owner when the unit owner causes a loss or claim for the community association. Joel Davis, CPCU, CIC, CIRMS, Marketing Manager for the Hoffman Estates, Illinois office of Community Association Underwriters of America, Inc., gave the following example: “I live in an eight-unit condominium and I’m in my unit and I fall asleep while smoking a cigarette, and that cigarette then falls and sets my mattress on fire. I get out alive and I get everyone else out alive, but all eight units burn down to the ground. What the waiver of subrogation is going to stipulate is that the community association is not going to be able to come after me to rebuild all eight of those units.” This also means that the association’s insurer cannot go after the person in this example. The association and its property insurance need to pay this on their own, and they cannot subrogate against the unit owner. 

Davis explained that the reason why the waiver of subrogation was written into the early condominium statues was to take certain decisions out of the board’s hands. Take an example of two unit owners having the same type of loss. Each of their water heaters bursts and the result is $10,000 worth of damage to each of their buildings. Let’s say one of the unit owners is well liked by the board. He volunteers on committees, he is a good neighbor and always participates positively in association meetings. The other unit owner, however, is the bane of the board’s existence. He causes disturbances at meetings and frequently calls the board president to harass him. In this example you can see where this law protects the board from inadvertently making an arbitrary decision to sue one of the owners and possibly not the other due to their personal feelings about either individual. Because of the waiver of subrogation, one does not need to decide if an owner should be sued in these cases, as the association’s master policy pays the claim. Davis explained that while insurance companies have lost large amounts of money due to paying claims, in cases where waiver of subrogation applies, it would have been much worse if they didn’t have the law because they would be paying even more in D&O liability claims. 

Davis explained that the indemnification clause is typically found in the association’s bylaws, and it states that if a board member is sued through their actions functioning as such, the community association shall indemnify the board member and reimburse them for any financial loss. He said that the purpose of the indemnification clause is basically to address the fears many people have about stepping up to serve on the board of their association. Many individuals are afraid to volunteer as board members for fear of the potential liability. “The indemnification clause is going to try and encourage people to take association leadership positions by telling them, ‘hey, if you make a decision out here and you get personally named in a lawsuit, have expenses with the lawsuit and you lose the lawsuit, the association will indemnify you,’” he said. 

When the association buys D&O liability insurance, it should be a policy that will be able to back up that promise. Davis warned if the proper policy isn’t written, then the association would need to write a check out of its own pocket to back this indemnification promise up. 

Community associations can get themselves into trouble if they decide to charge for liquor at such an event. In that case, an association may need to obtain a liquor license and then can’t be covered by the Host Liquor Liability coverage. In that case, an association would need Dram Shop Liquor Liability — that is, true Liquor Liability insurance. 

Contact Info:

Joel Davis, CPCU, CIC, CIRMS
Community Association Underwriters of America, Inc.
2300 North Barrington Road, Suite 400
Hoffman Estates, IL 60169
Phone: 847-278-8810
jdavis@cauinsure.com

Minnesota Reserves

Tanner Oldenburger, P.E., RS

Tanner Oldenburger, P.E., RS

Reserve Advisors, Inc.

Reserve Studies

March 25, 2019

In order to answer these questions, and provide other important details on this topic, we spoke with Tanner Oldenburger, PE, RS, Regional Engineering Manager from the Twin Cities, Minnesota of- fice of Reserve Advisors, Inc., a company specializing in reserve studies, serving clients in all 50 states and in 35 countries worldwide.

“Reserves are funds that are collected by the association from the homeowners on a monthly, quarterly, or annual basis, and set aside into a reserve account for the purpose of replacing the common elements of the association as they wear out,” said Oldenburger. The re- serve amounts are most commonly included as part of the co-owner’s regular association fee. The elements the funds are set aside for include those undertaken as large capital projects, such as roof and siding re- placements or pavement replacements. Although it is ideal for associations to have sufficient reserves for items such as these as they are needed, that is not always possible. In instances where reserves fall short, associations are faced with three undesirable options: 1) impose a special assessment on the co-owners, 2) borrow funds for the capital project from a bank, or 3) postpone project

Of course, it would be impossible for anyone to randomly decide the proper amount to hold aside in reserves. Many factors must be examined, including the age and condition of each common element the community association is responsible for, maintenance practices, interest earned on the reserve funds, as well as adjusting for inflation to the time each of those would need to be repaired or replaced. This is where a professional reserve study comes in. Often conducted by engineers, reserve studies offer a de- tailed analysis of all of these factors and provide recommended contributions the association can depend on for ensuring adequate reserves will be there when the association needs them.

Reserve studies have evolved over the years to where they are avail- able in various forms of sophistication, ranging from simplistic forecasts with limited support to comprehensive studies that provide advice that can save associations money. Today one can obtain a professional reserve study that contains cloud-based software that enables boards and managers to have a dynamic, “living” reserve study, that they can easily update as each actual capital project is completed and allows them to conduct unlimited “what if” scenarios.


Prior to starting the reserve study, the association should provide the re- serve professional with copies of the community’s governing documents — the declaration, bylaws, CC&Rs, and any other legal instruments that identify what the association is responsible for. “These documents will identify the property components that the association is responsible for maintain- ing,” said Oldenburger.

In addition to examining the documents, Oldenburger recommended convening with association leadership to ensure the actual needs of the community are addressed by the reserve study. “Equally, or even more importantly, our engineers have a thorough discussion with management and/or board members or committee members about each of the common elements and whether they want it included in the reserve study that we’re going to prepare for them,” he said.

There are several good reasons why the reserve professional doesn’t rely exclusively upon what’s in the governing documents. “First and foremost,” said Oldenburger, “we’re not lawyers and governing documents are legal documents. We use them as a starting point to get a general idea of the size and complexity of the common elements.” Also, he said that association documents are often not specific enough to properly determine which common elements are maintained through the association’s reserve account. The association board of trustees might treat the maintenance and replacement of certain common elements through the association’s operating budget and not the reserve budget. “I’ll give you a simple example: mailbox stations. While a mailbox station might be considered a significant item worthy of inclusion in the reserve budget for a small association of ten units, the replacement of mailbox stations might fall under the operating budget as maintenance in an association comprised of hundreds of homes as it’s, relatively speaking, a very small item to them,” he said.

While the association is responsible for maintaining the common elements, there is latitude for the board to choose how they maintain the elements, and from which budget — reserve or operating —they take funds to repair or replace. So for these reasons, a discussion with association leadership is key.

Oldenburger explained that a reserve study is made up of two parts, as defined by Community Associations Institute (CAI) and the Association of Professional Reserve Analysts (APRA) — the physical analysis and the financial analysis of the common elements. The physical analysis is comprised of three things. First is the component inventory, which is an identification of the common elements and their quantities, such as square feet, square yards, number of street lights, etc. Second, a condition assessment is performed, which is an evaluation of the current condition of each component based on the observation of the engineer performing the reserve study. Last is the life and valuation estimate. This is where the reserve professional’s engineering team determines the useful life, the remaining useful life — or better stated, how much longer the component will last before it has to be replaced — and the repair or replacement cost of each component.

The financial analysis has two components. First is an analysis of the fund status. This looks at the current amount of money in the association’s reserve fund at the time the engineer conducts the reserve study. It will be noted on the study as of a specific date, often the beginning of the fiscal year for the association. “This is a starting point for the engineer as he or she conducts the financial analysis portion of the reserve study,” said Oldenburger.

Second is the funding plan. “This is the plan that identifies the unit or homeowners’ reserve contributions that go into the reserve account to offset the anticipated future capital expenses and pays for those capital projects as they become necessary,” he said. The funding plan extends a minimum of 20 years into the future and, more commonly, is developed as a 30-year forecast.

To maximize useful lives and minimize long-term funding needs, every association should develop and implement a preventative maintenance schedule for its common elements. “Such maintenance activities directly impact an association’s schedule of capital projects,” said Oldenburger. “Inadequate maintenance can result in costly repairs, shorter than expected useful lives and a decline in a property’s overall aesthetics, all of which can significantly impact replacement schedules and long-term costs.”

The overall effect of preventative maintenance on an association’s long- term financial and physical health cannot be overlooked. Oldenburger briefly mentioned that MCIOA recently passed a statute requiring communities to prepare and approve a written preventative maintenance plan by January 1, 2019. “Minnesota Statute 515B.3-107 Upkeep of Common Interest Community requires communities governed by MCIOA to create a preventative maintenance report that includes a maintenance plan, schedule and budget for the association’s common and limited common elements. Furthermore, once approved, the association is required to share the plan and schedule with the unit owners,” he said.


Aside from having the information in the reserve study itself, there are other benefits associated with having a professional reserve study performed.

One benefit is that the reserve study can point out potential problems the association doesn’t know about. “You’d be surprised how often main- tenance issues are overlooked,” said Oldenburger. The reserve professional could also find possible unbudgeted or over-budgeted items. “We like to look at the entire operating budget, which includes the reserve budget,” he said. There are two reasons for doing this. One is to make sure that all property is accounted for and nothing was omitted from both budgets. The second reason is to ensure that no items were double counted and in both budgets. “When that happens, the association is obviously over- assessing,” he said.

Another major benefit of a reserve study, when followed by the association, is that it will eliminate, or at least greatly reduce, the possibility of special assessments. “Picture yourself as part of a young couple who recently bought a condominium trying to make ends meet and getting a surprise special assessment bill in the mail from the association saying that you have to come up with $4,000 in the next six months for a re-roofing project that wasn’t planned for,” said Oldenburger. Reserve studies make it easier for homeowners to manage their personal long-term financial planning by ensuring stable association fees, with only minimal and predictable increases.

Preservation of the market value of units or homes in the community is another benefit of having and following a proper reserve study. “This is a big one because peoples’ single largest investment is usually their home. A reserve study will help maintain the property in good condition, which helps strengthen the market values of the homes,” said Oldenburger.

The reserve study provides benefits to the board as well as homeowners. Since one of the board’s primary responsibilities is to maintain and protect the common property of the association, a reserve study helps them fulfill that fiduciary duty. The reserve study can also help the board members reduce claims of fiscal mismanagement by homeowners. “And having that long-term plan saves boards countless hours and meetings. The reserve study gives the board that long-term financial master plan that they need to prepare for both the short-term and long-term,” said Oldenburger.

For the property manager, the reserve study helps prepare the community for capital projects. “They need to know when capital projects are coming down the pike so they can go out to bid and help the board in understanding the bids,” said Oldenburger. It’s also a great tool when planning the next year’s budget. The information in the reserve study will help free up the manager to focus on their many other property management functions.

While some states have legal requirements regarding reserve studies, many still don’t. “The Minnesota Common Interest Ownership Act (“MCIOA”) 515B.3-1141 (a)(4) requires associations to reevaluate the adequacy of budgeted reserves at least every three years. This requirement applies to townhomes, planned communities, cooperatives and condominiums governed by MCIOA standards,” said Oldenburger. According to Oldenburger, other states that have statutes that involve either fund- ing reserves, establishing reserve accounts, or rules relating specifically to reserve studies include: Florida, Michigan, Ohio, Washington, Nevada, and others. Virginia requires a professional reserve study every five years. “The key thing that we’ve found over the years is that the number of states that are enacting legislation is growing. There is clearly a trend toward more legislation, not less,” he said.

Oldenburger recommended that a full reserve study, which includes a site inspection and condition assessment, should be conducted as soon as possible after transition from the developer. “Then it should be updated with a site inspection at least every three years and certainly no later than every five years,” he said. Another good time to have an update is after major changes to the property, such as following a large capital project. “However, it is very important for the board and management to review the reserve study every year. Many boards use the study throughout each year,” he said.

The initial reserve studies themselves can take anywhere from two weeks to three months upon authorization from the association, de- pending on several factors. “Weather conditions can slow down the development of a reserve study. We sometimes experience delayed inspections in the Midwest and Northeast due to extended bad weather,” said Oldenburger. The engineer needs to be able to see the roofs and pavement in order to assess their conditions, so if there is snow and ice on these surfaces that isn’t melting, that would cause a delay. Also, the scheduling time varies for different companies, so associations should ask potential reserve
professionals about their timeframes and schedules.

There are four general funding strategies for association re- serve accounts: baseline funding, threshold funding, full funding and statutory funding. Aside from statutory funding, the remaining three strategies are all about how much risk the association will be taking in funding their reserve account. Statutory funding is what associations need to have in reserves in order to comply with their state statutes. The other strategies would be at the association’s discretion. Baseline funding looks at the future expenditures and their timing, and calculates future reserve contributions such that the reserve account balance will reach $0 as the lowest point over the life of the analysis, anywhere from 20 to 30 years out into the future. “This approach is the highest risk for the association to assume because it will get down to a $0 balance at some point,” said Oldenburger. The threshold funding strategy is calculated like the baseline approach, with one very big difference — this plan never takes the reserve account balance down to $0. The reserve professional builds a cushion into the reserve account so that in the event that some capital expenditures are necessary sooner than project- ed in the association’s reserve study, the association will have the available funds to cover those costs without having to conduct a special assessment or take out a bank loan. The last strategy, full funding, also known as the component method, is the least risky of the strategies, but there’s a big tradeoff. “It’s also the most costly,” said Oldenburger. “What happens here is that each common element is looked at and funded individually. In other words, the association will begin fully funding for items that won’t be replaced for up to 20 years.” Oldenburger gave the example of the association’s roofs. “Let’s say they’ll need to be replaced in 20 years at a cost of $200,000. In this example the association collects $10,000 per year and sets it aside. The money builds up over time and isn’t used for 20 years. Now repeat this process with each of the association’s common elements and before long, you’re collecting a lot of money that won’t be used for long periods of time,” he said. This is the safest for the association, but is also significantly more costly than other strategies.

Oldenburger said that the reserve study should be used as a guide for future planning. “No one can predict with complete accuracy when capital replacements will be necessary. Weather conditions, for example, can alter what the reserve study provider projected several years earlier,” said Oldenburger. Even so, the reserve study is going to give the association the best chance of properly planning and funding their reserves.

To further insulate the community from the possibility of special assessments or needing a bank loan, Oldenburger recommended the reserve professional consider a cushion when developing the funding plan so there is money available in the event that a capital repair or replacement takes place sooner than initially projected in the reserve study. Another safeguard against the unexpected is to have frequent updates conducted on the reserve study. “The initial study is a snapshot in time, and common elements don’t wear out overnight. Things change over time, like the inflation rate, interest earned on funds, etc. Every few years the study needs a fresh update to prevent the need for special assessments,” he said.

Oldenburger said that a good reserve study provider should ask questions about the objectives of the board and association before completing the reserve study. “We like to learn about what I call the ‘culture’ of the association. Some like to just maintain their properties while others take an active interest and want to maintain the association in ways that one might consider over-the-top, but others don’t,” he said. He gave an ex- ample of redecorating the clubhouse. “One association may want to do this every five years, because the members prefer to see it being kept as fresh as possible, while another association might redecorate only every 20 years. Neither is right or wrong, it’s what I call the ‘culture’ of the association,” he said.

Association board members have several roles in the reserve study pro- cess, and one of those roles is to communicate to the provider not only the list of common elements that should be included in the reserve study, but these types of desires for the association to maintain its individual personality.

Asphalt seal coating is an example of one type of item that is frequently overlooked by associations. “Sometimes it’s in the reserve account be- cause of asphalt replacement, other times it’s in the association’s operating budget, and sometimes it’s not anywhere to be found,” said Oldenburger. When it comes time to do it, the association will struggle to find the funds to do it, or take the money from the reserve account even though it wasn’t part of the reserve budget.

For the most part, the reserve funds should be kept in their own separate account. Statutes regarding this are different in each state, and the laws are frequently changing, so associations should ask their accounting and legal professionals about this. “It’s really a legal question, and I’ll defer to the attorneys,” said Oldenburger. However, he pointed out an example of how Minnesota specifies the funds be kept. “The MCIOA statute 515B.3- 1141 (a)(3) states that associations must keep replacement reserves in ac- counts separate from their operating funds. Replacement reserves cannot be used or borrowed for operating expenses,” he said. Other states allow using reserve money for other expenses, but specify the funds must be paid back to the reserve account within a strict time frame. Another factor in deciding how to keep and use reserves is the strategy the reserve study provider used to fund the reserve account. “One method, known as the cash flow method or pooling method, pools all of the future replacement costs into a pool. That pool of funds is used to conduct the replacements in the order that they come due,” said Oldenburger.

Oldenburger explained cash flow analysis as a method of calculating the appropriate level of reserve funding. It’s also known as the pooling method. In short, using one of the cash flow methods, the reserve professional aggregates all of the future capital expenditures or project costs and “pools” them into one group. They then look at those future capital expenditures as they come due and fund the reserves with consistent annual contributions, with the objective that the reserve account will never fall into a deficit position or below a set minimum amount.

Oldenburger said there really is no such thing as leftover reserves. A reserve account is a dynamic thing. It’s constantly changing; money goes into it (reserve contributions) and money is drawn from it (payment for capital projects) on a regular basis. “And remember, the association never completely wears out, so the purpose of and need for the reserve account never comes to an end,” he explained.

At some point, if a reserve account has been overfunded over a period of time, the board could then reduce the regular common fees assessed to the owners. However, associations should beware of and avoid overfunding the account. “The negative aspect of overfunding is that the current owners are paying more than their fair share into the reserve account. This means that, as the current own- ers are paying too much, the future boards will reduce the amount of reserve assessments, and the future owners will pay less into the reserve account because today’s owners are paying for part of the future necessary contribution,” said Oldenburger. So, in essence, when you overfund, the current owners are paying toward a future fee reduction that, if they move, they will never be able to enjoy. And additionally, owners who purchase later in this timeline will not be contributing the same level of funding toward the reserve account as current owners.

“Regular reserve study updates will help keep the association on track,” said Oldenburger. These should be conducted every three years to avoid over- funding or, possibly worse, underfunding. Reserve study updates account for changes in the inflation rate of materials and labor, interest rate changes on the reserve funds and accelerating or delaying capital projects as compared to the original reserve plan estimates. “All of these events contribute to the calculation of an appropriate level of reserve funding,” he said.

According to Oldenburger, the prices vary on reserve studies, and there is even software that associations can purchase to do simplified, though not very reliable, reserve studies. However, cost should not be the main factor in choosing a reserve study provider. He also does not recommend relying on do-it-yourself software for this important service. Oldenburger said to look at the choice of which provider to use from a board member’s perspective. “What do I, as a board member, want out of that study? I want the kind of reserve study that will help me fulfill my fiduciary responsibility, protect the investment of the association mem- bers in their homes, provide our board with advice and recommendations that would save the homeowners money over the long run and educate us so that we can be more effective board members, while maintaining a community where the members look forward to coming home every night,” he said. For the most part, board members are neighbors in the communities they serve, and they should treat the decision about how to pursue maintaining proper reserves in terms of how it would affect their neighbors and themselves.

What is typically included in the cost of a reserve study? CAI and the APRA have strict guidelines as to the minimum components of what should be included in the reserve study. “National standards were developed in the mid 1990s by a small committee of national reserve study providers,” said Oldenburger. One can expect, at a minimum, a component inventory of each common element, a physical inspection and measurement of each common element, a determination of the normal useful life of each, the remaining life (how long before replacement is necessary), a status of the reserve fund at the time of the reserve study, and a funding plan that determines the amount of annual reserve contributions necessary to offset the anticipated expenditures for replacement over at least the next 20 years. “That’s the minimum,” he said.

Oldenburger said that reserve studies have changed in many ways over the past few decades. He explained, “We’ve seen a lot of changes over the years. In the early days, we found that most people who were doing reserve studies were property managers or board members because there wasn’t a reserve study industry yet. Property components were just beginning to wear out and associations clearly weren’t prepared for that. They’d take projections from contractors and guesstimate the future replacement costs in very unscientific ways. We saw accountants trying to get their arms around the question of how to fund for replacements. People were using different terminology in different parts of the country. Some were providing engineering inspection reports that were invasive in nature, providing more information than a board would ever need to plan for the future. Others were providing common element replacement forecasts without any kind of funding plan, which didn’t really help when it came time to budget. They still called these reserve studies, even though half of what we expect from reserve studies today wasn’t even included.”

Oldenburger said in the mid-1990s, CAI invited a handful of reserve study providers to meet and develop national reserve study standards and consistent terminology so boards and managers would have a basis from which to compare providers and have reasonable expectations of what they were buying. “Along with that came the Reserve Specialist designation program that required providers to provide their reserve studies in accordance with these standards. The purpose of the national standards was to provide boards with a standard reserve study that served as a budgeting tool,” he said.

Going forward, Oldenburger foresees the industry expanding. “In addition to more states enacting legislation to ensure that associations are protecting their members’ investments in their homes, the new generation of managers and boards are reshaping the way they use reserve studies. A demand for information in real-time is driving the industry towards delivering additional tools that allow for interactive planning. Associations to- day want to be able to evaluate alternate replacement options and be able to determine how individual replacement projects affect their long-term budget. Cloud-based software solutions, and to some extent excel spread- sheets, answer these types of questions and allow for greater collaboration in a team environment. The result: making more informed decisions that enhance their community’s long-term health,” said Oldenburger.

Contact Info:

Tanner Oldenburger, P.E., RS
Reserve Advisors, Inc.
2655 Innsbrook Drive, Suite A
New Brighton, MN 55112
(855) 575-1121
Tanner@reserveadvisors.com
www.reserveadvisors.com

Minnesota Finance

Thomas C. Engblom, Ph.D, CMCA, AMS, PCAM, ARM, CPM

Thomas C. Engblom, Ph.D, CMCA, AMS, PCAM, ARM, CPM

Association Loans

Under what conditions may an association need to apply for a bank loan? Who is responsible for paying the loan? Can board members or homeowners be held responsible in the case of default? What are the benefits, if any, of taking out a loan as opposed to using reserves to fund projects? What are the terms generally for association loans?

There are infinite questions involving association borrowing, but your first one may be “When on earth would an association need to apply for a bank loan?” Management and the board are supposed to be ensuring there are adequate reserves, right? If my HOA is applying for a loan, does that mean we’re in dire trouble and the association is mismanaged? The answer to that question could be yes or no, depending on a few different factors. However, associations do not only seek loans because they’re mismanaged or low on reserves. Fortunately, Thomas Engblom, CMCA, AMS, PCAM, ARM, CPM, PhD, VP/Regional Account Executive at CIT, whose doctorate is in business administration, availed himself to answer these questions for our readers.

The best place to start talking about association loans is to describe what an association may need a loan for. According to Engblom, the reason for and types of loans are geographically driven and depend on what type of physical property the association is comprised of. The loan could be for roof replacements, paving, siding, carpeting for the halls of a building with interior residence entrances, decorating of a clubhouse or lobby, adding a pool, adding a clubhouse — the list goes on. An association could obtain a loan for any number of capital repairs or improvements to buildings and common areas.

Financing litigation against the developer and manufacturers of building materials to remedy construction defects is another reason an association may need to obtain a loan. An HOA loan can be the best way to fund a construction defect litigation suit, as the loan can help the association through the process by funding both legal fees and building costs until the suit is settled — which can take several years.

Additionally, an association’s bylaws or declaration may have imposed requirements that prevented the association from securing and maintaining adequate reserves for their actual needs. Or, these documents may impose a minimum amount that needs to be maintained in reserves. Therefore, those funds cannot be used at the time the funds are needed.
So who is responsible for paying this loan, and are unit owners on the line for the money if the association doesn’t pay on time? Can the bank place liens on the individual units for the loan? Unit-owners are only indirectly responsible for the loan. Unlike a mortgage or home equity loan, the association loan is not secured by any physical elements of the community, including the individual units and common elements. Instead, an association loan is secured by the future assessments to be collected by the association. Additionally, there are no personal guarantors on the association loan, so board members are also not personally responsible for paying the loan.

What are the terms commonly assigned to association loans? Engblom said that the amount of an association loan can be anywhere from $50,000 to $50 million, and several factors will determine the length of the time for which the loan should be cast. This depends on the life expectancy of what is being financed. However, it also depends on the board, and the individual association, and includes factors such as how the association plans to fund those payments. For example, the board can actually special assess the unit-owners in order to repay the loan. In this case, the board can give unit-owners a choice of paying this special assessment as one large amount upfront, or they can pay over a specified period of time with an additional amount to be paid for interest. The board could also raise their monthly or annual assessments to pay the loan.

Either way, terms for an association loan are typically 5, 7, 10 or 15 years. Again, these terms would depend on the project being financed. According to Engblom, most association loans are actually paid before their term period expires. For example, he said, a 5-year loan is typically paid in 3 years, and a 10-year loan is paid in 7. Defaults are very rare in association loans. Engblom noted that association loans are a fairly new phenomenon — having only been around for about 18 years. And, he said that they are among the safest types of loans for banks to issue to customers.

The last component of the loan would be determining the interest rate. This is typically determined by the United States Treasury rate.

So what is required by the bank from the association when applying for a loan? According to Engblom, banks typically look at a number of items which help them determine if they can provide the loan to the association. One important factor is the association fee delinquency rate. The bank will examine this over a period, typically, of 4 months, and usually require there to be fewer than 10% delinquencies in the community. This would include units with accounts over 60 days past due. Additionally, it is common for the loan documents to have language that states that, during the repayment of the loan, the association maintain this desired, low fee delinquency rate. Since these common fees are the only collateral for an association loan, the security of these is very important to the lender.

Another important factor is the size of the association. This will affect its ability to obtain a loan. In referring to association size, typically banks will say “the bigger the better,” when an association is applying for a loan. Look at it this way, the more units in an association, the more the payments will be spread out over a larger number of owners who indirectly affect the repayment of the loan. According to Engblom, communities with less than 25 units will face some challenges in applying for funding from a bank.

The bank also looks at the number of investor-owned units in the community. According to Engblom, if a community has greater than 40% of its units owned by investors who rent those units, that community will have greater challenges with an association loan. Also, if one person owns a large portion of the units or has a large proportion of the voting control of the community, the association will not be approved for a loan.

Lastly, does having a loan on the books of the association affect the owners’ property values or cause the association to be viewed in a negative manner? This question can be viewed in a number of ways and depends on many factors. However, if the loan prevents the property and/or its common elements from deteriorating, such as if the loan prevents putting off necessary projects, which could lead to structural problems or worse, the loan can help maintain or even bolster property values. Additionally, in cases where a loan prevents special assessments or fee increases, residents maintain their personal cash to preserve quality of life, and even have more available funds to put into their own individual units. Having well-maintained and updated units helps bolster property values as well.

Engblom said no, residents and board members are not asked to provide personal information, such as personal tax returns, when the association is applying for a loan. Nor are the credit ratings of residents viewed. However, residents do indirectly affect the association’s ability to obtain a loan if they develop a history of paying their assessments late or allowing their units to go into foreclosure.

Financial Management, Adhering to a Budget and Financial Warning Signs

Financial management is perhaps one of the most critical facets of a homeowners association. Financial transactions factor into day-to-day interactions in an HOA, with residents paying dues and vendors providing goods and services. The complexities of an HOA, however, demand a business-like approach to financial matters in order to provide a well-functioning environment for all involved. Budgets, therefore, become essential to success.

How does an association diagram a budget? What can the association do to limit surprises in a budget? How do reserve studies factor in? What are the different types of budgets? Creating a sound budget and adhering to it for the fiscal year for the association is very important. Thomas Engblom, CMCA, AMS, CPM, PCAM, PhD, provided us with an explanation of the budget process.

According to Engblom, “A budget is a roadmap that provides an estimate of a community’s revenue, expenses and reserves. It provides an avenue for a community to plan activities, goals, maintenance, repairs, reserves, determine assessments, and minimize the unexpected.” While the necessity of an association budget may seem clear, the process itself can be quite complex. Engblom stated that an association should first consider the legal requirements for a budget in their state. Refer to state statutes as well as the governing documents of your association as your guidelines. “Every community association must have a budget. It is required at various levels of the law and in the governing documents,” Engblom said. He added that local laws may require a budget, whether for insurance, emergency, life safety, etc. All associations must conform to IRS rules, and mortgage institutions may set requirements that a community will need to meet as well. Additionally, budgets mandate the procedures to determine the applicable requirement for reserves.

Once the legal necessity of a budget has been established, how must your association proceed? From there, your association may take into account the needs and desires of homeowners. What services do they require on a daily, weekly, monthly and yearly basis? Which do they expect? Engblom also noted that associations should not simply aim for a net profit or loss. Don’t simply set a budget including all known expenses (i.e. routine maintenance, electricity, water, etc.). The budget will also need to account for and include unexpected expenses. If, for example, a natural disaster occurs, your association will need to be prepared. Ideally, a budget will limit the impact of financial surprises. Within a budget there is a chart of accounts, which is an organized list of the numbers of the association, categorized showing each item being budgeted for. This is detailed in the previous chapter on association accounting under the heading “Preparing and Organizing Budgets.”

When is the budget due? This depends on the association and is generally contained within the bylaws. Typically, budgets are done either by calendar year or fiscal year. Most do them by calendar year, Engblom noted. The association’s manager typically puts the budget together. A budget committee, headed by the board treasurer, can be formed by board resolution to come up with the nuances in the budget. This is an ongoing, standing committee. Engblom again underscored that an association should not just budget for money it expects or does not have. As an example, Engblom said, “You shouldn’t necessarily be budgeting for fines and late fees.” If income is not expected, don’t budget as if it is.

There are two components of a budget: revenue and expenses.

•    Revenue: assessments (which Engblom noted is the only component of value that an association has), excluding miscellaneous income of  late fees, fines, move ins and move outs, etc.
•    Expenses: operating expenses (i.e.: maintenance, utilities, administrative, management, insurance, copying, printing, Internet, etc.)

Furthermore, two components are affiliated with each budget line as to whether it is mandatory or discretionary. Mandatory expenses are things such as insurance and utilities. These are expenses the association is obligated to cover, as opposed to discretionary items such as pool furniture, a community newsletter or the expectation of an individual unit owner.

There are also two types of budgets:

•    Zero base: In this type of budget  all line items are set to zero. Therefore, all line items must be justified, rather than assuming a base line from the prior year. This assures that every line item is necessary and reduces the fluff within the budget. This zero base approach requires every line item to be calculated accordingly (i.e. utilities) based on usage.
•    Historical trend: In this type of budget an association uses the historical data from budgets past, then reviews  its past history to determine what the increase or decrease in expenses will be for the next year. As an example, Engblom said, “To increase the percentage, you can look at two years ago. You spent 17%, and then this year you spent 19%. So you know to increase 2% again for the next year.” Typically the budget has numerous line items that have inaccurate numbers in those accounts.

There are three (3) types of accounting methods to be used within a budget as follows:

1.    Cash method. Using this method, the association will collect money and pay it out as invoices are received. A great comparison would be one’s personal checkbook.
2.    Accrual is based on when income is earned (or billed), and when expense are incurred. Income and expenses are accounted for outside of when the actual cash comes in or goes out.
3.    Modified cash, also know as modified accrual, is the most complicated method for accounting, but also the best. It records income and expense on a cash basis with some on an accrual basis.

As mentioned earlier, the association can take into account the needs of the homeowners. Budget line items are determined to be either mandatory or discretionary. Mandatory line items are a need or an obligation, such as water, insurance, or taxes. Discretionary line items are a desire or expectation, such as a pool, playground, or golf course. The discretionary items can be ranked based on the desires of the homeowners, but mandatory items must always be budgeted for.

Reserve studies themselves are detailed in another chapter, but here is an overview of the studies and how they are utilized within the framework of budget creation. Once revenue and expenses are established, the association has the so-called bottom line of the budget. Engblom advised that reserves are taken out at this point. Reserve studies serve as a resource for capital expenditures that would be in the the future of the association. The reserve study consists of two components including a physical inspection and a financial inspection. “Reserve funds are set aside for the future, for replacement of major components of an association,” Engblom said, “and reserve studies should be updated every three to five years.” They may be required by a state statute, regulations, mortgagees, or the association’s own governing documents. The Federal Housing Administration suggests setting aside 10% of the total budget for reserves.

Funding for reserves consist of four aspect as follows:
1.    Statutory — Required by state or federal agencies.
2.    Fund Safety — Maintain in FDIC insured accounts.
3.    Liquidity — Don’t have all funds in certificate. Have some cash on hand for emergencies.
4.    Yield — The return on investments.

Reserve studies generally include capital improvements and major improvements. Capital improvements include existing entities that must be replaced, such as a roofs, siding or playground equipment. Reserve studies set money aside for the future, anticipating that something will need to be replaced or repaired. Engblom noted that the amount of money set aside can be judged from the useful life of the structure in question. As an example, “A roof has a 30 year useful life, but because of weather or the like, it may need to be replaced sooner or later. Reserve studies plan for putting aside money for these sort of things,” Engblom said.

Major improvements, on the other hand, include the addition of something new to the association, such as a clubhouse, pool, or golf course. These improvements  are not being maintained, as with a capital improvement, but rather they are being constructed for the first time.

Engblom pointed out some of the benefits of using a reserve study: meets legal and fiduciary professional requirements, provides for planned replacement of major components, minimizes the need for special assessments, enhances the resale value of units, equalizes new and old,  reduces personal liability from financial mismanagement, prioritizes a business plan for repairs, acts as a communication tool for the owners, can reveal maintenance issues that you haven’t seen, saves planning time, reveals unbudgeted items.

He also mentioned some of the drawbacks of a reserve study: underfunding resulting in the need for a bank loan, deferred maintenance, overfunding, board member liability and possible loss of directors & officers liability insurance.

In relation to a budget, a reserve study can most importantly determine what has not yet been budgeted for. It can provide an association with a more thorough road map for the what-if scenarios and help secure an association’s future.

Engblom noted that there are certain financial warning signs that associations must look out for. As mentioned before, reserves are a necessary aspect to the life of the association. If replacement reserves are not set aside, the association may have a problem. Why weren’t they set aside from the rest of the budget? This underscores the necessity of having a transparent budgeting process and making sure that all expenses are accounted for, even those hypotheticals that are backed up by a reserve fund.
 
Further financial warning signs include increased overdue assessments (delinquencies) or an increase in what the association owes. Engblom advised that associations should look for significant differences between budget figures. Has the budget for a certain line item suddenly propelled upward? Additional signs of financial mismanagement include when members’ equity is less than one to three months of the operating expense. Maintaining control of the finances within the budget and reserve fund will provide an avenue over unexepected hurdles for the board and the homeowners in preventing a financial impact in the form of a special assessment.
 

In addition, having control of your financial reports will provide a means of best practices for procedures relating to accounts receivable or accounts payable. In the global aspect for the association it can help discourage dishonest behavior within the association that may result in embezzlement, fraud or theft.

Extra money goes into reserves.

Calculating Association Assessments

Assessments are a common conduit of condominium and homeowners associations, as an intricate component in providing income for the operating budget and funding reserves for future community expenditures. Thomas Engblom, CMCA, AMS, CPM, PCAM, PhD, detailed for us what assessments are, how they are calculated, and how special assessments factor in. Of course, in order to keep your association running well, you must understand assessments and their purpose in aiding financial stability.

“Assessments are the proportionate shares of the expenses to maintain the property of the association,” Engblom said. Assessments are sometimes called maintenance fees or dues. How are assessments calculated? “They’re typically calculated on a percentage of ownership — which never changes for each co-owner. However, there can be a change in the monetary amount of the fees, but it will always be based on that owner’s same percentage of ownership.” Assessments are usually calculated in the initial phase of the association by the developer. “The developer creates a mathematical formula based on the cost of maintaining the new association,” he said. Engblom noted that as the association ages, logically, additional maintence is required thus increasing the association’s fees. In Chapter 6, changes in fees after the developer leaves the community are discussed.

Each owner’s percentage of ownership can always be found in the association’s governing documents.

What could cause assessments to be higher in one association as opposed to another, even though all variables and amenities are equal? Assessments are quite dependent on the actions and professionalism of the board and management. If those running the community are educated in association managment, they will have the knowledge to provide a budgetary structure that will maintain the association in its daily operations, as well as building proper reserves for the future. However, it is also important that those running the community adhere to their fiduciary duties, and always act in the best interest of the association. Problems can occur when an association’s governing body is only concerned with the political advantages of maintaining low fees. In the most drastic situations, some board members, knowing they want to sell their units in a few years, can make the community seem attractive to potential buyers by keeping fees artificially low while not putting any funds in reserves. Such a community would eventually come in for a crash landing — specifically, needing to special assess the unit owners and/or obtain a bank loan for capital improvements as they became necessary, or otherwise causing the physical association to deteriorate.

Engblom pointed out other factors which affect fees among different communities. “If you’re going to buy in an association with a pool, it will cost you considerably more to live there compared to a association without a pool. A pool will require maintenance, repairs, chemicals, furniture, attendants and more. Communities with pools also have an increased insurance cost over those without. Assessments are the sheer cost of living for the association — what it costs to maintain the common areas of that community. Comparatively, owners of single homes outside of a community incur costs to run and maintain their homes and properties. In a community, these similar costs are multiplied by the number of units for those similar needs.”

When special assessments or fee increases are necessary, associations cannot randomly calculate assessments based on the whim of the board. The assessment or increase must be made within the parameters of the governing documents and specific state statutory requirements. 

Collection procedures for delinquent unit owners are detailed in other chapters, however here, Engblom outlined the methods and importance of collecting regular dues, and how to evaluate the health of an association based on its delinquency rate.

Assessments are a financial obligation to the community association during a given period of time, which is usually broken down into payments, such as monthly, quarterly, etc., unless a long-term special assessment is manadated. “Assessments are paid pursuant to the governing documents of the association. They’re mandatory, so residents are obligated to pay them,” Engblom explained. Presently, numerous methods for payment are available — check, ACH (automatic debit), online payements through an association or bank website and credit card.

Every association should have a formal collection policy and take the time to educate owners about the consequences of delinquency. Associations should avoid discriminatory actions against delinquent account holders. “You should have a procedure and protocol — rule or regulation,” Engblom said. Board members can establish these procedures utilizing the business judgement rule, he added. Not only can this improve relationships and communication between the board and the residents, but it can also help ensure that assessments and monthly fees are paid on time. Furthermore, collections are crucial to maintaining necessary cash-flow and to reducing loss of payments from owners. “The bottom line,” Engblom said, “is that a collection policy keeps owners informed, provides a guide for the manager, and enforces a written policy.”

Since assessments make up the major portion of an association’s income, it is crucial that they are paid by the unit owners. However, most associations have at least some delinquent owner accounts. Engblom delineated the delinquency rates and how they should be evaluated:

0-3%    good delinquency rate
4-5%    reasonable delinquency rate
6-10%    declining delinquency rate
10%    horrendous delinquency rate
Over 10%     very bad delinquency rate

Engblom also noted that for association loans, delinquency rates must be less than 10%.

Special assessments, in addition to regular dues, sometimes constitute part of an HOA’s income. Special assessments generally make up for expenses that cannot be covered by the budget, either because operating expenses exceeded the budget, a natural disaster or similar situation occurred, a special project began, or too many residents were delinquent in their dues. Reserve funds, as noted in Chapters 8 and 12, alleviate some of the pressure of unexpected expenses. Special assessments pick up any monetary gaps not covered by reserves or the budget. Engblom said, “They are a one-time fee or charge.” They are not charged regularly as plain assessments are, although they can be collected on a similar schedule (i.e. monthly, quarterly, or annually). The dollar amount of the special assessment each unit owner pays similarly depends on their percentage of ownership.

A special assessment is typically voted on by an association’s board for an item or project that was not voted on previously during the annual budget planning. “It’s all driven by what the state requirements are, but in theory, the board approves the budget or special assessment. The board communicates the information, allowing the unit owners to review or discuss it at a subsequent special meeting for the purpose of the special assessment. The board always has the power to initiate the budget or the special assessment, however, depending on the governing documents or state statute, final approval may be contingent upon a vote of the unit owners. Furthermore, some states allow unit owners to petition the board of director’s decisions thereby repealing an action of the board while other states don’t allow that option.

Percentage of ownership always equals 100% when all units are combined. Engblom’s example: “If all the units were the same size, and you only have 10 of them, each unit would have 10% of ownership. If you have 1,000 units, the percentage decreases as the percentage sum must always equal 100%. The equation to calculate the percentage is based on square footage and/or location of the unit. Henceforth, square footage of units will change the percentage of assessments depending on their percentage of ownership.”

“Let me give you a situation,” said Engblom. “One of the properties that I own as an investment property had a swimming pool. The swimming pool was used by hardly anyone, and it was costing the association approximately $35,000 each year. There were  numerous problems with the pool. Suddenly, the association was going to need to spend $60,000 obtaining proper licensing from the state. The board said, ‘Well, we’re not going to waste that kind of money. For $70,000, we’re going to fill that pool in.’ The community decided to put a park in place of the pool area, thereby deleting the pool expense from the budget forever! This resulted in a three year pack back for the association. The association manadated a special assessment — a one-time charge paid either in a lump sum within two months, or monthly for five years at $50 per month, including interest as a result of the funding by the association.”

Contact Info:

Thomas Engblom, Ph.D, CMCA, AMS, PCAM, ARM, CPM
Vice President Regional Account Executive Midwest
CIT Group Inc.
(312) 209-2623
thomas.engblom@cit.com
www.cit.com

Minnesota Disasters

Thomas C. Engblom, Ph.D, CMCA, AMS, PCAM, ARM, CPM

Thomas C. Engblom, Ph.D, CMCA, AMS, PCAM, ARM, CPM

Disasters

While every homeowner association hopes for a community that runs smoothly and safely, HOAs must remain aware of the possibility of disasters and dangerous situations in order to provide their residents with the greatest amount of safety and security. Thomas Engblom, CMCA, AMS, PCAM, ARM, CPM, PhD, outlined a plan of action for homeowner associations, detailing what to do prior to a disaster, and how to manage if disaster does indeed strike. Disasters can include anything from weather-related incidents, including hurricanes and tornadoes, to man-made disasters and emergencies, including bomb threats. While each scenario differs in how an HOA must react, there is a certain amount of preparation that an HOA may do to help ensure the well-being of its residents, first and foremost, and to help reduce damage to property. 

Before enacting disaster preparation within an association, what exactly qualifies as a disaster? “A disaster is anything that would be unplanned,” Engblom said. Some common disasters include fire, flood, tornado, electrical malfunction, etc., which of course vary in scale. “You should always plan for something that would be abnormal to your area as well. Planning for a disaster, geographically you may have fire, flood, or tornado, but you should prepare for the unknown.” Consider any weather events that typically occur in your area, but also consider aspects of your surrounding area, including, for example, train tracks or chemical plants. Simply because a certain disaster or event has not occurred near an association or is quite rare, the association should still consider it a possibility and plan for it. Being over-prepared for a variety of disasters is a better plan of action than being completely unprepared. Bigger properties, with more units and residents, will need to prepare differently than smaller properties. 

Placing the burden of preparation entirely on the residents themselves is not an option. The association has a responsibility to its residents in the event of a disaster. The responsibility of the board is covered in the association’s governing documents. “This goes back to the board, and the board is the governing agency. The board has a fiduciary responsibility to maintain the common elements. How do you maintain those common elements? They essentially need to restore the common elements to the condition that they were in before [the disaster],” Engblom said. “You want to protect the association, and the bigger concern is that you don’t want any loss of life.” To illustrate this, Engblom gave the example of an association where the power went out. The association did not want residents to walk up to their units in the dark through the stairwells because residents could injure themselves. In addition to jeopardizing the safety of residents, such a hazard could become a liability to the association.

When actually planning for hypothetical disasters, Engblom suggested that associations prepare for different components of any problems that may arise. Additionally, disaster plans should be updated on a regular basis by trained professionals. Parties involved in the review process of a disaster plan include maintenance, management, the board of directors, or residents with a relevant skill set (fire personnel, tradespeople, medical personnel, etc.) to provide input. “You as a board member might not have the expertise, but if you call the fire department or the police department, they can give insight to some of the basic information that would be a part of this.” Engblom further noted that, if you have people involved in any of these fields within your own association, you can tap into their knowledge.

Insurance companies should be involved in the process as well. “You want to know how much they will cover and what authority you will have,” Engblom said. The insurance company can provide the funds necessary, depending on the situation, to prevent any additional damage after the disaster. He advised that the association should first call 911 in the event of an emergency before contacting any other involved parties (including restoration or insurance companies). 

Engblom also noted that FEMA (Federal Emergency Management Agency) provides information regarding disaster plans, including how to make a disaster preparedness kit and how to act both before and after a disaster occurs. They also provide booklets that can be kept by associations and their residents. The booklets cover a range of topics related to disaster preparedness, including what should be kept in preparedness kits — including water, flashlights, rope, plywood for boarding up windows, etc. Detailed information can be found on FEMA’s website at www.fema.gov.

Associations should establish command centers to prepare prior to, and to coordinate following, the disaster. “A command center can be in the office or it can be in a different location so that everyone who is filtering through — such as contractors and emergency response personnel — can be briefed,” Engblom said. In the emergency disaster plan you should also have a meeting place. “It can be down the street. Maybe it’s at a church, maybe it’s at a school. You want it conducive to your situation. You want people to go there and meet so that you can have a head count,” Engblom said. Meeting locations may change depending on the season or the type of disaster. The main component is that the meeting place will serve as an information and treatment point as well as a refuge for residents.

Engblom noted the importance of establishing if any residents have special needs or circumstances that would be affected by certain situations. For example, if the power goes out and a resident needs an oxygen tank, having that knowledge on file allows the association to better ensure that resident’s safety. Associations should provide evacuation plans for residents and stipulate specific plans for non-ambulatory residents. If your association allows pets, provide a plan for them. Local pet hotels serve as a good option for boarding. Planning for every type of disaster requires that the association plan for the aftermath of every scenario as well. 

 

Associations must also consider how to communicate information and updates to residents in the event of a disaster. Engblom said, “You may have a dedicated cable channel that you can utilize. You can call people at home, by cell phone, or email them.” Automated technology that utilizes email or phone to send out blasts of information to certain groups of people is a good choice. This can be customized to fit the needs of your association as well. If a task force exists, they can be sent information specific to them while residents can be sent their own relevant information. Note that some lines of communication will cease functioning during certain scenarios (i.e. if there is a fire, updates by home phone is not the most efficient choice).

In order to best prepare residents, the association should have meetings to go over the disaster preparedness plan. They may also want to hold a mock-drill. Inform residents of the potential of upcoming events, such as fire drills and town hall meetings. Forms can be provided for residents to complete. “Consider having owners acknowledge receipt of the plan with a signature page,” Engblom said. The plan can be included in association documents, such as the rules and regulations, and can be mailed out on an annual basis with a summer communications or annual meeting packet. Ensure that the plan is included in your resale disclosures.

In the event of a disaster, an association should hold meetings on a regular basis to keep residents informed and to discuss what damage has been addressed and how the situation should be dealt with. This harkens back to maintaining open lines of communication. “If you’re with a management company, they will be the conduit for the communication that you have.” 

Following a disaster, the association demonstrates their responsibility by liaising with a restoration company to repair any damage that occurred. The restoration process is discussed in detail in the next chapter, but here is a briefing of what typically should occur. If the disaster covered a wide area, a restoration company will need to prioritize a list of their own, which may delay repairs within your association. “The question becomes, do you have multiple restoration companies as a backup?” Engblom said. As will be detailed in the next chapter, associations should be prepared with information about restoration company contacts to help speed up the process of fixing any damaged common elements and returning the community to a place of normalcy.

Associations also should be aware of security issues and put measures in place to prevent burglaries if units will be unoccupied. “Call your vendors to make sure they are ready, willing, and able to perform board-up services and begin interior dry out,” Engblom said. While security of your residents remains the priority, securing a building against theft helps to mitigate the stress following a disaster. Associations should further secure their important documents, including insurance policy documents, checks, owner lists, banking information, and a complete set of the governing documents.

As far as documentation of the disaster itself, associations need to report any damage to their insurance company. This process is detailed in Chapter 10 — Insurance. Briefly, the extent of documentation is done on a case by case basis and depends on the type of disaster, Engblom said. Insurance companies typically ask the date and time that the event occurred and what steps you are taking. Engblom recommended that you schedule an adjuster to call as soon as possible. If possible, require your restoration contractor or other vendor to meet with the adjuster on site to verify damage; try not to allow the adjuster to visit the site unaccompanied. Get the claim number as well as your insurance company contact’s email address so that you can immediately follow-up with them, noting all of the information previously exchanged over the phone.

As part of preparing in advance, associations should catalog specific building information. Keep a file of the brand, model, and serial numbers of pumps, motors, appliances, swimming pools, and any other major equipment. Conduct a physical inventory of items such as furniture and equipment. Engblom added, “Videos of these items [before a disaster] will be invaluable.”

T

he media may show up at an association in the event of a disaster. Engblom suggested letting a representative from the management company deal with the media, as they are more likely to have the expertise and the knowledge necessary to adequately address any questions. Engblom also suggested keeping the media off of the property, as they may only exacerbate ongoing problems. 

While disasters can occur on a vast scale and vary greatly in type, associations do have the power to mitigate damage and panic to a certain extent. Preparing for a wide range of scenarios can help provide residents with a greater sense of security and can help the association fulfill its responsibility to the residents.

  • First aid supplies
  • Emergency cordoning tape
  • Rope
  • Sheets and blankets
  • Battery-operated megaphone and whistles
  • Flashlights
  • Portable AM/FM radios
  • Walkie-talkies
  • Spare batteries and manual battery
  • Chargers
  • Flares
  • Poster board and markers
  • Blockades and flashing lights
  • Bottled drinking water
  • Water purification tablets
  • Non-perishable food
  • Camera
  • Plywood Sheets
  • Portable generators
  • Hygiene products
  • Filtering face masks
  • Tool kit
  • Plastic sheeting and duct tape

Contact Info:

Thomas Engblom, Ph.D, CMCA, AMS, PCAM, ARM, CPM
Vice President Regional Account Executive Midwest
CIT Group Inc.
(312) 209-2623
thomas.engblom@cit.com
www.cit.com

Minnesota Plumbing

Justin W. Moe

Justin W. Moe

All Ways Drains Ltd.

The Association’s Plumbing

Plumbing is a crucial part of any community association. As such, it is important for managers and board members to become familiar with common plumbing problems and the process for working with a contractor. What kinds of issues are easily recognizable? What should managers and board members look for when selecting a plumbing contractor? How can association residents help prevent plumbing problems? We spoke with Justin Moe, owner of All Ways Drains in St. Paul and Minneapolis, Minnesota, to answer these questions and more.

What are some of the most common plumbing repairs? Moe said that he most often sees clogged drains and pipe leaks in water and drain piping. But many issues can often be spotted ahead of time if you know what to look for.

Moe explained, “Pipe leaks often show signs of corrosion prior to leaking. It is best to take care of these before they become a larger problem.” However, corrosion is easier to spot on exposed pipes, and not all pipes are exposed. “If the piping is not exposed, then these bad spots may not be visible,” he said. Other telltale signs include stains on drywall or other surfaces. He said that managers and board members are welcome to inspect plumbing if they can do so safely and should look out for things such as “slow drains, leaking or corroded piping, continuous or frequently running toilets, dripping faucets, and low water pressure.” What if a problem becomes reoccurring? Moe noted, “Repetitive service calls for the same issue may mean there is a larger problem or other contributing factors.”

He also recommended performing preventative maintenance to help keep the association’s plumbing in good condition. Moe elaborated, “Clogged drains can often easily be prevented with preventative maintenance, which would typically mean high pressure water jetting the drain lines to remove any build-up in the pipes before it causes a complete blockage.” Yet there’s only so much a plumbing contractor can do to pre- vent plumbing issues.

He also emphasized educating residents on proper plumbing use, specifically what can and cannot go down the drain. Moe stated, “Unfortunately, no amount of preventative maintenance will prevent someone from putting something down a drain that should not go down a drain, and that is why education is very important.” He continued and said that even the amount of grease that comes off of food plates is enough to cause blockage over time, and that garbage disposals can also cause problems if they aren’t used properly.

When selecting a contractor, it is important to know what to look for. Moe gave these following recommendations: “Give clear instructions on the scope of the work that is to be estimated. Take time to research the contractors who are providing estimates. Are they known for providing low estimates and then, once they have the work, find reasons to increase the cost of the job? Are the contractors familiar with the multi-housing industry? Does the contractor work with multiple management companies or multi-housing properties? When something has gone wrong for the contractor in the past, do they do their best to make the situation right by the customer?” All of these things are important to consider. As to the contract for the project, Moe said that the work to be completed, project costs, and any exclusions should all be clearly defined and stated in the contract.

What is the recommended communication process between a board member, manager and contractor? Moe said that it’s best for the association to have one point of contact in direct communication with the contractor and that it is usually the manager of the association. “When multiple people are involved, then it is generally a good rule to try to keep these communications in writing via email. Unfortunately, when information is passed from one person to the next, things often get changed or misunderstood,” he explained. When communicating with residents about plumbing projects, Moe again suggested that the association have one point of contact relay information to residents and to preferably keep important communication in writing.

In what manner and how often a contractor updates and communi- cates with the association largely depends on the preferences of the association. “Some just want to know a job is done, while others may want to know the details. Some clients prefer a phone call when done or an email. Often, a client is present and there is no need for an update, or the repair is obvious,” Moe explained.

What kind of insurance requirements or documents should manag- ers and board members ask for from a contractor? Moe stated that con- tractors should provide the association with, or proof of, the following: liability insurance, workers’ compensation, auto and umbrella insurance certificates, a W-9, their license number and copies of any appropriate bonds. Generally, he said, requirements are outlined by the association. “Once the contractor has been made aware of the requirements, then he or she should review their coverage to make sure that it meets or exceeds the client’s requirements,” he said.

Throughout the project, Moe said that the association should expect the contractor’s personnel to be professional and honest, to clean up after themselves and to care for the customer and their belongings.

What are common reasons for delays on projects? Reasons for delays on projects and other issues are often outside the control of managers and board members, and even the contractor. Moe listed some of the common causes: “traffic, materials and product availability, and unknown factors — things that are behind walls, in ceilings or buried underground.”

What are some common reasons for conflict between managers, board members and contractors? Moe said that such conflict is almost always due to some kind of miscommunication. “Clear and precise communication is key for everyone,” he said.

While it is not ideal, an association may find itself faced with a cost overrun, where the actual cost of the project in the end exceeds the estimated cost. There are many reasons why this may occur, Moe said, and it is often due to unknown factors. “For example, it turns out that not just one small section of underground piping needs to be replaced, but rather a large section or the entire line. Or it turns out that there are other buried utilities in the same area that may cause the work to be delayed, or cause the work to take additional time. Another example would be that parts are unavailable for a fixture, and therefore that entire fixture will need to be replaced,” he explained.

How should managers and board members be notified of cost over- runs? “Once it is known by the contractor that costs may change, the con- tractor should inform the point of contact for that particular job. Again, preferably in writing if possible,” Moe said.

Managers and board members may find themselves with a role to play throughout the contracted project. As stated earlier, they may serve as the first point of contact for the association when communicating with the contractor or residents. Moe said that they may also be responsible for preparing the contractor’s work area. He explained, “Make sure the work area is clean and any personal items are removed, if possible. Pets should be kenneled or locked in a room that the contractor will not be going in.”

What is unreasonable to expect from a contractor? Moe answered, “Expecting that someone can be at their location immediately. Traffic, weather and construction are a constant challenge just for traveling. Expecting that the contractor will not make a mess is unreasonable for many jobs.” As for projects and repairs in general, Moe stated, “While it may seem like the contractor does magic, there actually is no magic involved, and no one has a magic wand that can fix things with a wave of that wand.” He continued and explained what managers and board members should expect from a quality contractor. “What is not unreasonable is expecting that the contractor will clean up after themselves and take precautions to prevent damage or minimize any mess,” he said.

Managers and board members are also partly responsible for ensuring that the contractor fully understands the association’s needs. If a contractor does not seem to be fulfilling their obligations, Moe offered his recommendations: “Communicate! Discuss the situation with the contractor and ask if the problem can be resolved. Often, a contractor may not realize that they are doing something wrong or not doing something they should be doing. Contractors are just a human as the next person, and they do not have mind reading capabilities. Most contractors honestly want their customers to be happy and satisfied, but that sometimes takes extra communication between the contractor and the client. If discussing the situation does not correct the problem, then put it in writing via an email or letter. Make sure this communication is addressed to the appropriate person and ask for confirmation that the communication was received.”

Contact Info:

Justin W. Moe
All Ways Drains Ltd.
567 Shoreview Park Road
Shoreview, MN 55126
Phone: (612) 366-7206
allwaysdrains@gmail.com
www.allwaysdrains.com

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