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Michigan HOA / Condo Book
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How are the elements of a community defined? What establishes 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 the responsibility of the association? These issues and others are established in what’s called an association’s Covenants, Conditions and Restrictions (CC&Rs). Attorneys Stephen Guerra and Jeffrey Vollmer, of Makower Abbate Guerra Wegner Vollmer PLLC in Farmington Hills, Michigan spoke with us at length and explained the nuances of CC&Rs as well as many other important common interest community topics. One important note — in Michigan, as well as some other states, statutes are different for condominiums versus homeowner associations (HOAs). That is something to keep in mind for nearly all aspects of association governance and living.
Guerra explained that CC&Rs typically refer to an eponymous document called the declaration of covenants, conditions and restrictions, which is recorded against property in a subdivision. It’s a title that is in general use for a document that contains restrictive covenants — or use restrictions. Sometimes, in jurisdictions other than Michigan, this title is also given to a document of restrictive covenants in a condominium. However, in Michigan, the document that serves this purpose in a condominium is called the Master Deed.
CC&Rs are traditionally recorded as land becomes subject to them through filing with the county register of deeds office.
Now, CC&Rs should not be confused with the rules and regulations of an association. Rules and regulations are something different entirely. Most distinctively, boards can generally change rules and regulations without holding a vote of the association’s members — the CC&Rs cannot be changed in this manner. Rules and regulations deal more with the more hum-drum details of daily life, such as when the trash is allowed at the curb and what items are restricted from being placed on balconies. However the rules and regulations work in conjunction with the CC&Rs. How so? First, Vollmer noted a distinction between how these work in condominiums versus HOAs. He explained that the Michigan Condominium Act recognizes an association’s rules and regulations as part of the Condominium Documents all residents must follow in the State of Michigan. They are not statutorily recognized in HOAs that utilize a declaration of CC&Rs. So whether or not a board has rule power at all is going to depend on whether there is a grant of power to pass rules in the declaration itself. At that point the declaration is going to govern the scope of that rule making power and the depth of rules and regulations the HOA can enact.
In condominiums, where it is provided by statute — that is, state law — the rules and regulations have been determined by various court cases in Michigan to apply to what are referred to as de minimis aspects of daily life, and to clarify grants of discretion given to the governing body. “For instance, a restriction may prohibit landscaping on the common elements except when approved by the board of directors. The board can then adopt rules and regulations to clarify which type of landscaping will not require specific board approval. The rules serve to outline the parameters of discretion afforded the board.” Vollmer said.
The de minimus aspect of the daily life component of rules and regulations is very similar to the clarification of a grant of discretion. “The restrictions may prohibit unsightly conditions or conditions which are detrimental to the appearance of the condominium project,” said Vollmer. The rules and regulations can actually specify what is determined to be an unsightly or detrimental condition. It can deal with regulating when residents can place their garbage out for pick-up and when the containers need to be brought back.
These types of details that clarify substantive restrictions are what rules and regulations are for. Rules and regulations cannot establish substantive restrictions. Since they are not recorded or voted upon, you can’t use rules and regulations to fill gaps or needs where you don’t have a grant of discretion already relating to the context in question. “. A good example is the absence of any restriction limiting pets in the community. The rules and regulations cannot say, ‘ No pets,’” Vollmer said. Something like that requires an amendment of the declaration or the condominium bylaws to establish the substantive restriction. “Having rules and regulations affords the board some flexibility in keeping up with the needs and desires of the residents over time because rules and regulations can usually be amended by a vote of the board. Rules and regulations are not intended to modify or alter the bylaws or use restrictions, as such amendments usually require some super-majority vote of the members,” Vollmer said.
Which governing document carries the most weight in an association? If you’re looking for how an association operates, articles of incorporation are number one. Bylaws are number two.
If you’re talking about restrictions on use of property, you’re going to be talking about the declaration of restrictions in a subdivision or HOA sense and talking about the master deed and condominium bylaws in a condominium sense. “We tend to separate the master deed, bylaws and condominium subdivision plans, but keep in mind that bylaws and condominium subdivision plans are exhibits to the recorded master deed,” Vollmer said.
When referring to the master deed, you’re referring to three separate parts of the master deed in conjunction with one another:
-the Master Deed itself
-the condominium bylaws, usually as exhibit A to the master deed
-the condominium subdivision plan , usually as exhibit B to the master deed
How detailed do the CC&Rs need to be in the governing documents? According to Vollmer, older CC&Rs mainly concerned themselves with a list of building restrictions. More modern declarations deal with several different items. In addition to the architectural restrictions, more attention is paid to certain facets of operating an association, levying assessments and enforcement powers. In cases where you have shared recreational facilities, the CC&Rs specify the usage of those facilities.
“The CC&R’s should identify the creation of an association to administer the community and should reference the existence of bylaws for that association,” said Vollmer. If an association is funded through assessments or dues, there should be detailed provisions providing for those assessments and their enforcement. “The recorded CC&R’s should be the primary source for the substantive restrictions governing the community, including the types and purposes of any assessments. HOA bylaws should be focused on governance issues, such as voting, meetings, directors and officers. Any attempts to place substantive restrictions in the Bylaws are misguided,” Vollmer said. The existence of a statutory framework for assessments in condominium projects, on the other hand, makes them entirely different and allows such matters to be covered in the master deed and condominium bylaws.
It must also be specified how the association may change those restrictions from time to time. Those are the components of a good set of CC&Rs. Of course, the needs are dependent on what the association is going to take care of. “The scope and breadth of the restrictions may be far less if the only common area is an entranceway. If there is a pool, clubhouse and other recreational facilities, the restrictions may be more detailed,” Vollmer said.
One potential problem with governing documents is the use of vague language. On this topic, Guerra explained that the biggest issue with vague language is that it’s subject multiple interpretations, with the final interpretation coming down to a judge.
“If the documents are unclear, judges will focus on figuring out ‘the intent of the drafter’ by reviewing all of the documents in their entirety to ascertain what the drafter desired given the restrictive scheme in the project ,” Vollmer said.
There are many judicial rules and maxims by which these interpretations are made. One example, he explained, is that ambiguous provisions are resolved in favor of free use of the property. “Under this judicial rule, restrictions which are not carefully drafted may have no impact because ‘free use’ of the property is preferred over enforcing an ambiguous restriction,” he said.
There are situations where vague language cannot be construed. “If you are dealing with competing interpretations that cannot be resolved, you should consider amending the language to eliminate this problem,” he explained. Vollmer stressed that amending the language before a problem arises is less costly than fighting in court over competing interpretations, and it also ensures that the document reflects the needs of the community at that given time.
If boards follow their rules and documents, does the potential exist for them to be challenged successfully?
“Recorded restrictions must follow the rule of reason,” Vollmer said. In other words, just because something is in the restrictions or rules and regulations, does not mean it’s necessarily enforceable. There must be some useful purpose being served by a particular regulation. It cannot violate public policy and it must not violate any other law or regulation by which the community that it is imposed upon is governed.
As an example: “A common restriction in older documents prohibits satellite dishes anywhere in a community without written permission. However, that restriction is at odds with FCC Rules and Orders preventing associations from limiting certain dishes and installation locations. The permissive use of the law trumps the restriction.,” Vollmer said.
Another example arises with respect to enforcing single-family use restrictions, particularly if they require residents to be related.. “While they may seem reasonable, any attempt to enforce them will violate the Fair Housing Act and will subject the association to a discrimination complaint ,” he said.
A provision can be unenforceable simply in the way it has been drafted. “While Michigan law recognizes public policy supporting the right to enact restrictive covenants, those restrictions cannot violate other areas of established public policy,” he said. “Voiding a restriction based on public policy grounds is a convenient way for a judge to strike down an unreasonable restriction.” An example of this could be someone wanting to reduce their carbon footprint by being allowed to use a clothesline in an HOA where clotheslines are prohibited in the rules.
Another example of rules that would be challenged are those which violate the Fair Housing Act Amendments. We provide detail on the Fair Housing Act in another chapter of this book; however, we mention it here as it affects the enforceability of rules and regulations.
“It applies to condominium associations and HOA’s regardless of when those communities were formed and their restrictions were drafted ,” said Vollmer. Many old documents fail to account for the rights of disabled residents to seek reasonable accommodations from their association or make reasonable modifications to common areas. . “Some of those principles have been incorporated into the Michigan Condominium Act.” Michigan also has its own anti-discrimination statute, The Elliott-Larsen Civil Rights Act, which piggy backs on what the Federal Government has done with the Fair Housing Act amendments.
“Any enforcement action, as well as requests from disabled residents, cannot be evaluated on the text of the restrictions alone. Boards must view these issues under the lens of the relevant anti-discrimination statutes ,” said Vollmer.
He explained that these types of complaints are becoming plentiful, and they are easy to file. They are expensive for an association to deal. “Restrictions on pets are slowly being eroded away. Disabled residents may present evidence of the need for an emotional support animal under the Fair Housing Act amendments ,” he said. Pet restrictions have been marginalized by the relative ease through which residents may visit a doctor willing to write a letter stating the resident has a disability that is remedied by them keeping a pet.
“The costs and potential legal exposure of a civil rights complaint associated with challenging the existence of a disability or the need for the pet usually means that the pet will be permitted ,” he said.
Because of the justifiable fear of facing a civil rights lawsuit, many of these decisions are determined administratively by the associations rather than in a court of law. Thus, the complainant has a good chance of getting their way in these matters.
Is a committee’s decision final when penalizing a resident rule-breaker, or can a resident appeal to an association’s board?
“It depends on the association’s governing documents and whether a committee has been formed in the first place ,” said Vollmer.
He explained that most committees are formed by and staffed by the board of directors. “Occasionally, governing documents establish committees whose members are voted on by the owners instead of appointed by the board. Those committees are known as committees of the membership. ” Committees of the membership have separate powers and are more autonomous from the board of directors than traditional committees (the social committee, communications committee, etc.).
Committees that operate by and through the board of directors usually do not have independent power, other than to recommend to the board. On the other hand, committees of the membership can have separate powers and would not need a grant of authority from the board since they derive their authority from the documents themselves.
However, if a decision has been made by the board rendering a resident guilty of breaking a certain rule, it doesn’t make sense for the resident to go to the same committee to appeal. “If there is no committee in place to review violations, the ultimate decision rests with the Board. There is no higher power within the association. ” said Vollmer. He noted that if an association is going to have an appeal procedure, they should have one that makes rational sense. But appeal procedures before the same people within an organization really don’t make sense, and ultimately, if the board makes a decision that a resident disagrees with, the resident should take their appeal to a court of law.
How does an association determine fine amounts? “Most often the restrictions or bylaws will contain an escalating fine schedule in which the first violation results in a warning notice, the second one gets a fine, the third one gets a higher fine, the fourth and subsequent ones result in the largest fine. Fortunately for condominium associations, even if the fine amounts are not listed in the bylaws, state law authorizes them within a rule adopted by the board. Such a structure eliminates arbitrary fines,” said Vollmer. Once you take discretion out of the process, you remove the possibility of someone saying the board has behaved in an arbitrary or capricious manner.
However, it is not necessary to have a fine schedule, and you can have a system where each fine is determined by the body that is doing the hearing and then ultimately confirmed by the board of directors. Some associations have different fines based on the severity of the violations. “If there is extra incentive to protect against threats to the safety and welfare of the community, an enhanced fine may be warranted, as opposed to following the escalating fine structure for something like putting trash out early ,” he said.
The more discretion you put into the system, the more you need to keep good records of the circumstances that comprise a violation and the fine levied, along with the factual circumstances surrounding that. “Boards should be consistent in levying fines. Varying from the fine schedule or specified fine for a particular violation may result in the board being accused of arbitrary or discriminatory conduct ,” said Vollmer.
Vollmer also added that associations are not required to provide an appeal process for fines if the board conducted the hearing.
The concept of Due Process is found in the US Constitution “Governments shall not deprive any person of property without due process of law. While associations are not government actors, certain due process principles are applicable to the assessment of monetary fines. Associations should not, and cannot in the condominium setting, levy monetary fines without placing the offender on notice and providing a hearing ,” said Vollmer.
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, and when, and that it was in violation of a particularly identified restriction.
“Initially, the offender is entitled to notice of the particular violation of the governing document and what the penalty may be. After notice has been issued, the offender should receive a hearing to offer a defense to the alleged violation, including the right to present evidence in defense of the violation. ,” Vollmer said.
If it can be determined that a violation has actually occurred after following those steps, and the association has the right to fine, due process has been satisfied and the fine may be levied .
What is the process for an association to amend their CC&Rs? In a condominium situation, according to Vollmer, that is covered by a mandatory statute and requires two-thirds of all eligible voting co-owners in an association to approve it. In seven different instances noted in Michigan’s statutes, first mortgagees also need to approve.
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 government by the whole. To them, transparency means everything gets voted on by the members, and the vast majority must agree on everything that is enacted. According to Vollmer, that is not the practical implication of transparency in community associations. The members of the association vote for people to serve on the board to make decisions for them.
In its real sense, transparency is where decisions are made known to the co-owners. “Generally, boards should keep their meetings open to observation by the members ,” said Vollmer, “but that general rule can be limited by the meeting location. If the meeting is not being held at a clubhouse or other public location, and is confined to a director’s home, it’s reasonable for board members to be uncomfortable in making the meeting open to the public .” However, he said that if those who come to the meetings make those meetings unproductive because they try to insert themselves into the work of the board, that doesn’t work. “Residents attending board meetings should not interject themselves into board discussions – those residents were not the individuals elected to the board! There are many tough decisions that need to be made, such as whether or not to raise assessments, and therefore an elected board is needed to make those decisions.
Should there be secret meetings, where there are no minutes kept and no one knows about the meetings?
No, there should not be. But can the board operate without being in full view of the association members, especially when they’re deliberating decisions involving a legal privilege or privacy?
“Absolutely, boards are entitled to go into executive session to discuss those matters,” said Vollmer. “That does not reflect a lack of transparency; certain decisions affecting the association require it.” There needs to be respect for those volunteering their time as board members to do the job they’re elected to do. However, there should be access to records. According to Guerra, in the State of Michigan the Condominium Act and Nonprofit Corporation Act cover access to records, but meetings and deliberations do not have to be an open process.
What kind of notice is required to inform residents that a new rule is in effect? According to Vollmer, there is nothing in the law that requires specific notice. You either have no requirement or some stated requirement in the restrictions. Many restrictions in the State of Michigan require a thirty-day advance notice.
He also said that you usually won’t see terms of notice in any CC&Rs. It is part of the policy-making of the association to determine how much notice will be given.
Alternative Dispute Resolution (ADR) is basically arbitration or mediation either inside the association or by an outside party. There could be a number of dispute outcomes that could be imagined as possibilities within an association. “By and large, internal dispute resolution within an association tries to fix claims that other residents are violating the documents ,” said Vollmer . It could be used where co-owners are complaining about co-owners, the association is complaining about co-owners, or co-owners complaining about the association.
The nature of mediation, which is to get people to talk about and solve their own disputes, in the traditional model, does not require independent knowledge of the underlying subject matter. “That is true,” said Vollmer. “Mediators do not need specific expertise in the underlying subject matter, just a willingness to explore potential resolutions that solve the dispute and to be creative in doing so .”
On the other hand, arbitration is most effective if the arbitrator has knowledge of the subject matter. “Arbitrating a matter before someone who has no knowledge of community associations is akin to litigating a case in front of judges. Generally, you will be tasked with educating the arbitrator so he or she may arrive at an informed decision .” Unlike in a court situation, where you can’t choose the judge, in arbitration, Vollmer explained, you can choose your own arbitrator. You have the best opportunity here to choose someone who is qualified. Vollmer recommends that the arbitrator you choose should have knowledge of community association law and governance.
There are no actual decisions imposed by mediators. A mediator does not make decisions. A mediator facilitates discussion, and if a resolution is achieved, an agreement is entered into as a contract between the two disputing parties. This is not the case in arbitration. “An arbitrator will issue a binding decision within the scope of the arbitration contract ,” said Vollmer. “Under the applicable Uniform Arbitration Act, the binding decision issued by the arbitrator is going to be final and enforceable by the circuit court, and cannot be appealed, unless the arbitration agreement contains an exception ,” he said.
Who pays for the dispute resolution? Vollmer said that some modern documents specify that the association may send parties into mediation at the co-owner’s expense. If it’s an association arbitration, it’s probably going to be at least a shared expense between the people agreeing to arbitrate. “And sometimes the loser pays the arbitration costs,” he said.
“Conceivably, every restriction, and any amendment, could impact the sale of properties or their resale value ,” said Vollmer. The argument is whether that effect is a positive or negative one. “Public policy favors these restrictions because, at their core, they are intended to uphold and enhance the value of property. It is presumed purchasers reviewed these restrictions and decided to purchase the property based upon that scheme,” he said.
Restrictions provide the stability of maintaining things that residents don’t 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 desired community standard. Given this premise, Vollmer explained, it’s difficult to argue that the restriction actually hurts the value of the property.
Classic examples of restrictions that could come into question here would be pet policies and leasing restrictions. Vollmer stated, “If pets are banned, you are arguably reducing the number of potential purchasers. If leasing is banned or restricted, it is possible that investors will be turned off from purchasing within the project.”
However, do either of these things devalue the property or increase the value of the property?
“It depends on the desires of the prospective purchaser,” he said. Certainly these types of restrictions limit the number of people who may buy in a particular community. But those who do buy do so knowing about and even desiring the restriction. So then it represents a value. For example, someone purchasing in a community that restricts leasing may desire that community because all the units are owner-occupied. Another example is a buyer who doesn’t want to deal with a neighbor’s barking dog — a community’s no pet policy would be a plus to that buyer.
“It can be challenging for associations to determine whether the increased interest from those looking to have the restriction in place will offset decreased interest from those adversely affected by the restriction,” he said.
Architectural controls are those with respect to the maintenance or construction of exterior improvements of the community. They address any new construction or any reconstruction or updates, alterations or modifications to exteriors of buildings.
What is reasonable is largely what is written in the original documents or amended in the original documents in accordance with the requirements of the particular document. “The Condominium Act prohibits changes in the exterior appearance of the unit or in other portions of the condominium project, subject to the terms of the condominium documents. The architectural controls in HOA’s are solely dependent on the restrictions drafted by the developer,” said Vollmer . He explained that you can generally write anything as a developer’s attorney regarding those restrictions, as long as you don’t violate any other legal concepts. “For example,” he said, “requiring that purchasers only hire one specific builder or the developer to construct buildings is likely to be viewed as unreasonable.”
Pretty much any type of architectural control that doesn’t violate other laws will be considered reasonable since the restriction is being placed upon the property prior to it being purchased. Thus, the buyer has knowledge of the restriction prior to the purchase of the property. “Reasonable architectural control restrictions are going to be upheld regardless of whether the purchaser read them or not,” said Vollmer.
Can associations require that renovation work be permitted and contractors need to be licensed and insured?
Associations can require contractors to be licensed and insured. However, Vollmer points out, “To the extent that the work does not require prior approval, owners have the right to pull permits and perform their own work.” You can’t have a provision that prevents a homeowner from pulling their own permits and doing the modifications when the city allows it. “Such a restriction is likely to be deemed unreasonable,” he said.
According to Vollmer, in most cases, yes. “Elaborate play-sets may be designed with a concrete base or other attachment to the land. In those instances, they could be deemed permanent structures. The best way to avoid this debate is to have a restriction specifically addressing play-sets, regardless of whether they are temporary or permanent in nature,” he said.
Can associations restrict or prohibit the installation of energy efficient systems for aesthetic reasons?
“In Michigan, currently, you can,” Vollmer said. “However, it’s possible some government rules will be forthcoming which prevent associations from restricting ‘green’ improvements if they meet certain standards and comply with applicable codes ,” he said. There are still associations doing that and also amending their documents to restrict solar energy panels on roofs for aesthetic reasons. “Prohibiting solar panels remains entirely permissible in Michigan,” he said.
Under certain limited conditions, if the association’s documents allow it, they can grant a variance. “The criteria for granting a variance should be rigid, and similar in nature to the objective criteria used by municipalities in granting variances to their zoning ordinances. Just because the applicant is a neighbor, or because he or she voted for you in the last election, does not justify a variance. Steer clear of those subjective standards in deciding whether to make an exception to the restriction,” said Vollmer . Those objective standards must include, at a minimum, that the reason for the variance is not self-created by the person requesting that variance. If it is, granting the variance would be an arbitrary or capricious act and therefore could be deemed unenforceable in a court of law, according to Vollmer.
An encroachment in a common area is when somebody erects something or takes action in an area that is commonly-owned by the association. According to Vollmer, in a well-documented community there is usually a self-help provision to take action to reduce encroachment violations. In these situations, you’d send a notice for the violator to remove the encroachment, specifying that if it’s not removed it will be taken away by the association’s maintenance crew at the cost of the offender.
In the most severe cases, a resident could have encroached on a common area for such a lengthy period of time that they may say that they now own that area individually by adverse possession. “If those claims are raised ,” said Vollmer , “you are going to need to take this court to resolve the dispute.” Of course, it is difficult to imagine residents could take commonly-owned property and possess it individually. However, Vollmer noted that in a severe situation, an association may need to get a court judgment quieting title. When these issues are long standing, they become more costly because they require litigation to sort out.
Can an association be held responsible in a situation where there was insufficient lighting caused by lighting restrictions?
According to Vollmer, yes. “If the association creates a hazardous condition there could be liability for the consequences of that condition,” he said. This statement applies to much more than a lack of lighting. Vollmer explained that in some ways, if you don’t attempt to do something, you’re better off than when you attempt to do something and don’t do it well enough. Essentially, if the association is altering the natural state of the environment and does it in a way that creates or exacerbates a hazard, the association will be liable for the situation they have created. “The board has a fiduciary obligation to consult with professionals qualified in developing a security lighting proposal, if that is the intent of the lighting. The proposal should be implemented under the oversight o the lighting professional. Doing these things will help reduce exposure to liability ,” he said. If the association decides where light is needed on its own, and then creates an area that in unprotected in comparison to areas they are protecting, the association has then created a hazard. Any time an association is creating modifications for safety they should get an expert’s opinion, and follow it. This minimizes any potential liability.
“Not in the same way police issue speeding tickets ,” said Vollmer. Associations don’t have police power in the traditional sense. Instead, they can impose fines or penalties through their fining power for what essentially are violations of the condominium documents of which the rules and regulations are a part. “It is reasonable for the board to adopt a rule imposing a speed limit,” he said, “and if the speed limit has been posted and the rules published, the board can levy fines.” The difficulty you run into, he noted, is giving tickets to people who are not co-owners. “Can you determine who the guest was visiting the community? Ultimately, the right to levy fines extends to the owner,” he said. For guests or invitees who speed, you would need to issue the fine to the co-owner they are visiting. Ticketing those guests directly can only be done by a police officer.
Guerra stressed that when putting together restrictions and rules on holiday displays, associations need to be holiday neutral. “You should not be referencing specific holidays in the rules. The desire to limit ‘Christmas’ lights from after Thanksgiving until after New Year’s improperly differentiates between Christian and non-Christian holidays,” said Vollmer. He noted that you can’t choose certain holidays to name in the rules. You need to have rules for what would be allowed for any holiday. “It is alright to specify time periods by which decorations are permitted for holidays, so long as you do not identify those holidays based on religion,” he said.
Holidays that happen in locations with heavy winters can be treated differently than holidays in mild weather. “Weather could play a factor in extending the time for how long holiday decorations might be allowed to stay up. It is reasonable to give owners more time to remove decorations during the winter on account of the poor weather conditions, so long as that extension is not holiday specific,” he said.
According to Vollmer, there are certain types of signage that are going to be a little more problematic than others. However, the bottom line is that in a private community such as a condominium situation, where there is commonly-owned property, associations have the right to restrict. Alternatively, in individually-owned property, such as in HOAs — that will become significantly more difficult because there are court decisions out there that do not even allow municipalities to tell somebody they can’t have a political sign on their front lawn. “If a municipality cannot adopt an ordinance restricting political signs, can a community association? Maybe – but this is a situation where the restriction could be challenged on the basis it is unreasonable or against public policy ,” he said.
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 accounts. A community with an abundance of homeowners in arrears on their assessments could be declined for a capital improvement loan when needed — therefore preventing the community from performing necessary major repairs or replacements. Also, the FHA looks at the number of delinquent homeowners in a community in its approval process, and won’t approve communities with over a certain percentage of past-due accounts. If an association can’t obtain FHA approval, allowing potential purchasers to obtain FHA mortgages for homes in the community, it can have a huge negative impact on home sales for the entire neighborhood. Cleaning up past-due accounts in an expeditious manner will not only benefit the association itself, but also all the homeowners who have a stake in the community. So how should this be done?
There are many ways to deal with delinquent homeowner assessment accounts, and various factors that need to be considered prior to taking any collection action. “First, you need to assess the situation of the owner and the property to make an educated decision on which route will be the most effective in recovering the balance,” said Michigan attorney Jeff Vollmer.
The process begins by performing a preliminary asset search to determine whether or not the account in question is likely to be collectible. “If we determine the owner is collectible, we generally pursue options that will result in a money judgment in favor of the association. Once a judgment is taken, we proceed to collect on the judgment by garnishing wages and bank accounts and exercising other collection remedies,” he said.
Vollmer said that if there is a doubtfulness of collection, or significant equity in the property, associations generally go down a route toward foreclosure. Whether to go about foreclosure by advertisement or by judicial means will depend on various factors. One factor is whether or not there are potential title issues involved. Additional factors are issues involving other encumbrances and liens, as well as priority issues. “If there are title issues or a multitude of competing liens, we may suggest a judicial foreclosure so all of those issues can be worked out in court,” he said.
There are two forms of foreclosure that can be pursued with respect to a community association lien provided “power of sale” language is contained in the condominium documents – which most of the times is the case. The following excerpts are from Vollmer’s firm, Makower Abbate Guerra Wegner Vollmer PLLC, and provide descriptions of the two.
Foreclosure By Advertisement: The first version that is possible is foreclosure by advertisement. This is entirely a statutory proceeding and is performed in accordance with the provisions of the mortgage foreclosure by advertisement statute. In this type of situation a notice of foreclosure sale is published in the legal news for four weeks prior to the scheduling of a sale date. That notice must also be posted by the local sheriff or court officer on the door of the property being sold. It is incumbent upon the party foreclosing to make sure that they have identified and notified all parties with an interest in the property. After the publication period, the sale is then held and it proceeds in the same fashion as outlined below for a judicial foreclosure. Assuming the association ends up with title to the unit for failure of anybody else to bid, the deed is subject to a six month redemption period similar to a judicial foreclosure – after which time the association can proceed to evict the occupant of the unit and either sell the unit or surrender the same to a party with a higher priority.
The major differences between a foreclosure by advertisement and a judicial foreclosure described below is the fact that there is no court proceeding required at the beginning of the process before the sale is held, as would be the case in a judicial foreclosure. Therefore, the cost of the judicial proceeding and the waiting period before commencing a foreclosure is saved. Unfortunately, unlike a judicial foreclosure, a foreclosure by advertisement can be attacked judicially at any time prior to the expiration of the redemption period. This would involve the filing of a complaint by a party with an interest in the property, claiming that the foreclosure sale should be set aside for any number of reasons related to irregularity such as failure of notice, imperfections in the posting and advertisement of the unit, or even counterclaims involving the assessments on which the foreclosure was promised. If such an action is filed just prior to the expiration of the redemption period, it has the effect of staying the expiration of the redemption and setting the case back to square one pending the outcome of the judicial challenge, which may take several months to over a year. An attack on the foreclosure sale after the fact is not possible in a judicial sale. Also, in the case of a judicial foreclosure, you get a personal judgment against the delinquent co-owner as well. With advertisement, the property is being used to satisfy the debt and you have effectively given up your right to take a money judgment against the owner .
Judicial Foreclosure: The second option is judicial foreclosure. While this option takes longer than a foreclosure by advertisement, and costs more, there is an advantage in this procedure because once the sale is held, it is final as the court that issued the judgment also issues an order confirming the propriety of the sale and its final effect. After the expiration of the redemption period, the sale cannot be challenged and the association can then proceed to have the unit vacated and either sell it or surrender it to a superior encumbrance.
The procedures leading up to the actual foreclosure sale are different in that the association commences a judicial foreclosure through the filing of a complaint with the circuit court. Depending on whether or not the defendant answers, by either a default motion or a summary disposition motion, the association obtains a judgment of foreclosure and also a judgment of personal liability upon the co-owner who owns the unit. Based upon the obtaining of that judgment, the association moves forward with the sale rather than just publishing the notice as in the case of a foreclosure by advertisement, except that the earliest that publication of the foreclosure sale can occur is 6 months after the filing of the lawsuit. Publication for a judicial foreclosure must occur for 6 weeks and notice of the sale must be posted in 3 public places in the County
Once the determination of which route to pursue is made, attorneys normally will inform the association and get their approval prior to commencing the process. “Usually, the first step is to send a demand letter to the responsible owners advising of the balance and warning of additional collection efforts if the delinquency is not cured,” he said. If they do not receive a response to the demand letter, the attorney will then file a lien upon the unit. If a response to the lien is not received, they will move forward on the path determined prior to starting the process.
Does it make sense for associations to go a different route and sell unpaid assessments to a collection agency? “ Maybe,” said Vollmer . “Collection agencies usually accept delinquent accounts on a contingency basis and percentages can vary.” He cautioned that if you are only referring accounts that you are reasonably sure you will never collect, it doesn’t cost you anything, so it doesn’t hurt. “If an owner is clearly collectible, the success of the collection agency will reduce the net recovery of the association. Instead of recouping the full balance plus costs and collection fees, the association only walks away with a percentage,” he said.
Another possible option for those seeking to collect delinquent accounts is Small Claims Court. If you have a debt that is collectible, filing in Small Claims Court is an option for boards or association managers to use to pursue the debt. An attorney would not do this on the association’s behalf. “Attorneys are not permitted to appear in small claims cases ,” notes Vollmer.
What are the proper means of communication with the debtor during the collections process? “We urge our clients to stop any communication with the delinquent owners or their representatives once we start collecting on an account,” he said. The primary reason for this is that once the collection process starts, the costs of collection are charged to the co-owner. Additionally, having only one party speaking ensures accuracy and accountability.
Also, in many cases associations would end up settling for less than the full amount due or agreeing to something they should never agree to. There is also the risk of inconsistency in communication with the debtor co-owner. “In order to avoid inconsistency on amounts owing, coordinating payment plan proposals and everything else that can come up in a delinquency, we like to serve as the point of contact, which then allows us to filter one message to the board and any management company.”
Are there ways to set up repayment plans with debtors who express an interest in doing so? According to Vollmer, there are many ways to do this. However, he cautioned not to accept or even ask for payment plans that are unrealistic. “Entering into a payment plan that fails the first month wastes everyone’s time and delays recovery. Both the association and the owner need to be realistic about what payments are feasible,” he said. He explained that one of the biggest mistakes he sees associations make is setting arbitrary payment plans without looking at individual circumstances. “This is one situation where boards should be flexible ,” he said. “Payment capabilities are different for retirees on fixed incomes versus owners with full time jobs and no dependents .”
He recommended tailoring a plan that makes sense — one which would provide the debtor the ability to make the agreed upon payments. “At its core,” he continued, “the payment arrangement should not result in the owner falling further behind. That will only serve to delay the inevitable and put the association in a more precarious situation later on ”
Something additional to note regarding collection tactics: The Fair Debt Collection Practices Act, a piece of federal legislation, governs the collection of debts against consumers. “There are a lot of obligations placed on debt collectors under this law ,” Vollmer said, “and attorneys collecting debts for association clients are considered debt collectors and must comply with that statute.”
Must associations comply with the Fair Debt Collection Practices Act when setting up any payment plans or pursuing debtors themselves?
“An association attempting to collect its own debts is not subject to the Act, as it is not engaged primarily in debt collection. It is the attorneys, and sometimes the managers, who should be concerned about this law’s requirements, which apply to most forms of communication with the delinquent owner ,” Vollmer said.
Vollmer also recommended not engaging in any practice to attempt to embarrass the delinquent co-owner. “There are sizeable risks associated with publishing names and account information of delinquent owners. Boards should not engage in this practice ,” he said, “if there is an error , you could face a defamation claim for erroneously reporting that someone hasn’t paid a debt,” he said.
He pointed out that it doesn’t make sense to take this risk since, if someone can’t pay, embarrassing them won’t make any difference in their ability to do so.
Once a collection case goes to court, there are a number of different actions that can be taken to collect the debt. “Under Michigan law, a condominium association has the ability to sue for both a money judgment and the right to foreclose. That lawsuit must be filed in circuit court ,” said Vollmer. He explained that if you want to foreclose in any situation, unless you’re doing it by advertisement, you also need to go to the circuit court because they have sole jurisdiction to do that. District courts — and small claims courts are part of district courts — can only give you judgments for money. You can’t foreclose a lien in district court. Rather, you’re going to get a judgment for an amount due.
“A primary drawback of filing a simple money judgment in district court is that it only captures amounts owing as of the judgment date. As additional installments come due after the judgment, you have to go back to court, perhaps on multiple occasions ,” Vollmer said. That is the downfall of district courts. The limitation of jurisdiction in district courts is not usually a problem. Since the limit is $25,000, it would be unlikely for an association to allow a co-owner to become so deeply delinquent without taking action.
Another downside of district court is that it produces an unsecured judgment, which means that it’s dischargeable in bankruptcy.
There are three ways to collect on money judgments — garnishment, levy and execution.
Garnishment is the seizing of money due. Some examples of what can be garnished are loans due the debtor, bank accounts and wages . “With a judgment, you can garnish an entire bank account and 25% of the debtor’s wages ,” he said.
A levy is a seizure of personal property. “This document authorizes the court officer to seize personal property of value, and sell it to help satisfy a judgment. It is most often applied to cars, motorcycles or boats ,” explained Vollmer.
An execution is the same as a levy except it is on real property rather than personal property. “The execution would allow you to sell real property, other than the real estate in the community, to pay down the judgment ,” he said.
Vollmer explained that it’s not considered an unauthorized practice of law for someone to file their own liens. However, the problem with people who are not attorneys doing that is if they make mistakes — file for unjustified amounts or amounts in the future, or if they don’t follow statutes, such as Michigan’s, which says you can’t put any collection costs on your lien amount — they are going to make their lien attackable in court, and possibly even voidable, in court.
“In an extreme case,” he said, “you could be facing a slander of title claim for recording an erroneous or unjustified lien against the property. If you are going to adversely impact an interest in land, you need to know what you are doing or hire an attorney who does ,” he said.
“It depends on the preferences of the particular association. Most communities prefer to issue a demand letter before proceeding with a lien. Some communities like to start with a lien. If the lien is the first step, the ancillary attorney fees and costs will be higher. Although many delinquencies are cured upon receipt of an initial demand letter, some owners will not make arrangements to pay unless they see that their property interests have been impacted. Even if the association starts the process with a demand letter, it only needs to wait approximately five weeks before moving forward with the lien,” Vollmer said.
There are many different circumstances dictating the best route for collection. Furthermore, during the process, additional factors can alter the direction the process will take. Here are a few scenarios and factors that affect an association’s collection actions.
For example, is it advisable to go after delinquent owners who decide to walk away from their properties, particularly those owners who did a strategic default? Vollmer said that they determine whether or not to pursue a debtor who has abandoned the property after performing an asset report. If the debtors have assets, he said, yes, it is advisable to go after them. “If the balance exceeds a certain threshold it makes sense pursuing these owners because the chances of success are good ,” he said.
Vollmer stated that there are two classes of association debtors — those who can’t pay, and those who choose not to pay. “For those who can’t pay, there is no tool in the toolbox to force payment ,” he said. Since they cannot pay, there is nothing you can do that will enhance your ability to collect the debt. “As for those who choose not to pay, community associations, and particularly condominium association, have an assortment of remedies at their disposal to encourage payment ,” he said.
Another decision to weigh is whether to pursue foreclosures against delinquent owners or whether it is more advisable to allow banks to foreclose and assume the financial obligations. Vollmer explained that associations and their attorneys would not be able to obtain the necessary information to make that determination in any situation. “There is no rhyme or reason as to how and when banks decide to start their foreclosure. We have seen instances where the owner may be deceased, or the property may have been abandoned for a couple years, but still no foreclosure by the mortgage company,” he said. Internal bank matters are not something the association would be privy to.
Vollmer further noted that the association would not know if the bank was receiving a payout of federal mortgage insurance, for example, or if it has otherwise written off that debt so it is no longer carried on its books. “Unless the bank voluntary records a discharge of a loan it has written off, you are not going to be made aware of that situation ,” he said. He recommended that associations proceed with foreclosure even if there is a bank out there not being paid its mortgage payments. “Sitting idly by while the unpaid balance grows and the property continues to depreciate is not the answer. Sometimes you need to take action to get the property off center ,” he said.
If the bank comes in during the time that the association has already started the foreclosure, the association can always discontinue it. “Putting the bank on notice of the association’s foreclosure can sometimes accelerate the bank’s foreclosure. It may act as a wake-up call for the bank to say – ‘We need to do something with this property’,” he said.
Once the bank starts the process, at least in Michigan, there isn’t much point in the association moving forward with their own foreclosure. Not unless there’s an error in the process whereby the association has an argument that they’re entitled to a better priority than the bank is giving it. “In the rare situation where the association’s lien was recorded prior to the mortgage, you need to take action to assert your lien interest with the foreclosing bank,” he said. “Unless there is a bank error which impacts the association’s lien priority, it is unlikely you should involve yourself in a bank foreclosure, except to monitor the results of the sale and any potential overbid the association might claim as a junior lienholder .” The association’s priority, he noted, is set by statute, and they’re going to receive whatever is left over, if anything, in the order of their priority. “In the vast majority of cases there is no equity or overbid at the foreclosure,” he said, “so there is usually nothing to protect and the association’s lien is extinguished .”
However, aside from when a bank starts its own foreclosure procedure, Vollmer pointed out that another circumstance where he would stop collection efforts against a co-owner would be if that co-owner’s status had changed to the point where the debt had become uncollectible. ”From time to time, the life circumstances of the owner change. The owner may have started with a job and assets, but then lost that job and any liquidity ,” he said. . Alternatively, if the bank pays the sum due when it comes in, why continue to pursue the co-owner if you’ve been paid in full? These are examples of when to stop collection efforts. “Halting collection efforts is the exception, not the rule ,” he said.
The period of redemption is set by statute and is the period of time during which a debtor — or other entity with an interest in the property they want to protect — can pay all sums due and retain title to the property.
Foreclosed properties can become an eyesore for certain communities. Particularly in HOAs — lawns go un-mowed, weeds grow, paint peels, pipes freeze and cause leaks. How can associations get banks to handle maintenance issues on foreclosed properties?
“One option is to sue them for breaching the restrictions,” said Vollmer. He also said that some associations have self-help provisions that allow them to do whatever needs to be done maintenance-wise and to bill the unit. When you have that type of provision, he recommended sending one letter stating the repair or maintenance needs to be done in a specified number of days, and if the work is not done, the association should just proceed with the work and bill the unit. “Once the bank forecloses, the underlying mortgage is wiped out. The association should not be competing with other lienholders at that point, and if the banks are not going to take care of the property, do it for them and assess the costs,” he said.
There are also limits on the amount of past-due assessments lenders are required to pay. “Michigan laws does not afford condominium associations’ lien priority over foreclosing banks. However, the Condominium Act requires foreclosing banks to pay assessments from the date they acquire title to the property, which has been construed as the foreclosure date. Banks are responsible for paying assessments during the 6 month redemption period following a foreclosure, even if they do not have possession of the property,” said Vollmer. Anything prior to the date of the sale itself, he noted, cannot be recovered legally in the State of Michigan.
What are the pros and cons of foreclosing on a delinquent unit with the intent to rent the unit to recoup the association’s fees?
Vollmer said that this is often an option where you are not otherwise going to collect and somebody has a higher priority on the Unit that you do not wish to pay or that you believe exceeds its value. And in that case Vollmer does not see a downside of renting the unit.
“If the property is in good shape, and the association does not have to fix it up, it can generate rental income to not only offset the monthly assessment but help pay down the balance accrued by the former owner. Even 6 months of rental income is better than continued unpaid assessments during that time,” he said. He noted that this is especially true if there is a bank out there in the wings that has a mortgage that legally has a higher priority than the association. The one thing to be cautious of here is that you do need to act properly and professionally in your actions as a landlord. The association is advised to hire a professional to handle the landlord responsibilities.
“There are legal requirements for leasing real property boards may be unfamiliar with. It is important that all required disclosures are made and the lease does not overpromise to the tenant on the lease term,” said Vollmer. He noted that condominium association boards are not usually professionals in handling real estate or even homeowner associations for that matter. That’s why they hire managers. “If the association’s property manager is not capable of leasing the property, find someone who has experience in this area. Even though you may only be leasing the property for a short period of time, there are pitfalls associated with being a landlord including such issues like security deposits and municipal rental registrations,” he said. He further stressed that since real estate is a regulated industry, you need someone who knows what they’re doing.
If a lender does come in when you are renting such a unit, could they argue that there are no delinquent assessments they’re required to pay?
Vollmer explained that there are two types of association documents out there. There are those that have a specified manner in which payments are applied, and those that do not. If you have a provision that says that any money is applied to costs, expenses, and then assessments in the order of its delinquency, and you’re renting the unit as an association, you’re going to apply the money in the manner which that provision requires. This means that technically, even though you have rental income, that rental income may not be paying current assessments because there are still amounts to be paid from prior due assessments. “In those situations, if the bank forecloses during the term of the lease, we would argue that the rental income is being applied to unpaid assessments arising prior to the foreclosure, leaving the assessments accruing after the bank foreclosure as the bank’s responsibility ,” he said.
Unless the bank has a receiver, they will not be able to take your rent income. On the other hand, in cases where there is no application of payment language in the association documents, in Vollmer’s opinion, the association would need to pay the current assessment and then apply the rest to the back assessments that may be owed. In that situation, there wouldn’t be anything for the bank to pay.
Knowing which records should be kept, where to keep them and how to store them can help an association maintain access to important historical data about itself. 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 refer to work records, financial records or even minutes from the meeting where the contractor was chosen to weigh future decisions.
First, you need to determine what types of records need to be kept. This includes a number of different records used in the normal course of an association’s operation, such as:
• financial records
• tax records
• unit files or lot files
• work records (including contracts with vendors, employee records, warranty documents, work logs, etc.)
Next, you need to determine for how long to keep each type of record. “The length of time that a record must be retained depends on the type of record,” said Guerra. Certain corporate records, according to Guerra, need to be held basically forever. These include:
• governing documents
• financial statements
• meeting minutes (from both board and association meetings)
According to Guerra, Michigan doesn’t mandate a given level of record retention by law. Record keeping mostly has to do with what the governing documents require. For example, some bylaws require that minutes be kept and other bylaws don’t mention minutes at all. Always consult your governing documents for specific instructions.
The fact is, Guerra said, “You need minutes and records to confirm and support what actions were taken.” So it is in an association’s best interest to keep accurate and thorough records.
How detailed do board meeting minutes need to be? “Meeting minutes should only be a record of what was done at a meeting, and should merely contain a statement of the particular proposal and whether the proposal was adopted or rejected,” said Guerra. That is what a proper set of minutes does. Some associations make the mistake of noteing in the minutes every person who had a question and every discussion that took place. “None of that is required or recommended to be included in the minutes,” Guerra said. When compiling your meeting minutes, list only what the board specifically resolves to do at the meeting — in other words, the specific motions or actions taken. “They should include only the detail necessary to reflect the actions taken,” he said.
Are there any requirements as to what form records are kept in? More and more people are keeping documents in an electronic format. “Maintaining records in electronic format is fine,” said Guerra, “as long as they’re backed-up somewhere, there is more than one copy, and the record can be reproduced in paper.” He said there is no statute in the State of Michigan on record keeping or how long you need to keep records.
Where may the association records be stored? Can they be stored in the home of a board member? “There is nothing prohibiting this and sometimes the home of a board member is all that’s available for storage,” said Guerra. Sometimes management companies store the records, sometimes they’re stored electronically, and sometimes they’re stored off-site — sometimes in the Cloud. “There are a numerous ways and locations to actually keep the association’s records,” he said. There is no particular method of storage that is specified in any statute.
Are there any restrictions on putting records online? According to Guerra, there are privacy restrictions that relate to personal information. The same things that can get you into trouble with defamation can get you in trouble for making them public on a website. “The board needs to make sure private and privileged information is not disseminated to the public,” he said.
Certain documents have requirements outside association governing documents that need to be met. “For instance, tax returns and records related to tax returns should be kept for at least seven years as the IRS has the right to audit the association during this seven-year period,” said Guerra.
Your corporate records are the only things the association should keep forever because they are the association’s corporate history. “Most other documents have a shelf life of some time, with length of ownership, contract terms, warranty periods, statute of limitations, and good business judgment helping guide how long the record should be retained” he said.
Who has access to records? According to Guerra, only members of the organization and their advisors have access to records. The association is entitled to put a process in place for fulfilling residents’ requests to view association records. Guerra noted that the process must be reasonable and must comply with any response time frame mandated by statute. “A board can’t make it it an onerous situation because the members have a statutory right to review,” he said. For instance, the association can’t require payment to merely see the records.
However, Guerra said that if a resident requests copies of documents, and the association incurs expenses making those copies, the association may ask for reimbursement for those copying expenses..
Even still, some records need to remain private, or at least until a court order says they’re no longer private. “Certain records have legal privileges attached to them, like communications from an attorney. Certain records have liability attached to them if you disseminate them, like potential breach of privacy issues and defamation issues,” he said. The board needs to adopt a policy requiring that certain information remain private and not subject to member review, such as:
• account balances
• Social Security numbers
• other sensitive, personal information
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 potential disgruntled residents. While these fears are not wholly unfounded, 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 their service will be valued, even if all residents don’t agree with every decision they make. Most associations have safeguards in place indemnifying 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.
There is no statutory requirement for associations to have written election procedures. Guerra pointed out that in Michigan, since these associations are mainly nonprofit corporations, if you don’t have election procedures in your documents (which is rare), you will find enough in the Nonprofit Corporation Act to have an election.
Is there a legal obligation to provide notice of an election? Guerra noted that every association meeting, such as one for elections, must have a notification . There are also time-frames specified for association meeting notices. “The Michigan Nonprofit Corporation Act specifies that the notice must be sent at least ten days and not more than sixty days prior to the meeting,” he said.
The frequency of these elections depends on the circumstances of each association. However, Guerra said that in Michigan, associations are required to have an annual meeting of the membership of an association. “How many board members must be elected, if any, depends on whether there are any open positions,” he said. It is typically stated in the governing documents when an association’s annual meeting should take place each year and whether the change in board members should be staggered. “These are all matters typically addressed by the governing documents, although there are provisions in Michigan’s Nonprofit Corporation Act that address annual meeting timing and that can be used if the governing documents fail to do so.”
Can an association install term limits for board members? “Yes,” said Guerra, “but I typically recommend against term limits.” Guerra pointed out the fact that term limits basically limit the talent pool stepping up to the board. These are volunteers who offer their time to the association, and not everyone is willing to serve. So if you term-limit those willing to serve, who will succeed these willing co-owners?
\In an election, those being voted into positions are directors of the board. Note the distinction between directors and officers:
Directors: When you’re talking about nonprofit corporations, which most associations are, directors are generally elected by members of the association. They are vested with the power and authority to direct the corporate affairs of the association.
Officers: Officers are generally appointed by the board of directors, and they have jobs to do, but they don’t have a vote at the board meetings. In most cases officers are directors as well, but legally they have different rights and responsibilities depending on whether they are acting as directors or officers.
When in pursuit of new board members, how is the nominating committee chosen? Many documents specifically indicate what the composition of the nominating committee will be, and in other documents there is no direction whatsoever. There is no requirement in Michigan to have a nominating committee. “Some documents contain provisions relating to a nominating committee, and in most cases a nominating committee is going to be appointed by the board, with the board having the discretion as to who they choose for the nominating committee,” said Guerra.
Are nominations from the floor allowed? In many cases you’ll have a nominating committee but you’ll still also allow nominations from the floor or nominations by self-submittal. “Unless specifically prohibited by the governing documents, nominations from the floor must be permitted, and it is fairly easy to be nominated from the floor, and individuals can simply nominate themselves or have one of their friends nominate them,” he said. However, some associations have provisions in their documents that call for a closed slate prior to the time of the meeting and no nominating at the meeting. “In those cases, if an individual hasn’t submitted their nomination to the nominating committee or they are not otherwise chosen by the nominating committee, the individual is simply not going to be allowed to run,” he said. Basically, this issue is document-specific.
Can an association board endorse a slate of candidates or a single candidate? “Yes, and it does happen,” says Guerra. He said that doing this carries some implications. “If the board is popular and endorses a candidate, the candidate will likely get elected. If the board is unpopular and they endorse a candidate, the candidate will likewise probably not get elected,” he pointed out.
Can an association adopt a rule that restricts people from becoming board members? “Yes,” Guerra said, “but again, it’s discussed throughout these chapters, the regulation must be reasonableFor instance, you can’t discriminate against or disenfranchise certain groups of people.” What you can do is have a rule that states that someone who has been convicted of a crime that involves dishonesty or lack of integrity in the handling of money can’t serve on the board. It becomes a little more questionable when you have an association that wants to adopt a rule, for example, stating that only resident owners and no investor owners can hold a position on the board. “This is unreasonable because you are prohibiting non-resident owners even though non-resident ownership is allowed,” he said.
Can an association request a background check on potential board members? Generally, I would avoid such investigations because it essentially entails existing board members running checks on other people who perhaps may be challengers,” he said. There is also the question of what is done with the information obtained in a background check. “The board is not a police forceand could end up having liability potentially for defamation or for handling the information incorrectly,” Guerra said.
During the campaigning phase of the election, do associations need to provide access to association media for candidates to campaign?
Guerra does not recommend allowing campaigning through these resources. “Arguably, once you let one person campaign thorough association resources, you have to allow everybody to do so,” he said. That can get quite expensive and burdensome.
Does an association need to require residents to register in a board election? Most associations do since it needs to be established who the owners of the property are. “Most of these organizations require ownership of property in order to be a member,” said Guerra.
The ballot process depends on the governing documents of a particular association. Directors are usually elected at the annual meeting of the association, and it is noticed ahead of time.
Generally, the ballot process involves the following:
• announcing candidates
• taking nominations from the floor
• closing nominations
• appointing inspectors
• hearing from the candidates
• collecting the votes
• having the votes tallied by the inspectors of the election
• announcing the results
Guerra explained that ballots are not recorded — meaning they’re not in the public record. They are on a tally sheet, and an association can either keep the ballots themselves, or they can destroy them in lieu of the tally sheet. “That’s up to the individual corporate practice,” he said.
Who has access to election results? “In nonprofit corporations, which include most homeowner and condominium associations, the association’s members have the right to inspect the association’s records under procedures outlined in the nonprofit corporation act and in the association’s policies for requesting the same,” said Guerra. “Upon appropriate request, that would be a record of the association that somebody would be entitled to view.”
For those unable to attend the election, what is the process of establishing a proxy vote? According to Guerra, proxies are permitted unless the governing documents provide otherwise. The documents may state a limitation on the use of proxies, which is valid. Otherwise proxies are generally available. A proxy needs to have certain legal requirements met. “It has to designate who the vote is being given to, for what it is being allowed to be used, and it has to be signed or transmitted by the member authorized to give away the vote ,” said Guerra.
He also said that proxies can be either general or specific. “Quite often, general proxies are utilized in elections where you have nominations from the floor at the time of the meeting,” he said. Specific proxies are instead typically utilized when the vote is for something that can be established ahead of time, such as a vote for an amendment of the documents. The specific proxy would specify how the proxy holder must vote.
To illustrate the definition of cumulative voting, Guerra gave an example. “You have 3 open positions on the board, and you have 3 candidates for those 3 positions. Everybody has the right to cast 3 votes, one each for the open position. That is non-cumulative voting. If the association permitted cumulative voting, each person would be allowed 3 votes and would be able to give all 3 of those votes to one candidate .
Once the voting is complete, it is the role of an election inspector to count and tally the ballots and certify the result. “These volunteers are often appointed at the meeting and consist of members who are neither running for the board nor related to someone that is running for the board,” said Guerra.
How should the association proceed if the election results in a tie? Guerra suggested, if this happens, you should first ask the parties who are tied if one is willing to withdraw. “If they do, that resolves the problem, if not, you can revote,” he said.
What is the process for an election challenge or recount? Guerra said the challenger would need to raise the challenge at the meeting to preserve the challenge. If the challenge is not raised at the meeting, it is arguably forever lost. If properly challenged, a recount typically requires a majority of the membership present at the meeting to approve a recount. .
Being knowledgeable of how to govern your community responsibly in this regard is highly important.
What is a common-sense approach to stay in compliance with the Fair Housing Act? “Treat everybody the same,” said Guerra. “Review all of your actions through a standard of equal treatment of everyone,” he said. The minute you see something which possibly excludes or targets someone in particular, you have reason for looking into what you’re doing further, and possibly seeking legal counsel. “If it doesn’t apply to everybody, it has the potential to be discrimination,” he said.
He explained that problems with the Fair Housing Act can result in some very substantial liability for the association. “Fair Housing Act compliance in the State of Michigan is handled by the Michigan Department of Civil Rights. The Michigan Department of Civil Rights, at no cost to the complainant, will institute an investigation against the association to determine whether a person’s rights have been violated. Assuming there has been no discrimination, the complaint will often be dismissed after the association provides a written response and the Department of Civil Rights conducts its investigation If, on the other hand, the Department of Civil Rights has reason to believe there has been discrimination, the Department will conduct an administrative hearing to determine if the association has violated the claimant’s civil rights under the Fair Housing Act. At that stage, the association is at a disadvantage because it is in front of an administrative agency that has the power to interpret and enforce its own rules,” said Guerra. “The Association doesn’t necessarily want to put itself in front of an administrative proceeding arng that is has not committed discrimination, when the Department of Civil Rights has moved forward with an administrative hearing after going through an investigation stage and saying, yes, there is reason to believe there has been discrimination,” he said.
Additionally, the Fair Housing Act has significant penalties associated with it. “In some of these discrimination cases there have been judgments entered in the hundreds of thousands of dollars,” he said.
Guerra explained that only after going through the administrative hearing are you allowed to appeal the decision in a court of law. “So it can be exceedingly time-consuming and expensive,” he said.
For associations — like any governmental entity, or any private citizen — there are limitations on how they can treat others. Associations, like anybody else, cannot discriminate against any protected class or due to one’s:
“So associations, especially when you’re talking about enforcing restrictions through a fining procedure, self-help or through the courts,, must treat everybody the same. The enforcement of these restrictions must be uniform (i.e. they cannot be arbitrary) and cannot be discriminatory either in form or application. So when an association is doing its job to enforce restrictions, it could is have implications in the civil rights arena,” he said.
Any time an association strays from uniformity or equal treatment, they face the possibility that someone will file a civil rights complaint.
Could Fair Housing Act violations be considered civil violations or criminal penalties? “They are typically civil, but could rise to the level of criminality as well. For instance, in the case of taunting based on ethnicity, this civil violation could rise to the level of ethnic intimidation, which is a criminal act. It is possible that you can have conduct that is both a civil and criminal violation,” he said.
What constitutes problematic wording in a covenant or rule made up by the association? Problematic wording includes any covenant or rule that is not neutral in terms of age, gender, religion, sexual orientation, etc. “Once an association starts creating distinctions, you’ve got a potential problem,” said Guerra.
“Discrimination is based on whether protected class are being treated differently,” he said. He also explained that over the years the law has evolved to add protected classes. Race, religion, national origin, age, familial status, disability, and sexual orientation are all now protected classes.— “It’s a slowly moving target,” he said.
“From a legal standpoint, is religion a potential legal concern in the area of civil rights? The answer is yes,” said Guerra. He provided an example that you cannot, in your rule making, favor one religion over another. “A classic example are rules and regulations addressing when an owner may put up and must take down ‘Christmas lights’’ but never permitted or had a rule dealing with anybody’s Halloween decorations, Hanukah decorations, or other religious or non-religious holidays. An association must be content-neutral in its rules,” he said. You cannot favor or oppress any given religion in what you do.
How are religious displays treated in the Fair Housing Act? “If you’re giving one religion the opportunity to do something that you’re not giving another religion, you’re discriminating,” he said. He explained that there is no law that says that you need to allow people to display holiday decorations or lights of any kind on commonly-owned property. “Many associations choose to allow people to do that. Well, once you venture into the area of doing that, which is discretionary, you need to make sure you do it for everyone,” he said.
Can associations prohibit religious services held in common areas? Guerra said, yes, as long as they’re restricting all religious services, not just certain ones.
Are sex offenders or individuals who pose a direct threat to a community considered disabled? For Fair Housing Act purposes, can there be restrictions against them?
Guerra said that, sex offenders are not considered disabled under Fair Housing laws and are not otherwise a protected class. “Specifically, in Michigan, the association can adopt restrictions that prohibit sex offenders from occupying a residence in the community,” he said.
Are associations allowed to have any bias against allowing residence by families with children? “The only bias that is tolerated would be with respect to communities that are certified as housing for older people. That is government-sanctioned discrimination against people under the age limit,” he said.
For communities with children, how can pool and clubhouse rules discriminate against children, and is it okay for associations to establish rules restricting children from these areas? Guerra noted that this is an evolving area and that there have been many recent court decisions addressing the issue. “Associations often get into trouble when restricting children at the pool and clubhouse,” he said “Focusing on items such as swimming ability and behavior will help avoid a claim of discrimination based on age or familial status,” he said.
Rules and regulations need to be carefully crafted, keeping in mind objective standards. You can’t use generalizations or stereotypes in creating rules. “Why is sixteen the magic age, or twelve, or thirteen? Why not instead focus on whether or not the person is in fact able to swim?” Focus on the real issue, in this case, the ability to swim, not the age. “That’s where you run into problems,” he said, “You can’t overly generalize. You have to use some objective standard to differentiate.”
This doesn’t mean you can’t restrict certain uses of the pool at certain times. For example, when time is set aside during specified hours for lap swimming. “It’s the stereotypes and generalizations that are going to get the association in trouble,” Guerra said.
Is an association required to allow animals for those who have a prescription or note from their doctor for a comfort or service animal? “It’s not all that simple, but more often than not if somebody is willing to pursue what is needed to satisfy the Fair Housing guidelines, yes, the association will have to permit support animals, regardless,” said Guerra.
Does an association have any right to question the resident about the prescription or note? “The Association has the right to request that the adequate or required information be contained in the document,” he said.
You won’t see a statement in the Fair Housing Act that says that, if you have a note from your doctor, you can have a pet. “It’s not nearly that simple,” said Guerra. He noted that HUD has provided guidance indicating that written support for an emotional support animal need not only come from a physician or psychiatrist, but also may be provided by a social worker or other mental health professional who is in a position to know whether the animal provides emotional support that alleviates one or more symptoms or effects of the disability.. “It doesn’t mean they have to be a physician, but they do have to have appropriate qualifications. There has to be the identification of disability,” he continued. There also needs to be a connection between the disability and the keeping of a animal as part of the treatment plan, or way to ameliorate, to some degree, the effects of the disability. “There is lots of information required and some dots that have to be connected, at least in some arguable fashion, before the letter is going to be an appropriate submission. So if you don’t have everything you need,” he said, “and that’s required by the law, yes, you’re entitled to ask for it.”
What is the difference between a comfort animal and a service animal? “They’re entirely different,” said Guerra. “Service animals are actually going to have some type of certification training behind them to do work or perform specific tasks for a person with a disability. They can be seeing-eye dogs — that’s one type of service animal. There are various others, where they actually assist the person in conducting day-to-day activities of some sort,” he said. Alternatively, he explained, emotional support animals are usually there for psychological reasons, or they are something that makes a person feel emotionally better.
However, according to Guerra, both types of animals are covered by the same set of regulations under the Fair Housing Act. “If you provide the requisite information,” he said, “it doesn’t matter whether it’s a certified service animal or an emotional support animal, you’re going to have to allow it.”
“In Michigan that is not possible as the Court of Appeals has determined that in most instances a size or weight restriction on animals is unenforceable because it is ‘unreasonable.’ And by unreasonable, the Court of Appeals upheld a judge’s determination that the size and weight of an animal itself does not have any logical relationship to the potential harm that was the target of the restriction. And as part of his explanation, he said a forty-pound pit bull is going to be far more dangerous to the community as a whole than a ninety-five pound black Labrador,” said Guerra.
Does the American’s with Disabilities Act (ADA) affect how an HOA draws up its own rules on service animals?
Guerra’s opinion is that it doesn’t. “The association is going to find itself implicated not through the ADA, but through the Fair Housing Act,” he said. The ADA, he explained, only applies to public accommodations. ADA implications may apply to association facilities that are open to the public, but not within units. The ADA is much more specific with respect to construction standards for making public facilities accessible, but in the area of service animals, there will be nothing more in the ADA than is already required by the Fair Housing Act.
Is it permissible for the association to restrict certain areas where the comfort animals are allowed? Guerra said that you can restrict only if there is some health regulation that you need to comply with.
Is it common to require that these animals be photographed when they first come onto a property? “Sure, as long as it applies to any animal,” he said. He explained that it’s perfectly reasonable for an association to require the registration of pets. “It should not just limit itself to the registration of some pets, because if it does, that’s going to be an unreasonable restriction,” he said. If it’s seeking registration and/or pictures of all pets, he notes, there is nothing wrong with that.
Can an association, while allowing comfort animals, limit the number of those animals that a resident has? Guerra said, if there is a demonstrated need for more, which would come from the person treating the occupant, then, in his opinion, the association would have to allow additional comfort animals..
What is a transition? Guerra explained, “In Michigan, in the condominium sense again, the Condominium Act talks about the ‘transitional control date,’ and it is the date on which the management and the administration of the condominium is transferred from a board of directors controlled by the developer to a board of directors controlled by the non-developer owners. A similar scenario happens in an HOA. At some point in time the declarant is no longer the only party who can vote and the only party who administers the association and the declaration, and there’s actually a board of directors elected by the non-declarant owners to govern the association. That is considered to be the transition.”
In this case, homeowners would hope for the developer to take it upon itself to address those issues. However, Guerra explained that in many cases this does not happen. “Before transition, the board is controlled by the entity that presumably would be responsible. So, while something could and should be done before transition, the fact is that issues are rarely addressed, because the people in charge would basically be looking to impose liability on themselves,” said Guerra. He explained prior to the transition, in the condominium sense, there is a period of time during which an advisory committee made up of non-developer owners is formed. This committee brings issues to the attention of the developer-run board of directors that are brought to their attention by other non-developer owners.
Is there ever a situation where a developer will pay expenses out of their own pocket to keep assessments artificially low?
Guerra said yes, and that this frequently happens. “If after transition the association finds that its assessments have been kept artificially low, or in another sense it finds they overpaid a bunch of expenses or the developer is claiming it made a loan to the association for which it now wants reimbursement, there is legal recourse against a developer. Case law exists nationally indicating that for a developer-controlled board to artificially keep assessments low for the purpose of selling units, is a violation of the fiduciary duty owed to the membership,” he said. Associations have the right to pursue that scenario judicially.
Homeowners themselves do not have the right to inspect a developer’s financial records. “Although the members have the right to inspect the association’s books and records, absent litigation, you’re never going to be able to inspect the developer’s financial records. You don’t have any specific rights. You can get the right to look at developer financial transactions once you file a lawsuit through discovery procedures,” Guerra said.
If the developer enters into a contract on behalf of the association, what happens after transition? In this case, is the association responsible?
“Under the Michigan Condominium Act, after the transitional control date, if the developer has contracted with itself or its affiliate for the purposes of providing management or other services to the association beyond the transitional control date, the association has statutory rights to terminate that arrangement,” he said.
“If you have a long-term management agreement, and you can show it’s the developer or an affiliate of the developer, you can cancel that portion beyond one year according to our statute as well.”
A construction defect is a condition existing due to an error made during construction. For an association to remedy the defects while still pursuing damages from the developer, Michigan attorney Stephen Guerra recommended proceeding with the repairs and documenting the conditions. “The bottom line is because the developer may be responsible for a problem does not exempt the association from its obligations and duties under the recorded documents. So if this is a common element for which the association is responsible, and it’s defective, it may take several years to conclude a suit against the developer for correction of that defect. The association cannot ignore the problem for that long and indeed has an obligation to make sure the damage does not get worse. So, once you put the developer on notice that there’s a problem that needs to be fixed, if the developer doesn’t, to the extent the association is responsible for the item under the governing documents, the association really has an obligation to move forward to take care of those things for which it’s found,” he said.
He urged that the contractors doing the work document everything they see through photographic and written evidence, which the association should preserve for a later time. “You have the added ammunition, rather than relying on estimates at the time you pursued the claim, you have actual costs and expenses, and a pictorial history of exactly what was wrong and how it was fixed,” he said. Proper evidence of the defect is very important. “Financial liability is the biggest thing and there is no liability without evidence.”
For any individual owners in an HOA, those owners with defects in the construction of their residence would typically need to pursue any defects within the confines of their own property themselves.
Guerra also noted that prior to pursuing any defect litigation, you need to obtain an evaluation from an expert in the field to determine the nature and extent of the defect.
The key is to document everything.
According to Guerra, the developer needs to be notified of a problem during the time in which the developer is still responsible. “The Michigan Condominium Act has a specified statute of limitations for bringing claims against the developer and others associated with the development and management of the project. So during the period that the developer is still subject to the statute of limitations, the association certainly is going to make demands upon the developer for everything that it believes and can show is the result of deficiencies in the developer’s or its contractor’s performance,” he said.
Guerra stated that you should notify the developer through any form of written communication. “You want to make sure it’s written so it’s traceable and it can be proven,” he said. Again, this underscores the importance of good documentation.
“They probably will claim a warranty has expired,” said Guerra, “but there are several concurrent warranties that go with the sale of property. In most cases, you have not only expressed warranties, but you have implied warranties.” Whether or not these warranties can or cannot be disclaimed would be up to the claimant’s attorney to handle.
“Even if you have an expressed warranty that has expired, (those are usually the one-year limited warranty when you buy a home), you have implied warranties of fitness, habitability, and of construction in a workmanlike manner — all of those implied warranties, which if not validly disclaimed, would run for a period of up to six years, as opposed to the one-year, limited warranty that comes with the sale.”
A claimant’s attorney needs to look at all the potential warranties and applicable provisions as to when the claims accrue (that is when the warranty period begins to run). In Michigan several limitations periods begin to run only when you know of a claim or should have known of a claim. Be aware, as well of any Statutes of Repose that may be applicable.
According to Guerra, the vast majority of judicial contests over construction litigation are eventually referred by the bench to arbitration. “It is their favorite method for trying to resolve construction disputes, primarily because there’s a lot of detail and expertise needed So it is consistently felt in Michigan that it is preferable to have construction cases arbitrated as opposed to actually tried,” he said.
However, in Michigan, associations are not required to go into arbitration. “The Michigan Condominium Act that allows arbitration by consent of the people involved. There is also a statutory provision that mandates arbitration if one or the other person chooses it — in certain situations that are involving claims against the developer, either claims by the co-owners against the developer or claims by the association against the developer. You have the unilateral ability to take certain of those claims and submit them to arbitration under certain dollar levels. For an individual it’s $2,500; for an association it’s $10,000,” he said.
Jeffrey L. Vollmer
Makower Abbate Guerra Wegner Vollmer PLLC
23201 Jefferson Ave.
St. Clair Shores, MI 48080
Stephen M. Guerra
Makower Abbate Guerra Wegner Vollmer PLLC
30140 Orchard Lake Road,
Farmington Hills, MI 48334
When it comes to the association’s finances, how can boards be assured they’re handling things properly? 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 become the victims of theft or fraud when it comes to their funds? We spoke with Linda Strussione, CPA of Owens and Strussione PC in Shelby Township, Michigan to answer these questions and enlighten readers on other important accounting topics.
There are two different accounting methods, accrual and cash. Which is the best one for associations? According to Linda Strussione, accrual works best for associations. She explained the reason for this is that it follows the American Institute of Certified Public Accountant’s (AICPA’s) requirement that at least the annual report at the end of the year be on an accrual basis. Accrual basis accounting is the technically correct method because it recognizes income in the year it was supposed to be collected,
whether it’s collected or not. Accrual basis accounting also recognizes expenses in the fiscal year in which they occur, whether they are paid or not. This method gives the association a true picture of what the income and expenses were for in a particular fiscal year. The other method is called cash basis accounting but only recognizes income and expenses when they actually happen, therefore, assessments are not recognized until collected and expenses are not recognized until paid.
Strussione said there is, in fact, a professional requirement for how the accounting is done. In Michigan, if an accountant is doing audits or reviews, they are required to follow the American Institute of Certified Public Accountants (AICPA) guidelines. This mandates that reports be done on an accrual basis.
When creating the association’s budget, of course it makes sense to categorize expenses. What is the best way to categorize these, and how detailed should the categories be?
Strussione explained that there are certain categories that are commonly used, and within those are sub-categories, which break the main category into greater detail. The first category associations typically list is the “Administrative” section. Within that section there will be sub- groupings such as office, legal, professional, accounting, paper, postage, etc. The second category that would appear on a typical association budget is “Operating Expenses” — which includes things such as utilities and rubbish removal. The third category seen on a typical budget is “Repairs & Maintenance.” This category can be as detailed as needed, and include anything having to do with interior or exterior maintenance and repairs. “Sometimes the more detailed the better,” said Strussione. If an association has a clubhouse, they can have a fourth category of expenses for that. “We recommend they keep that separate so they know exactly how much the clubhouse is costing,” she said. After this, Strussione recommends having a category for “Reserve Expenses.” This is where the association predicts what their reserve withdrawal expenses will be used for during that year. The last category would be “Insurance & Taxes.” These are the main categories Strussione recommends for boards creating budgets. Those main categories can be expanded further using sub-categories. Strussione again stressed that “the more detailed, the better.”
The operating fund is the portion of your association dues dedicated to be used for monthly accounting of income and expenses. At the end of the year, the operating fund is like retained earnings in the business world. It’s the accumulated net profit and losses of all the operating years of the Association. The goal as a non-profit association is to bring the operating fund close to zero.
The advantage of having detailed sub-categories is that they allow an association to see exactly what expenses they are estimating every year. “For example, in the Repairs and Maintenance category, you could have something like cement, or window replacement. You’re going to have large ticket items that go through the operating expenses, but they don’t necessarily occur every year,” she said. The Repairs and Maintenance category is sometimes 80% of the total budget. 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, but you’re going to have variable costs that come up,” said Strussione.
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 or management company, but the board is ultimately responsible. Strussione recommended reviewing the budget 3-6 months prior to the end of the association’s fiscal year, but she also said that you should look at it throughout the year. “If they’re gathering data and trying to figure out what they need to do for the next calendar or fiscal year, or if they’re expecting their expenses to go up or down, or determine what major expenditures may be incurred in the next fiscal year, I recommend they look at their budget at least three times a year,” she said. An association will finalize its budget for the upcoming year toward the end of their current year. Then Strussione also recommended that the association review the budget 4-6 months after the start of the new year to compare actual expenses to their projections.
Does the association’s accountant typically review the budget prior to its being approved by the board? “We typically see it after,” she said. Although, sometimes boards will consult with their accountants prior to approving their budgets to see if they have any recommendations. “It’s a good idea,” she said, “because your auditors sometimes catch mistakes that the board makes.”
What are an association’s annual reporting requirements for financial statements? According to Strussione, under the AICPA rules, the association’s accountant is required to follow the Codification Code for financial statement presentations for condominium associations. These mandated methods were formerly guidelines, but starting in 2009, they were placed under the AICPA Codification Code. “If you are a CPA and you belong to the AICPA, you are mandated to report using the Codification Code,” she said. She warned if you use a CPA firm that is not familiar with ac- counting for common interest realty associations (CIRA), their reporting will most-likely not conform to the rules on financial statement presentation for a condominium association. Associations are required to report as a non-profit therefore having separate columns for operating funds vs. the replacement funds.
Unlike a budget, which is the board of directors’ projection of income and expenses for the fiscal year, the financial statements are the actual reports of the association’s income and expenses. The board and manager should analyze this report 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 up- coming budget. Another variable expense is insurance. Additionally, the association should do a physical inspection of their property to see if there are any big projects that may need to be tackled in the upcoming year. “They should do physical inspection reports,” said Strussione. “You need to pay attention to that and see if they need to be incorporated into the budget.”
What types of tax returns does an association file? The two types of tax returns a condominium association is allowed to file, on the federal level, are Form 1120, which is the tax return for corporations, including condominium associations, or Form 1120-H, which is the tax return man- dated for homeowners associations (HOAs) and which can also be used by condominium associations.
The calculation of income for both of these types of returns is the same. For each you must separate the membership income from non-membership income, because membership income is not subject to tax. The membership income is the income received from all regular members, such as assessments and late charges. The taxable income is the non-membership income. This would include things like income from clubhouse rental, interest income, dividends and capital gains.
The calculation for the expenses is the same on both types of returns as well. You can deduct a percentage of your management fees, accounting fees and administrative costs.
So what are the differences between filing the 1120 versus the 1120- H? “The difference is that on Form 1120, the net taxable income is subject to a corporate tax rate of 21 percent. Also, if there is a net-operating loss, associations can carry forward that loss for up to 20 years. For Form 1120-H, the taxable income calculation is the same, but the tax rate is a 30 percent flat tax after a $100 allowed deduction and there is no net taxable loss carry forward allowed,” said Strussione.
In Michigan, as well as some other states, if associations file Form 1120-H, they do not need to also file a corporate state tax return. While this seems like an incentive to file the 1120-H, Strussione said there is no advantage to doing this. “When you look at it, Michigan state tax is only 6 percent. So you’re better off filing the federal at 21 percent and the state at 6 percent — it’s only 27 percent, and you get the loss carry forward versus if you file the 1120-H, you pay a flat 30 percent,” she said. She also said this would be a state-by-state decision, since every state has a differ- ent way of calculating their state taxes as well as different tax percentages.
So why would anyone ever file the 1120-H? Certain associations that are true HOAs are mandated by the government to file the 1120-H. So condominium associations can choose to file the 1120 rather than the 1120-H, but HOAs do not have this choice. “In the eyes of the IRS, if you’re a condominium association, on an annual election basis, you get to elect which of the two forms you file,” she said. Some local municipalities also requires the Association to file a Corporate Income Tax.
Each fiscal year a condominium association has excess assessments over expenses, a net profit, or excess expenses over assessments, a net loss. The Internal Revenue Rule 70-604 states that if there are excess assessments over expenses these monies must be re- turned to the co-owners or applied to the following year’s assessments in order for them not to be taxable to the corporation.
A condominium association is subject to tax under the Federal IRS rules even though it is incorporated as a non-profit in the State of Michigan. A meeting should be held each year where a responsible party, board of directors, or vote by election decides whether to have any excess paid back to themselves or to have the excess applied against the following year’s assessments. To apply to the next year, Strussione suggests that they prepare the subsequent year’s budget and add an income line “carry forward from IRS Rev-Rule 70-604” for a line item amount. Then, in order to not throw off the budget, include a separate expense line called “contingent expenses” for the same amount. This amount is, at best, an estimate, as the actual amount is usually not known at the time of budget preparation. She also suggests that the board of directors make the vote and document the board of directors’ minutes stating that they have elected to carry forward any excess assessments per IRS Rev-Rule 70-604. “For our condominium association tax clients, we include a separate line on the attachment page to the Form 1120-Corporate Tax Return stating that ‘per IRS Rev- Rule 70-604 the excess will be carried forward,’ and we show the calculation,” Strussione explained.
The IRS code section does not state who must make the election. Our firm contacted the IRS in 2017 and documented that it doesn’t matter who makes the election as long as it is a party responsible to make decisions for the corporation. Therefore, the board of directors can make the election and avoid having to take it to all residents for a vote.
A Peer Review is a process by which a qualified CPA firm re- views the operational procedures of another CPA firm to ensure that those procedures meet certain standards. The program is intend- ed to help the public understand the oversight of firms and gauge the ability of a CPA firm to provide certain services at an expert level. Peer reviews are required of all firms that are members of the American Institute of CPAs, and all Michigan firms that perform audits, reviews or compilations relied upon by third parties. Most CPA firms undergo a Peer Review of their accounting and auditing practice at least once every three years. Owens & Strussione PC has had peer reviews every three years since 1992 and has always received the highest grading level.
There was an amendment to the Michigan Condominium Act that affects the requirements for community association audits. The new State of Michigan requirements are in effect for associations with fiscal years starting after January 14, 2014. The change affects all condominium associations of co-owners with annual revenues greater than $20,000. The amendment specifies that these associations need to have an audit or re- view of their records and financial statements performed by a certified public accountant (CPA) on an annual basis. In the past, associations could do a compilation of their records. This is no longer allowed because it is mandated that an audit or review is needed.
Such associations have an option to opt-out of these audit and review requirements, but they must do it on an annual basis. In order to opt-out, they need to have a majority vote of all the membership, which is all co-owners, declaring that they want to opt out. The majority vote needs be repeated on an annual basis, and done in accordance with the association’s bylaws.
“If they don’t have an election to opt-out, then they need to have an audit or review engagement performed,” said Strussione. If an association successfully votes to opt-out of the audit or review requirement, they can then do a compilation and tax return. Strussione said that this amendment is the biggest change in the State of Michigan’s condominium association accounting law in over 30 years.
How can associations protect themselves from fraud? The most common scenario of theft of association funds occurs when an association allows their bookkeeper to physically make deposits of the association’s money and also approve invoices and pay bills. “There is no division of duty,” said Strussione. “That is the biggest threat of fraud to an association.
Another common threat is when a board allows for only one signer on a bank account. “They just allow one board member to be the signer on a reserve savings, certificate of deposit, or checking account, without requiring two signatures,” said Strussione. This gives the signer the opportunity to commit fraud. “With a second signer on a bank account you would need to have two people in cahoots together if you’re paying fictitious bills. It could happen, but it’s less likely if you have more than one signer on the bank account,” she said. Strussione 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 who is the only signer on the bank account is having the association’s bank statements mailed direct- ly to their home. “That is a fraud indicator right there,” said Strussione. “They’re controlling 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 or living beyond their means,” she said. She also warns about board members who express they have financial concerns of their own or for a family member. A person experiencing a desperate financial situation could be a potential threat for committing fraud against the association.
Strussione said that the most important thing to look for in a certified public accounting firm is if they are a member of the Michigan Association
of Certified Public Accountants (MICPA) and the AICPA. If the firm is a member of the AICPA, they are mandated to belong to the Peer Review Program. Therefore, association needs to find out if the CPA 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, Strussione strongly recommended asking if they are in compliance with the AICPA’s Peer Review Program. Linda also said that you should ask to see a copy of their latest Peer Review acceptance letter. Strussione stressed that, in Michigan, CPAs are not allowed to be performing audits or reviews unless they’re part of the Peer Review Program.
She explained further what the AICPA’s Peer Review program consists of. Based on the size of the firm, they can either self-select another CPA firm to come and perform the peer review, or they can turn their re- cords in to the state to do the peer review. Small companies, such as those with one CPA, are allowed to submit their own records to the State of Michigan and the state performs the Peer Review. Medium or large sized firms need to have an outside accounting firm come in and audit their records to make sure the CPA firm is complying with the AICPA’s rules. Firms are reviewed on how they prepare financial statements, how they audit, how they document their work papers, if they’re keeping up with the standards of the AICPA, if they’re complying with the government’s rules on how to do financial statements for condominium associations, and more. “It’s a really big thing,” she said.
Strussione also recommended asking about the firm’s expertise in working with condominium associations. Find out if they are preparing financials using the Codification Code for Common Interest Realty Associations (CIRA). Ask what position they take in preparing a financial statement. Do they take the position of filing Form 1120 for a corporation and take advantage of the lower income tax rates and net operating loss rules, or do they file a simple 1120-H Homeowner Association Tax Return subject to a higher tax rate? What are the qualifications of the people who will be doing the association’s audit? What continuing education classes do the firm’s accountants take to keep up their CPA licenses? Are any of those classes taken for government reporting, or working with condominium and homeowner associations? What type of continuing education keeps them up-to-date with condominium associations? “These are all pretty important questions,” said Strussione.
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, and the size of the association in terms of the number of cash receipts and cash disbursements per month. “Those items are what indicates to a CPA firm what to charge an association,” said Strussione.
She also said the majority of associations are billed on a fixed fee. “They pay one price to do the job,” she said. Other associations, however, are billed per diem because the activity in their situation varies from year to year. Some years they are billed more, and some less, based on what is going on. “Some of the condos are so complex that CPAs just charge by the hour to do the job,” she said. The hourly bills should have detail out- lining how many hours of staff time and how many hours of partner time are included in the billing.
One last bit of advice Strussione gives is not to select a firm solely based on price. “You need to see if people are really checking your re- cords,” she said.
Linda Strussione, CPA
Owens & Strussione, P.C.
50217 Schoenherr Rd
Shelby Township, MI 48315
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 Scott Breslin from McCredie Insurance Agency, Inc., in Flint, Michigan, and Robert Travis, CIRMS, CPIA from the Newtown, Pennsylvania, office of Community Association Underwriters of America, Inc. (CAU), a national insurance company which specializes exclusively in insuring 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 HO6 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 additional living expenses, 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 inter- acts 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 HO6 policy — the unit owner’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 H0-6 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 H0-6 policy kicks in is when there is mi- nor damage that is under the amount of the deductible of the association’s master policy. Then the H0-6 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 during the in-between years, Travis said that you should get an automatic 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 in- sured 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 percent- age 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 dis- cover 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 go- ing 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.
“Ordinance or Law coverage is also a very important aspect of Property coverage that cannot be overlooked,” Scott Breslin said. He further explained that Ordinance or Law coverage includes three insurance agreements: coverage A, coverage B, and coverage C. Coverage A replaces the portion of the building that is not damaged in a coverage loss. “Municipalities have laws that state that, if a building is destroyed by more than fifty percent, the undamaged portion must be torn down and the entire building rebuilt,” Breslin said. Coverage B refers to demolition cost, which pays for the cost to demolish the undamaged portion of the building. Coverage C refers to the increased cost of construction. Coverage C comes into play if a municipality requires that building codes be updated.
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 is going to be 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 some- one 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 re- lief. “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 fulfill- ing 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 himself. 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 cover- age 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 mini- mum required by other entities.
Board members should make sure they’re named as an additional in- sured 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.”
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. Travis 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.
Travis 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 burst 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. Travis 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, he said, they would be paying even more in D&O liability claims.
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. Travis 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. Travis warned, if the proper policy isn’t written, then the association would need to write a check out of its own pocket to back up this indemnification promise.
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 some- body 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 li- ability policies that are written for all the community associations that they manage. Managers should also make sure that their management company, the site manager 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 de- fine 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 board members, 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.
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. There are basically four parts to General Liability.
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 li- cense 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.
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.
Not every association has employees, however, every association should have workers’ compensation insurance coverage. Travis said that 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 partners in 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 cover- age for those employees. However the sole proprietor or partner in most states cannot cover himself under that policy. The reason be- ing is that sole proprietors or partners 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 or her. 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 pro- vide 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 go- ing 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, a Commercial Umbrella policy is not a special policy to cover the umbrellas around your community’s swim- ming 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 underly- ing 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.
5454 Gateway Centre, Suite A
Flint, MI 48507
John has retired from Reserve Advisors.
In order to answer these questions, and provide other important details on this topic, we spoke with John P. Poehlmann, RS, a principal from the Milwaukee, Wisconsin office 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 Poehlmann. The reserve 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 replacements or pavement replacements. Although it is ideal for associations to have sufficient re- serves 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 projects.
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 detailed analysis of all of these factors, and provide recommended contributions the association can depend on for ensuring adequate re- serves 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 reserve 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 for which the association is responsible for maintaining,” said Poehlmann.
In addition to examining the documents, Poehlmann recommended convening with association leadership to ensure the actual needs of the community are addressed by the reserve study. “Equally, or even more important, 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 Poehlmann, “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 or 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.
Poehlmann 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 what is 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 Poehlmann.
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.
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 maintenance issues are overlooked,” said Poehlmann. 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 certainly 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 Poehlmann. 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 Poehlmann.
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 Poehlmann.
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 Poehlmann. 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. “For instance, the State of California requires that associations hire a professional reserve firm to provide a full reserve study with site inspection every three years, and an annual update in the years that a full reserve study was not provided,” said Poehlmann. Virginia requires a professional reserve study every five years. According to Poehlmann, other states that have statutes that involve either funding reserves, establishing reserve accounts, or rules relating specifically to reserve studies include: Minnesota, Michigan, Ohio, Hawaii, Washington, Nevada, and others. “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.
Poehlmann 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, depending 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 Poehlmann. 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 time- frames and schedules.
Poehlmann 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 Poehlmann. 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, Poehlmann 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.
Poehlmann 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 example 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 process, 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 because of asphalt replacement, other times it’s in the association’s operating budget, and some of the time it’s not anywhere to be found,” said Poehlmann. When it’s 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.
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 Poehlmann. 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 Poehlmann. “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.” Poehlmann 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.
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 account- ing and legal professionals about this. “It’s really a legal question, and I’ll defer to the attorneys,” said Poehlmann. However, he pointed out an example of how Florida specifies the funds be kept. “In Florida, state law requires that reserves can only be used for their intended purpose unless approved in advance by a vote of the members,” he said. Other states al- low 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 Poehlmann.
Poehlmann 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. He then looks at those future capital expenditures as they come due and funds the reserves with consistent annual contributions into the re- serve account with the objective that the reserve account will never fall into a deficit position or below a set minimum amount.
Poehlmann 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 (paying 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 owners 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 Poehlmann. 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 cur- rent owners.
“Regular reserve study updates will help keep the association on track,” said Poehlmann. These should be conducted every three years to avoid overfunding, 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 Poehlmann, the prices vary on reserve studies, and there is even software that associations can purchase to do simplified, but 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. Poehlmann 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 members 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 com- ing 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, of which I was fortunate enough to be one,” said Poehlmann. 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.
Poehlmann said that reserve studies have changed in many ways over the past few decades. “My partner, Ted Salgado, and I started conducting reserve studies in the 1980s, which was only about 15 to 20 years from the birth of the community association industry,” he said. “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’d see 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.”
Poehlmann said in the mid-1990s, CAI invited Salgado and him, along with a handful of other 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, Poehlmann sees the industry expanding. “In addition to more states enacting legislation to ensure that associations are protect- ing 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 spreadsheets, 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 Poehlmann.
Todd Walter, PE, PRA, RS
Reserve Advisors, Inc.
735 N. Water Street, Suite 175
Milwaukee, WI 53202
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.
Do banks require any documentation from the residents in the approval process of the association loan?
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 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.
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.
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.”
Thomas Engblom, Ph.D, CMCA, AMS, PCAM, ARM, CPM
Vice President Regional Account Executive Midwest
CIT Group Inc.
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.”
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
- Sheets and blankets
- Battery-operated megaphone and whistles
- Portable AM/FM radios
- Spare batteries and manual battery
- Poster board and markers
- Blockades and flashing lights
- Bottled drinking water
- Water purification tablets
- Non-perishable food
- Plywood Sheets
- Portable generators
- Hygiene products
- Filtering face masks
- Tool kit
- Plastic sheeting and duct tape
Thomas Engblom, Ph.D, CMCA, AMS, PCAM, ARM, CPM
Vice President Regional Account Executive Midwest
CIT Group Inc.
What happens when a property damage disaster occurs in an association? What steps need to be taken at the time of the disaster and afterwards in order to restore the property to its predisaster condition? Who is responsible for taking the necessary actions, the residents or the association? We spoke with Aneil Kersey, Vice President of Concraft in Auburn Hills, Michigan to answer these questions.
Property damage events result in the destruction, ruin, and loss of possessions and property. However, the effects on a property manager, association board members and the affected co-owners can reach much further than just the property involved. Due to this, individuals involved in such situations need to remember two common themes: the necessity to keep a level head under intense emotional stress and perceived chaos and they need to remember the difference that an experienced, qualified, certified restoration contractor can make.
Restoration companies handle clean-ups and repairs for a wide variety of disaster situations. These can include many different situations. Anything from storm damage, such as shingles missing from a roof, siding that gets blown off the exterior, fires, floods and sump pump backups, to a car driving through a building or biohazard clean- up (such as situations where people pass away). Restoration companies have specialized training in a variety of restoration situations, such as smoke removal or determining when structural items should be re- placed depending on how much char they have on them after a fire. They also have a unique knowledge and experience on how to properly clean and restore building materials and personal belongings that have been impacted by fire, smoke, soot, water, microbial growth, etc. A reconstruction or remodeling company, on the other hand, makes repairs, additions, and modifications to buildings without the added challenge of dealing with soot, char, microbial growth, etc. “A restoration company may appear to be the same as an everyday reconstruction company, however, the unique talents and abilities they bring to the table are invaluable in putting the structure back to its pre-loss condition,” said Kersey.
If an association is experiencing any type of water damage, such as a broken water supply line in a common element, water damage from a fire suppression system, or if there is a hole in the roof due to storm damage, they should call a restoration company for emergency help. “We want to mitigate or prevent any secondary damage from the initial catastrophe,” said Kersey. He said for any emergency, the company should be on-site ASAP (within one hour) from receiving that phone call. Arrival on site within one hour is a good guideline with regards to the industry. He explained that in an emergency response, a company should get to the catastrophe as quickly as they can, do an assessment of the damage, and stabilize the site so that there’s no more damage occurring. “You take into account the safety of any of the tenants, co-owners or building owners that might be there,” he said. The company will also stabilize things to the point where an estimator can come in and prepare the repair estimate for the reconstruction company. Also, in the event the loss is very severe, a meeting with the board of directors, affected co-owners, managing agent, and restoration/reconstruction company to educate all parties on responsibility of repairs and timeframes is recommended.
Who should the association call first, the restoration company, or their insurance company? Kersey recommended calling the restoration company first to stabilize the damage and provide an assessment for re- pairs. “Many associations today have larger insurance deductibles, $5,000 or $10,000, so before they submit an insurance claim, they should prob- ably call the restoration company, allow the restoration company on-site to do their initial evaluation, perform any emergency services that need to be done, and then the restoration company can follow up with the association, either directly or through a property manager, to tell them what’s going to be involved and give a rough estimate of the costs associated with what the repairs and mitigation would be,” he said.
Once the site has been stabilized and evaluated by the restoration company the association can make the decision as to whether they want to file an insurance claim. Kersey noted that the restoration company should be involved in every step of the process on behalf of the association. The association should give the insurance claim information to the restoration company, including the name of the insurance company, the claim number and the adjuster’s contact information so the company can meet the ad- juster on-site. The restoration company will then do a walk through with the adjuster and agree to the scope of work. The restoration company should also ensure the association’s coverage is being maintained properly for the necessary repairs due to the damage.
Once the evaluation of the work is done, the restoration company will prepare an estimate for its work. Kersey said this can take anywhere from a few hours to a couple weeks depending on the severity of damage. Once prepared this is submitted to the insurance adjuster. The adjuster will re- view the estimate and call the restoration company with any observations, concerns or requests to the restoration company. Once the estimate is approved there is a work order or contract that should illustrate the dollar amount the restoration company and insurance company agreed to. This is known as the replacement cost value.
The association needs to understand that the restoration company works directly for them and therefore the contract for work should be signed by the property manager and members of the association’s board.
“The restoration company is working for them, whereby the insurance company provides the insurance for the risk that they insure the association for,” he said. The restoration company should meet with the insurance company so that an agreed upon scope of work can be created. Based upon that you will get an agreed upon amount of what the claim will cost. “The insurance company’s legal or fiduciary responsibility is to the association. So once the insurance company has an agreed scope of work that they will pay off of, payment for the agreed dollar amount will be paid to the association,” he said.
The association should check the dollar amount of the contract along with the payment terms for when the monies are due. Associations should also look at the terms for change orders. “Anything that’s outside the scope of work that is listed in the initial agreement would require another written agreement for change orders or supplements along with signatures from all the necessary people so there are no surprises at the end,” said Kersey.
Once the contract is signed and returned, the restoration company will commence work. “Initially this will involve a pre-construction meet- ing with the contractor’s project manager, the association’s property man- ager and any other necessary parties. At this meeting a review of the job scope should be discussed, selections made (such as paint colors, carpet, cabinets, and countertops — anything cosmetically that needs to be select- ed) and any special circumstances discussed. After this meeting, all materials can be ordered, tradesmen scheduled, and an accurate job schedule can be created. With regard to material selections, many of these selections are dictated by the association’s bylaws, but sometimes the co-owners are al- lowed to make these selections.
The work starts with any necessary demolition, deodorization or restoration, then after that, any repair work would be done. “On a larger job that would be framing, the mechanicals, heating plumbing, electrical, then insulation, drywall and paint, cabinets, trim, carpet, right through the end,” he said.
What the association should expect up front is a start to finish schedule from the restoration contractor, and then throughout the process there should be open, transparent communication between the contractor, the property manager and the association. This way the project should go smoothly, and any issues that are brought up by the co-owners, condo association and property manager can be dealt with promptly by the restoration company.
What is the role of the restoration company in regard to dealing directly with co-owners? The restoration company can communicate directly with anyone who has concerns. One caution is to make it clear to the co-owner that the restoration company is working for the association, typically through the property manager. He said that many times co- owners are unclear about what they own or what the process is. So there needs to be open communication between the association, the property manager, the restoration company and the co-owners. One area this be- comes apparent is with regard to damage in a co-owner’s unit that is their responsibility based on the association’s bylaws. If the materials inside are a ‘betterment or improvement,’ the co-owner’s HO-6 insurance policy would cover a portion of the cleaning, repair, and/or replacement of these materials.
The association doesn’t need to wait for a disaster to happen to put the pieces in place in case one does. Restoration companies can be part of the disaster planning process for associations. The company can come in and instruct the association on who they should call if they have a water or fire event. They can also point out where all the water shut-offs and electric shut-offs are in the building. “So when something does happen, the on- site manager, property manager and condo board can all know what to do and who to call. Because once something does happen, there will be a lot of emotions involved,” said Kersey.
He pointed out that, depending on the severity of the loss, there could be a lot of chaos involving multiple co-owners. “That’s not the time to be making a decision as to what contractor you want to do the work. It’s better to do that upfront, when you can think things through, interview multiple contractors if necessary, and then set things up to get all emergency contact numbers and the names of people you should talk to,” he said. A restoration company can take the lead in working all these things out for an association.
The choice of what restoration company to use is up to the owner of the property, not the insurance company. “The association has the right to choose whomever they want to do the work,” said Kersey. The insurance company can make recommendations, but outside of providing referrals, they have no role in selecting what company will perform the work. Kersey highly recommended that the association make sure that the company they do select is an active member with the Restoration Industry Association (RIA). “The company performing the work would ideally have a Certified Restorer (CR) on staff, as this designation is the ‘gold standard’ of certification for restoration personnel. Other advanced designations are Water Loss Specialist (WLS) and Certified Mold Professional (CMP). Another organization that many respected restoration contractors belong to is the Institute of Inspection Cleaning and Restoration Certification (IICRC),” he said.
Kersey said that the biggest misconceptions in disaster restoration stem from managing agent, board of directors, insurance adjusters, and co-owners not understanding the association / co-owner responsibility. Oftentimes, the parties involved in the repair process / insurance claim do not realize or understand their responsibilities. This can cause friction, if co-owners do not understand where the association’s insurance ends and their personal homeowner’s policy begins. Also, some insurance adjusters are not properly trained on reading bylaws, which leads to coverage based on “interpretation,” and this could lead to delays and confusion.
He explained that many associations have a builder’s standard-grade insurance policy. However, there are three known association policies that deal with condominium associations that all parties should be aware of (Bare Walls policy, Single Entity policy, All In policy). Responsibilities and how they relate to different parties involved will depend to a large degree on the insurance policy that was purchased. The co-owners could have made a lot of upgrades to their unit after they purchased it, and if the association has a Single Entity policy, when a catastrophe occurs the con- dominium association only owes the co-owner for how their unit was the day it was purchased from the original builder. “That causes a lot of stress if the co-owners don’t have proper insurance,” he said. Those co-owners would need to pay out-of-pocket to restore their unit to include all the upgrades, and this, according to Kersey, causes them to be upset with the association, property manager or restoration company. So co-owners need to make sure their individual homeowner policies will adequately pick up where the association’s insurance responsibility ends.
Another misconception is that the restoration work will start in just a few days following the damage-causing incident. If it’s a substantial loss, there are a lot of things that need to happen. In the case of a fire, for ex- ample, there needs to be an origin inspection for the cause of the fire and allowing the adjusters for all materially-interested parties to walk through the entire job site. This would include adjusters from not only the association’s insurance company, but those from the co-owners’ individual insurance policies’ companies. “The process takes a little bit longer on the front end than a lot of people think it will,” said Kersey. Good communication, letting people know what to expect, is key to a successful restoration job. How well the repairs to the damaged structure(s) within the association proceed is largely up to the property manager and association board. Of course, the contractor who performs the work must be qualified, skilled, and certified to do the work they perform, but it is the job of the property manager to communicate exactly what they expect during the job. If you are not sure, make sure to ask plenty of questions and do not move on until you understand the information given as an answer. Through good communication, patience, transparency, and trust, an emotionally stressful and overwhelming situation can be handled promptly and professionally with great results for all parties involved.
1171 Centre Rd
Auburn Hills, MI 48326
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