Wisconsin HOA / Condo Book

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Wisconsin Legal

Daniel J. Miske

Daniel J. Miske

Husch Blackwell LLP

Covenants, Conditions and Restrictions (CC&Rs)

What determines the components of the common areas versus homeowner-owned areas? Where is it written that certain elements are the responsibility of the homeowner and others are the responsibility of the association? These issues and more are established in what’s commonly called an association’s declaration, although it is also called the covenants, conditions and restrictions (CC&Rs). Attorney Daniel J. Miske, a member of the College of Community Association Lawyers with the law firm of Husch Blackwell in Milwaukee, Wisconsin, 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 some states, statutes vary for condominiums, homeowners associations (HOAs) and cooperatives. In Wisconsin, there is a particular statute applicable to condominiums (Ch. 703 Wis. Stat.), but none that directly controls HOAs. Miske is currently involved in the drafting of a proposed HOA statute for Wisconsin, so make sure to check with your attorney on the status of any such law before proceeding with any amendment to your CC&Rs.

CC&Rs are recorded with the government entity, usually the county register of deeds, in which the particular association is located. Sometimes they are accessible via a governmental internet system. When CC&Rs are recorded, the land in the legal description of the document becomes subject to the terms within them.

In addition to the CC&Rs, the association may also have articles of incorporation (if they are a corporate entity), bylaws and rules and regulations. Most notably, according to Miske, boards can generally change rules and regulations without holding a vote of the association’s members. CC&Rs and bylaws, on the other hand, generally require a vote of the members for amendments, with the association documents often requiring two-thirds or seventy-five percent majority. Sometimes, boards are given the ability to change the CC&Rs by vote in limited circumstances, such as addressing errors and omissions, but the board would need a member vote to make substantial changes. Effectively, voting regulations can vary by state and association type as well.

In cases where it is required by the CC&Rs, mortgagee approval may be needed to pass amendments. In some states, but not Wisconsin, this approval can occur by default if the mortgagee does not respond to the amendment approval request within a certain time period. This recently became the law for condominium associations in Wisconsin, but not HOAs.

CC&Rs are the documents that govern the community from its outset, and they are generally rather broad and cover a wide variety of issues. They are created by the developer, who is sometimes known as the “sponsor,” though not in Wisconsin, Miske noted. Rules and regulations are created by the board, typically over the course of time and to the extent to which they are allowed as outlined by the CC&Rs. Rules and regulations work in conjunction with the CC&Rs and are used to supplement the governing documents. A good analogy would be that the CC&Rs are like the U.S. Constitution and the rules and regulations are like the laws that Congress enacts. Rules and regulations are used to supplement or address issues that are not specifically covered in the CC&Rs. If there is a conflict between the CC&Rs and any rules, it is generally held that the CC&Rs would control.

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

The initial set of CC&Rs, or the document legally defined as the master deed or declaration, carries the most weight amongst an association’s governing documents in part because it is recorded, Miske explained. Bylaws, on the other hand, are rarely recorded and rarely require mortgagee approval to amend. Finally, rules are almost never recorded and almost never require mortgagee approval to amend. However, each document needs to be carefully reviewed as there is no statutorily required form and each set seems to differ.

How detailed do the CC&Rs need to be in the governing documents? And what role does vague language play in drafting the “supreme law” of the community? Vague language is common within governing documents, Miske explained, “because the developer is trying not to offend anyone while selling lots, while the association, on the other hand, is attempting to find the most efficient means to manage the association.” He said that one of the problems with vague language is that it can make enforcement more difficult, but it can also give board members flexibility. Certain issues may need to be very detailed, such as members’ easement rights. Specificity is always best, but not to the extent that it limits the flexibility of the board. As an example, he said, the CC&Rs could include the board’s power to levy a fine or penalty against an owner for some infraction. A very specific way to define that power would be that the board has the power to fine, that fine can be no more than “X” dollars and it has to be administered in a certain way. This provides flexibility in terms of the amount, the way in which the fine gets levied, the way in which it gets waived and the mechanism by which fines are administered. In sum, it gives the board the ability to function.

Miske noted though, “There is case law nationally that requires a schedule of fines to be part of the association documents, so that a violator has advance notice of the potential fine in order to meet the due process requirements to which a member is entitled. Set fines, such as ‘X’ dollars, will obviously become antiquated at some point.” To address this, he often drafts the documents or amendments to make the fine or late fee amount a percentage of the assessment (e.g., 10% or 20%), so that it adjusts with inflation.

More specific language does not necessarily lend greater ability to enforce. Miske stated that, “A clear unreasonable rule is still unenforceable.” This concept is especially important as boards are charged with the responsibility of creating and revising rules and regulations over the course of time to supplement the existing CC&Rs. Conventional wisdom holds that boards are looking to control things, Miske noted, but that is quite often not the case. In fact, boards are often looking for ways to avoid micromanaging the association, but are often limited in their discretion if the specificity of the language in the CC&Rs mandates (often by using the word “shall”) that they do something.

Even if boards follow their rules and governing documents, the potential still exists for them to be challenged successfully, “because either the rules can violate the law or the rules can be deemed unreasonable,” Miske said. CC&Rs are presumed to be valid unless they are shown to be completely unnecessary, unreasonable or violate state or federal law. A board that is adhering to its governing documents is either doing something it is authorized to do or refusing to do something it doesn’t have to do. However, a legal concept known as “good faith” allows someone to challenge an action or inaction – even if it is consistent with the governing documents – by arguing that it is being selectively enforced, done in bad faith, “or the application of the rule has a disparate impact on a protected class — think race, creed, sex, religion, etc.,” he explained.

Take for example an association’s ability to restrict or prohibit the installation of energy efficient systems for aesthetic purposes. There are modern-day, state-by-state regulations that have tried to limit the powers of community associations to regulate these systems. According to some state laws, though none in Wisconsin at the time of the publishing of this book, associations may only be allowed to limit where these systems can be placed and how they are installed. By contrast, some states allow associations to outright ban systems like solar panels for aesthetic reasons, although with the rising popularity of green technology it is becoming harder to do so. Regardless of any such laws, Miske noted, owners could still challenge a board’s attempt to regulate or prohibit energy-efficient systems on the grounds that such restrictions are unreasonable.

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

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

Another potential Fair Housing Act violation would be trying to enforce single-family use restrictions, especially if the association requires residents to be related. In sum, any potential violation of the Fair Housing Act or state discrimination law is easy enough for residents to file complaints about, but expensive for associations to defend.

An association may have an appeals process in place, based on the governing documents. There may be specific language in the CC&Rs about an appeals process, how rules are enforced and how penalties are administered. But absent that language, Miske said there is no specific statutory language governing how an appeal to the board would take place.

Some governing documents allow for the association to form a committee, often called a “grievance committee,” specifically to hear appeals to violations. Although committees are typically created and staffed, at least in part, by the board of directors, grievance committees should not be. He explained that the duty of the grievance committee is generally to review a fine or violation imposed by the board of directors, so placing board members on the committee would likely create an inherent conflict. This type of committee (one without board members) is known as a committee of the membership, which is granted authority and autonomy by the governing documents. Miske strongly recommends having a grievance committee. “Its function is to act as the appeal forum for deciding rule violations or the amount of fines imposed by the board of directors. A grievance committee should not include board members if it is going to be used to review the decisions of the board in this narrow arena. The reason for excluding board members, or anyone with a conflict, is that it allows for due process,” he explained.

Is a committee’s decision final when penalizing a resident rule-breaker, or can a resident appeal to either a court or back to their association’s board? As explained above, it depends on the association’s governing documents. “In Wisconsin, it is not uncommon for the board to fine and if the fine is contested for the grievance committee to have the final decision. I have seen grievance committees overrule the board both as to a violation and the amount of the fine,” Miske stated. “The fact that the committee is not just a rubber stamp of the board is a good thing for everyone, and boards should appreciate the role of a grievance committee even when the decision is contrary to their original decision.” Many governing documents in Wisconsin say that you cannot appeal beyond the grievance committee. “The whole purpose of the grievance committee is to bring the matter to a conclusion, but of course the governing documents have to be written appropriately for this to occur,” he said. “If your documents don’t provide for either a grievance committee or that its decision is final, you should consider amending them,” he continued.

In some states, Miske said, associations are obligated to make alternative dispute resolution available as an alternative to litigation. The cost of alternative dispute resolution is either paid evenly by those involved or negotiated beforehand. Miske explained that there are two different types of alternative dispute resolution: mediation and arbitration. He explained, “Mediation and arbitration are two different things. Mediation, generally, is when you hire a third party to help the two parties resolve [the dispute]. If you reach agreement, great, but if you don’t, you can then go either to an arbitrator or to court to obtain a final decision.” “Everything in mediation has to be agreed on by the parties,” he continued. “A mediator, by definition, doesn’t have any authority to decide anything.”

“An arbitrator, on the other hand, is just like a judge in a court case. They make the decision and it can be enforced by the parties through the courts,” Miske said. If a party is dissatisfied with the arbitration award (the ruling) they can only object to the award and litigate the case if there was a showing of impropriety during the arbitration process. (See Ch. 788 Wis. Stat.) Miske noted, though, this is “very rare.”

How does an association determine fine amounts? Common sense and reasonableness should always prevail. Fining someone $5,000 because they failed to take their Christmas wreath off the door by the deadline is very inane and is just going to attract bad publicity.

Likewise, some state laws, but not Wisconsin’s, place restrictions on fine amounts. In Wisconsin, the test is if the fine is reasonable considering the facts and circumstances of the particular issue, Miske said. Fines are generally specified in the association’s enforcement policy, which is part of its rules and regulations. In some policies, there are specific fines for certain types of violations. In addition to traditional fines, an association may also seek to recover the costs it has incurred because a violation has taken place. These “fees” are often more enforceable and more reasonable than traditional fines. For example, if an owner violates a parking rule and parks their car in a prohibited place during a snowstorm, the association can likely recoup the cost of having that car towed in order to get the road plowed.

It is common for associations to use an escalating fine schedule, especially for relatively harmless violations, such as putting out trash at the wrong time. Miske said, “Generally, an association must publish its fine schedule for it to be enforceable.” He referenced a rather pertinent case regarding this: Turtle Rock III Homeowners Association v. Fisher (2017, Ariz. App.). While not from Wisconsin, the case is nonetheless instructive of the basic view of fines across the country. The issue at hand was that the association board was authorized to fine under its governing documents, and proceeded to fine based on that authority and the numerous violations by the owner. The trial court ruled in favor of the association, but the appeal court reversed the decision. Miske explained the court ruling, saying, “On appeal, the court ruled the fines were unenforceable, holding that ad hoc fines—meaning ones not on a schedule or published beforehand—are per se unreasonable. An association, therefore, at least according to this Arizona court, must first adopt a schedule of fines before assessing them.”

Some states, but not Wisconsin, even outline these fine schedules for condos and HOAs, making it easier and more enforceable for associations. Where that is not the case, associations may choose to dole out fines at their discretion, where each fine is determined by the board. However, the more discretion that exists in the system, the more likely that a court will find that the offender was not afforded due process. Miske also note that keeping good records of the circumstances surrounding the violation and the fine that was levied will increase the chances that a fine will be found reasonable.

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

Fines should never be simply punitive in nature, though, Miske said. The purpose of fines are to change behavior so that violators comply with the association documents and to alleviate the harm or financial cost brought upon the association by violations. Regardless, fines should be enforced equally throughout the community. Not doing so could be considered a form of discrimination.

The concept of due process is found in the United States Constitution. Due process requires that the person who is being accused is given knowledge of that which they are being accused. There is a certain amount of specificity needed to inform the person of what they did, when they did it and that it was in violation of an identified restriction. After the suspected offender has been notified, they must be given an opportunity to defend themselves of the violation. Miske explained, “To meet the due process requirement in Wisconsin, many associations require the complaining person to file a written complaint and, if the matter is contested, be willing to testify before the grievance committee. Otherwise, you may have trouble proving to a court that you provided due process to your member.”

If it can be determined that a violation has actually occurred after following those steps, and the association has the right to fine to begin with, then it can be said that due process has been satisfied and the fine may be assessed. (See Section 703.165 Wis. Stat. for a related reference to condominium associations.)

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

In its realistic application, transparency is when decisions are made known to all owners. Meetings may or may not be open to all owners, as it depends on the meeting location and the topics at hand. Miske said that decisions made by the board, for the most part, should be made during open meetings. “Unlike some states, in Wisconsin, there are no requirements for open meetings of association boards, however we strongly recommend it,” he said. At the same time, Wisconsin recognizes that there are certain topics that are sensitive in nature that require discretion, or demand legal privilege or privacy, and those meetings (or portions of the meeting) should not be open to the public. Accordingly, private executive sessions and closed meetings do not necessarily make for a lack of transparency. Regardless, all owners are allowed access to non-executive (or non-closed) meeting minutes, Miske said.

Furthermore, open meetings do not give owners the right to interject themselves into the conversation whenever they see fit. “During board meetings, there is no inherent right for members or owners to talk, but many associations set aside fifteen minutes or so at or near the beginning of the meeting for owner input or feedback,” he stated.

What kind of notice is required to inform residents that a new rule is in effect? The law does not usually outline how an association must give notice of a new rule, he said, but they are generally responsible for doing so in some manner. Once a resolution is signed and adopted, the board can then send it to members. Sometimes an association’s governing documents may specify how and when the board gives notice of new rules. Some associations may give little to no notice, but doing so risks the possibility of members challenging those rules, Miske noted.

How much time are residents allotted to comply with new rules? Some states may have a regulation specific to this, but Wisconsin does not. “Once again, it is generally a rule of reasonableness; accordingly, a new rule may take effect immediately or over time, or may grandfather in existing residents,” Miske explained.

How do associations define “reasonable”? Reasonableness is hard to strictly define, but it’s often simple to pinpoint in any given situation. Anything that leads to ridicule or widespread criticism is most likely unreasonable. Anything that is easily defendable is most likely reasonable. For example, it would be reasonable for associations to require that renovation work be permitted and specify that contractors be licensed and insured, Miske noted.

Can associations place restrictions that would affect the sale of properties in their communities? One could say that every restriction has the potential to impact the sale of properties in either a negative or positive way. Restrictions provide the stability of maintaining things that residents do not want changed, Miske explained. The premise of the entire restrictive property scheme is that the rules are desired by the people who will buy the property and are designed to uphold a certain community standard. Given this, it’s difficult to argue that a restriction actually hurts the value of the property, he said. Classic examples of restrictions that come into question here would be pet policies and leasing restrictions. One prospective buyer might be turned away by such restrictions, while others might find them ideal.

Can an association grant a variance to any type of rule? An association can grant a variance if its governing documents first allow it, or if the law requires it. Miske explained, “There’s been a lot of Fair Housing Act changes and at this time [associations] have to grant the variance for emotional support animals under certain circumstances, even if their documents say they can’t.” Reasons for granting a variance should not be subjective, favor-based or dependent on whom the owner knows on the board; reasons should always be objective. Those objective standards should always show that the owner did not self-create the cause for their variance request.

What are considered reasonable architectural controls? The CC&Rs can contain a wide array of architectural controls detailing specifically how a home can and cannot be built, what materials must be used and what can be added to the property. Generally speaking, Miske said, “Whether an architectural control is reasonable, assuming it does not violate some law or building code, depends on the neighborhood, what is written in the documents, what has been built or allowed to date and what has been prohibited to date.”

What are some of the negative consequences for associations that don’t enforce their own rules? If a board fails to enforce the association’s rules and regulations, Miske said the association can be sued. Individual board members can also be sued. Additionally, associations may have trouble enforcing an old rule that has not been enforced previously, absent notice to all of the residents that the rule will be enforced in the future. Miske’s basic belief is that, “If a board has no intention of enforcing some rule, it would be in their best interest to have it removed.”

Associations should also proceed with caution when attempting to restrict certain visual elements, such as the United States flag, political signs or holiday signs. Miske pointed out, “The first two have a particular condominium statute pertaining to them (see Section 703.105 Wis. Stat.), but as stated previously, there is no relevant HOA statute at this time in Wisconsin.” Other states have particular statutes that regulate an association’s powers in this free speech context. Associations are viewed by some states as quasi-governmental in the application of free speech, assembly and religion; so they should handle these subjects accordingly, much like any other government entity. Instead of prohibiting certain types of holiday displays, Miske advised that associations may be wise to attempt to only regulate their size and the duration that they are allowed to remain visible in the community. As for political signs, they may be easier to restrict in a condo association due to more common property being shared between residents, while HOA residents likely have their own lawns for displaying signs.

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

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

How do associations deal with encroachments in common areas? There are a few ways of dealing with this. Using the example of a resident who planted shrubbery in the common area, one method would simply involve the forced removal of the item. The association can send notice to the owner that the item in question will be removed by the association at the owner’s expense. If the encroachment might actually harm the common property or cause drainage or other problems, removal may be the only way to remedy the situation, Miske advised. “Of course, if the violation is harmless or actually enhances the look of the association, the board may want to simply render the encroachment harmless and then grant authority for the item. On the other hand, if the item is not acceptable to the board, the association may need to go to court to cover the removal costs,” he said.

Occasionally, a developer may construct something that encroaches on a common element or area. Miske said that in such a situation, nothing can usually be done. Some association declarations may even allow waivers for encroachments caused by the developer.

Like plant life, play sets can sometimes encroach on common areas. Before they are forcibly removed or made the subject of an agreement between the association and owner, it should first be determined if they are a temporary structure. Play sets that are simple enough to remove may or may not be a violation, so make sure that you review your documents.

Collection of Delinquent Dues

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 could be declined for a capital improvement loan when needed, therefore preventing the community from performing necessary major repairs or replacements. The Federal Housing Administration (FHA) also looks at the number of delinquent homeowners in a community in its approval process and will not approve communities with past-due accounts over a certain percentage. If an association can’t obtain FHA approval, which allows potential purchasers to obtain FHA mortgages for homes in the community, owners will have a smaller pool of available buyers. Cleaning up past-due accounts in an expeditious manner will not only benefit the association itself but also all the homeowners who have a stake in the community. How, then, should this be done?

According to attorney Daniel Miske, the first step is to have a collection policy so that each time an owner is delinquent the board does not have to reinvent the wheel as to how to proceed. “Collection policies generally provide that if assessments are more than 90 days past due the matter will be turned over to the association’s attorney for collection. If such a policy is drafted and adopted, it avoids many claims that the board showed favoritism toward one owner versus another,” he explained.

The second step in the process of collecting delinquent dues from an owner, according to Miske, is generally a letter from the association. This is a formal notice demanding that the owner pay his or her outstanding assessments, which are generally detailed in a ledger that may or may not be sent to the owner. This notice also warns of impending legal action if the debt is not paid by a specified deadline. Depending on the situation, the association’s letter may have a variety of other contents.

There are usually two options an association can pursue if the demand letter was unsuccessful in recovering the assessments owed and if any other efforts, such as the recording of a lien, were also unsuccessful. Generally, those two options are filing a money judgment lawsuit or a foreclosure of the lien suit on the delinquent assessments.

Some states, but not Wisconsin, give associations the option of evicting delinquent owners prior to going through the foreclosure process. When this is an option, associations may be less likely to pursue foreclosure, as the lien on assessments will have lower priority than the first mortgage on the property.

In Wisconsin and other states, Miske said that the association has to record a lien before it can foreclose. A lien is generally recorded regardless of whether a money judgement is sought.
A money judgment is a personal judgment against the record owner, which is the basis of attempts to execute on the person’s assets, such as wages and bank accounts. On the other hand, Miske explained, a foreclosure is designed to seize and/or change ownership of the property through a sheriff sale.

If the delinquent assessments are paid in full, by the time required, the property will be restored to the owner. Absent an error made by the association or its attorney, Miske said, “The association is not responsible for any mortgage.” Moreover, insurance and taxes for the property remain the responsibility of the owner until after the sheriff sale is confirmed. Once the foreclosure process is complete—which takes place upon the confirmation of the sheriff sale—the purchaser of the property will become responsible for the taxes, but not the mortgage.

When should an association pursue collecting delinquent assessments? It depends on the association, and perhaps even the state, but most pursue collections after three payments have been missed or after $500 has accrued, whichever comes first. This is an effort to make sure that fees do not immediately overshadow the assessments to be collected. Regardless of when an owner is turned over to the association’s attorney for collection, liens should almost always be filed in a timely manner in order to protect the association. “There’s only a four month window in Wisconsin to file those liens, and if you don’t file them you lose one of your best collection options,” Miske explained. “Additionally, forwarding the matter to your attorney early in the process often makes it much more likely that the delinquent owner can catch up.”

Can associations embarrass their residents by publicly disclosing their delinquencies? Associations cannot and should not embarrass residents in order to motivate them to pay overdue assessments. Doing so in order to punish a delinquent owner could constitute a breach of fiduciary duty or even a violation of their state’s consumer protection laws. Moreover, such treatment may constitute “harassment” under the state’s consumer protection law.

Miske elaborated that federal law, under the Fair Debt Collection Practices Act (FDCPA), provides that publishing or disclosing the name of delinquent owners is prohibited conduct and amounts to harassment under the FDCPA. However, the FDCPA only applies to third party collectors, so associations can argue that it does not apply to them. Miske described the problem as follows: “The state consumer protection act, which in most states does apply to associations, often provides that any person collecting from a consumer shall not harass. Since the FDCPA specifically defines publishing the name as harassment, it’s not much of a leap to believe some intelligent consumer protection lawyer will ultimately say, ‘well, since federal law defines publishing an owner’s name as harassment under the FDCPA, then the same act also amounts to harassment under Wisconsin’s Consumer Protection Act.'” Therefore, when disclosing balances or seeking to collect on an owner’s debt, it is highly recommended for associations to be accurate and to only disclose the debt to the person owing the debt.

As for keeping records throughout a collections process, associations should already have previously adopted policies regarding the collections process and what records need to be kept.

How can an association determine if an account is likely to be collected? One way to determine this is to look at the equity of the house and the balance on the mortgage, Miske said. If the house is worth more than the mortgage, it’s most likely collectible.

On the other hand, according to Miske, if the house is worth less than the balance of the mortgage, the house is empty, or the owner is missing and/or judgement-proof, then collection will be more difficult. However, following a foreclosure, the association could rent the house to generate revenue, which is a common solution.

What if the association deems collection doubtful? As long as a home is owned by a person rather than a bank, and it has not been sold through a sheriff sale, no account can be deemed 100% uncollectible. At the same time, unpaid assessments will continue to accrue until the association takes action. Thus, withholding action on a delinquency both prolongs the time it will take to obtain a judgment against the delinquent owner and causes the association to deal with a bigger balance.

However, if a home is sold through a sheriff sale, and that sale is confirmed by a judge, the previous owner is no longer obligated to pay future assessments; and thus, his or her balance will no longer rise. As Miske put it, “It’s not the sale that ends the debt, it’s the confirmation of the sale by the judge.” When that happens, the association needs to seriously consider writing off the balance.

Once an association determines that it is going to pursue foreclosure, a foreclosure complaint must be filed. If for some reason the unit owner is not accessible, is deceased, does not accept service or evades service, then a foreclosure can usually be served by publication of the summons in a newspaper.

Depending on the state, there may be two options for foreclosure: foreclosure by advertisement (not available in Wisconsin) and judicial foreclosure. Foreclosure by advertisement is a way of foreclosing upon a property without having to go through a court. However, foreclosing in this manner gives the owner an opportunity to recover their property after the foreclosure sale for a certain period of time.

A judicial foreclosure, on the other hand, renders the foreclosure sale final. It involves recording a lien and filing a foreclosure complaint, just as is done with a mortgage. Some states, including Wisconsin, require that all foreclosures be judicial foreclosures, Miske said. A judicial foreclosure must be performed by the court, and a court must enter judgement and authorize the home’s sale. Once the foreclosure complaint is served, there is a period of time during which the owner can file an answer. If the owner does not respond in time, or loses the case, Miske stated, “The association can seek default and proceed with the foreclosure process.” After the redemption period passes — generally six months in Wisconsin — a sheriff sale is scheduled and held, with the buyer from that sale becoming the unit’s new owner upon confirmation of the sale by the judge.

The Fair Debt Collection Practices Act (FDCPA) is a federal law that regulates the collection practices of third-party debt collectors in order to protect debtors. If the FDCPA is applicable with regard to a given debt, then there are a variety of controls on the debt collector pursuing that debt. Associations are not governed by the statute, as the association itself is not a third party debt collector, but collection agencies and attorneys are. Therefore, associations do not have to comply with the FDCPA when setting up payment plans or pursuing debtors, but Miske stated that they may have state consumer protection laws that do apply. “So they better know what they can and can’t do,” he said.

Debt collectors have a variety of obligations in regard to communication with debtors. Consequently, Miske noted, the association’s attorney should be the association’s main form of contact with the debtor. The association’s attorney should be kept informed of anything relating to that unit, to make sure everyone is on the same page. This includes informing the attorney every time a payment is made.

With regard to associations themselves, communications should be undertaken in the best way possible to help ensure the recovery of money owed and to get owners to pay assessments moving forward. Communication directly from the association or management company should be kept open with the debtor “on all other matters,” Miske explained. “But all debt communication should be directed to the attorney.” He continued, “Because in every federal circuit—there are eleven of them—there are slight variations on what can and cannot be stated to a debtor or what is required in the demand letters. In the seventh circuit, which is where Wisconsin is located, there is a particular form to the demand letter if collection is going to be attempted within the first thirty days.” Since board members and managers are not familiar with the various requirements of the FDCPA, Miske advises them to stay away from those discussions.

When possible, communication should be done in writing for documentation purposes and ease of sharing with the attorney. “If the debtor happens to call the board or property manager, confirm the call with a follow up email and forward a copy of the email immediately to the attorney. However, the best practice remains not to have any communication with the debtor about the debt once the matter is turned over to the attorney for collection,” he said.
Collection Agencies
For the most part, it does not make sense for associations to sell unpaid assessments to a collection agency. It may make sense, after a sale has been confirmed, for any unpaid debt by the prior owner to be collected by a collection agency, Miske said. Obviously, the new unit owner would be expected to pay assessments every month going forward.

When hiring a collection agency that bases its compensation upon a contingency of some sort, it is already understood that the association is to accept a smaller portion of the total amount owed. This is because the collection agency will take a specified percentage of the collection as payment if the debt is successfully recovered. If an association is at the point where they have hired a collection agency, then they have already deemed the balance to be difficult to collect. Reclaiming forty percent of an otherwise uncollectible debt is still better than not reclaiming anything at all, Miske noted.

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

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

The plan should hold the owner accountable for staying current on future assessments, while still repaying delinquent assessments, he explained. If the owner fails to stay current on future assessments, the agreement should allow the association to take action and foreclose or obtain a judgment on the balance due. This gives the association a way to address the debt if the owner doesn’t follow through with the agreement.

Payment plans may vary by owner, but the association should remain mindful that large variances may be argued by disgruntled debtors as a form of discrimination. Miske said that plans should be drawn according to an owner’s ability to pay, but should not wipe out any of the assessments or debt until all of the payments are made.

Regarding repayment plans, Miske explained, “In Wisconsin it doesn’t hurt you to file a lien, so make sure you protect the debt by timely filing the lien. However, you also have to be careful not to wipe out your lien by accepting a promissory note.” He continued, “Because the note then becomes the debt, you may well have lost your lien rights. A lot of collection people, who don’t fully understand liens and foreclosures, would likely want the note, but the note probably doesn’t help you here.”

Are new owners responsible for paying assessments owed on foreclosed properties? They may under certain circumstances, but associations cannot simply tack on extra fees during the sale of the property in order to recover costs. In some states, but not Wisconsin, if the association has already started the collections process, the new owners (the bank or otherwise) may be obligated to pay some or all of the past due assessments. In some cases, associations may even demand recovery of attorneys’ fees from the new owner.

Alternatively, Miske said the association can implement transfer fees, commonly $200 to $500, on all property transfers to help support the association financially. “A possible outcome is that if a bank obtains a property through foreclosure, that is one transfer, and when it then resells it, which is common, the association gets paid a second transfer fee,” he explained.

Associations should accept partial payments from delinquent owners, though they must be careful when doing so, he advised. If there is any language surrounding the partial payment that implies the owner is paying in full, and the association accepts it, the request for the remaining payment may not hold up in court. Not accepting partial payments at all, on the other hand, could also look bad in court. “So if you receive a partial payment, with language noted on the check or accompanying documents that implies or states in any fashion that it is payment in full, be certain to obtain legal advice as to your options,” Miske said.

In some instances, small claims court may be a viable option when pursuing delinquent fees. It could be a smart and affordable option for an association if the association is experienced in debt collection and knows where assets of the debtor are located — for example, where the debtor is employed.

When an owner fails to pay assessments, the association can bring them to small claims court by filing a standard breach of contract case. This is because the CC&Rs of the association are considered a form of contract, Miske explained, and the owners are expected to pay the assessments as described therein. However, going about it in this way does not necessarily ensure that the association will recover anything. “Equally important is that every association should understand that some owners have been through the small claims process more than once and are very good at delaying things and making them extremely expensive for the association with little risk to themselves,” he noted.

A recommended alternative in some states, but not Wisconsin, may be to file the case under the Forcible Entry and Detainer Act. Doing so may still give the association the ability to at least seize the property and use it to recover fees. Wisconsin does not have a forcible entry and detainer act, Miske stated. “We have no way to get into a unit we don’t own. We have easement rights to go in to fix stuff if it’s a danger to the community, but we have no way to detain and rent it out absent ownership of the unit,” he said.

To “execute” on an asset means to take or seize it. An execution is the physical act of enforcing a judgment. Miske explained that, “In Wisconsin, an execution is performed by the relevant county sheriff department. The sheriff will demand that the owner (debtor) turn over any non-exempt assets. Generally, this procedure works best if the debtor owns a cash business (e.g., bar or laundromat) or has a business with physical inventory owned by the debtor that the sheriff can seize. For the sheriff to actually seize any assets, the creditor must be willing to pay the cost of a bond to protect the sheriff. Another collection option is a garnishment. A garnishment is simply a lawsuit filed against any third party that owes money to the debtor (e.g., bank, employer, or any other third party) claiming those funds for payment of the judgment.”

In your normal wage garnishment, said Miske, the debtor’s employer withholds a certain portion of the debtor’s non-exempt wages (wages above the poverty line). Before the association or any creditor can file a garnishment it must first obtain a judgment against the owner.

If an owner fails to pay assessments, the association can record a lien. Some state laws, but not Wisconsin’s, require that a lien be prepared by an attorney, because a non-attorney’s preparation of the lien could be deemed the unauthorized practice of law. Similarly, if there are found to be mistakes in a recorded lien, the lien will likely be dismissed in court.

Collection of a debt is often dependent on leverage. For this reason, it is recommended that associations do not hesitate to record a lien. In addition, it provides protection to the association in the event of an owner’s bankruptcy or attempt to sell or refinance their property, Miske noted. Some associations may issue their demand letter to the delinquent owner prior to filing a lien, while other associations may file the lien first. As stated earlier, some states, including Wisconsin, also require associations to record a lien prior to going through the foreclosure process. (See Section 779.70 Wis. Stat.)

Miske explained, “Twenty-two states have some sort of lien priority relating to HOAs or condominiums associations. Wisconsin has a statutory lien (see Section 779.70 Wis. Stat.), but it has no priority. Therefore filing a lien early in the process establishes the priority of your association’s lien.”

According to Miske, it is generally not economically advisable to pursue delinquent owners who decide to walk away from their properties. Instead, it is more worthwhile for an association to foreclose on the home and then rent it out to recover money. According to Miske, it is very unlikely that an association will recover something from a delinquent owner other than their home, especially when the owner has already abandoned their home. When an owner “walks away from” their property, they are often essentially trying to give the property to their bank in exchange for not owing the remaining mortgage.

If the association tries to pursue a delinquent owner who has abandoned their property, it can only really pursue that owner’s personal assets. “For example, the owner may have a car or a boat or a cottage, but absent some other asset of value or a steady job, it is very unlikely that the money spent pursuing the delinquent owner will be worth it,” he explained.

The association’s options for pursuing personal assets after receiving a money judgment are fairly limited, Miske noted, but include execution, garnishment or a supplemental exam. However, seeking recovery of debt through personal assets is never a sure thing. For example, if the owner declares bankruptcy, and depending on the type of bankruptcy, the association may never recover that money directly from the owner.

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

A Chapter Seven bankruptcy entails a liquidation of the owner’s assets. In this situation, once an owner is discharged from bankruptcy court, the association can no longer collect from the owner personally, though it is still entitled to collect on its lien. The association is also entitled to collect future assessments.

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

A judicial foreclosure is a foreclosure via the court system. It involves recording a lien and filing a foreclosure complaint, just as is done with a mortgage. Miske said that some states, including Wisconsin, require that all foreclosures be judicial. A judicial foreclosure must be performed by the court, and a court must enter judgement and authorize the home’s sale. Once the foreclosure sale is confirmed by the court, it is final.

Some states, but not Wisconsin, allow for foreclosure by advertisement, in which the foreclosure notice is published publicly in some manner, including a foreclosure notice on the front door of the property. Foreclosure by advertisement often occurs when the owner proves to be unreachable. A few states allow it as the only form of notice required when pursuing foreclosure.

While a foreclosure by advertisement may be simpler to pursue than a judicial foreclosure, the sale of a property through a foreclosure by advertisement is not necessarily final. After the property is sold, the delinquent owner has the opportunity to recover the property by paying their debt in full, for up to a certain period of time, known as the redemption period. Miske said that the redemption period expires when the owner may no longer recover the property after the sale.

If the home’s lender comes in once the association has already started the foreclosure, can the association discontinue it? The association can discontinue the foreclosure process at any time, but it is not recommended that it do so. Even when a lender has begun its own foreclosure process, Miske noted that there is no guarantee, or law, that requires the lender to finish their foreclosure process. “For example, the owner may pay their mortgage, but not the association. So if the association had dismissed its foreclosure, it would then need to start over,” he said.

Should an association move forward with its own foreclosure once the lender begins their foreclosure process? Associations might be hesitant to start the foreclosure process if they see the lender has already done so, but it should really act whenever it sees fit and not rely on the lender’s actions alone. Alternatively, an association might be more motivated to respond in kind if the lender has already started the process. Miske stated, “The association might also want to look at filing a cross-complaint in the bank’s foreclosure action against the owner for foreclosure, as this would save service and filing fees.”

When must a lender pay delinquent assessments? “After the sheriff sale of the property has been confirmed by the judge. Before that time, the assessments are owed by the delinquent owner,” Miske said.

When is the bank held responsible for the maintenance of the property? “Again it is after the sheriff sale of the property has been confirmed by the judge. But there are laws and local ordinances that may place duties on the bank to perform certain actions while the property is in foreclosure— such as a duty to make sure it is heated so the pipes don’t freeze,” Miske explained. Once the bank receives a deed for the property in its name, it becomes responsible for paying that property’s future assessments until such time as the bank transfers title to the house.

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

Short sales may or may not be in the association’s best interest, Miske said. Short sales occur with properties that have little to no equity. While a short sale may ensure paid assessments from a new owner going forward, he explained, it will also usually result in the association not recouping some of those delinquent assessments. Associations may be better off going through the foreclosure process and renting out the house in the meantime to recover at least some money, but it depends on the facts of each situation. Miske said, “One thing is certain, an association should not say ‘yes’ or ‘no’ to a short sale without understanding all of the facts.” A short sale is acceptable, however, if it results in a full recovery of debt for the association, even if the lender is at a loss, though that is a rare case.

If an association becomes the owner of a home, Miske said, “Regardless of whether or not there remains a mortgage or other liens on the home, the association may want to rent out the home in order to recover unpaid fees.” It would then find itself in the position of being a landlord. An association’s best practice when it comes to its landlord duties is to follow the law, he advised. Wisconsin, like many states, has detailed laws governing the obligations of landlords, so associations should become familiar with those laws and follow them. In order to meet these obligations, Miske said that many associations hire a professional property manager to ensure compliance with all relevant laws.

If repairs must be made while a tenant is occupying the house, then the association is responsible for making them, he explained, as they are responsible at that point for making sure the house remains habitable, much like a traditional landlord. If the tenant fails to pay rent, the association may need to evict the tenant.

Since the tenants could be dispossessed if a superior lien (e.g., first mortgage of a bank) were to complete a foreclosure sale, Miske said that the association needs to include a provision in the lease addressing the termination of the tenancy under those circumstances.

As for security deposits, associations must follow the same regulations that other landlords must follow. Not following the proper procedures for handling a tenant’s security deposit could subject the association to damages and attorney’s fees for that tenant. Given this, it’s best to have leases reviewed by the association’s attorney.

To sum up the collections options available to associations, absent a voluntary payment by the owner, it generally comes down to foreclosure and/or a money judgment.

A foreclosure is an in rem proceeding, which is an action that focuses simply on the property and does not seek any personal judgment against the homeowner. A foreclosure judgment does not allow asset execution. It is only used to take possession of the delinquent property. The process begins by recording a lien, giving notice to the owner and then, if payment is not made, filing a foreclosure action. There is no foreclosure without a lien.

A money judgment, on the other hand, allows the creditor to take advantage of the post judgment collection remedies discussed in part earlier, including execution and garnishment. “However, there is nothing stopping an association from filing one action seeking both a foreclosure judgment and a money judgment, which is the recommended approach,” according to Miske.

The Association’s Records

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

Should associations keep records, and if so, what records should be kept? Most associations keep records and some states, including Wisconsin, have statutes that outline which records are required and for how long they must be kept. An association’s governing documents may also describe which records are supposed to be kept. Records that are commonly kept include financial records, tax records, owner files, meeting minutes and work records (including contracts with vendors, employee records, warranty documents, etc.).

Financial records and the manner in which they are kept are typically based on recommendations by an auditor or standard accounting principles. Tax returns and similar financial records should be kept for at least seven years, per the Internal Revenue Service, as that is how far back an association may be audited. Miske said that the law requires the association to keep certain corporate records — including its declaration, bylaws and minutes — indefinitely, as that is the association’s corporate history. Apart from government statutes and requirements from the governing documents, associations should use their own reasonable discretion as to how long to hold on to various records. Miske explained, “Keeping documents longer than is legally required adds costs and creates risk for the association, which is why associations should adopt document retention policies. Keeping documents that are no longer required to be kept also adds risk because it allows someone who is suing the association additional documents to review for evidence. This creates additional costs in a number of ways, not the least of which are the association’s attorney fees to review these documents — that could and should have been destroyed before there was an issue — before they are produced to the opposing attorney.”

The location and manner of storage of the records depends on the association and any regulations from the state or the community’s governing documents, he said. An association with a clubhouse will usually store its records there, and one with a management company will usually store its records with them. If an association has neither of these things, it may choose to store its records in the home of a board member or the board president. Regardless of where the information is stored, Miske said that person must make certain records available for inspection to other members on request. (See Section 181.1601-1604 Wis. Stat.) Many associations are now choosing to keep electronic records. When doing so, it is important to keep a backup and to make sure they can be reproduced on paper if needed.

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

Who has access to records and can some records remain private? Individual owners should have access to those records that the law entitles them to inspect (see prior section for statutory authority), including financial ones. Miske stated, “This includes the right to copy them, or have them copied, for a reasonable charge.” Any inspection process put in place by the association must be reasonable and lawful.

What is an association’s responsibility regarding members’ personal information? Access to members’ personal information depends on the community’s governing documents and state law. Access over other privacy concerns also varies. For example, if an owner decided to build an addition to their house, such as a deck, other community members would be able to see the paperwork for that in that owner’s file. In reality though, knowledge of the deck wouldn’t be kept private anyway as it would be quite obvious to neighbors. Information that may be kept private, Miske said, generally, is one or more of the following:

1. Communications with the association’s attorney.
2. Debts owed by members, including the amount of the debt.
3. Personnel information relating to employees and agents.
4. Medical records and information.
5. Contract bidding.

Association Board Member Elections

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

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

Is there any legal obligation to provide members notice of an election? Miske stated, “Yes. Elections are typically done at the annual meeting, and notice of this meeting is required to be given to all members.” State laws and/or the governing documents will dictate the frequency of elections for an association. If proper notice is not given, it can be said the election is invalid.

Can associations install term limits for their board members? Miske said they can. Associations can install term limits for their board members if the bylaws or the declaration are amended to include term limits. Bylaws do not usually contain term limit provisions, but that doesn’t mean the bylaws can’t be amended to include them, he noted. Typically, the bylaws only list the qualifications one must have in order to serve as a board member. For example, the bylaws might say that in order to become a board member, an individual must be an owner of a home within the community.

What is the distinction between directors and officers? Directors are those who are elected to the board, and officers are almost always elected by the directors to perform specific duties, he explained. There are usually only a few officers on a board. For example, on a seven-member board, there may only be four officers, such as a president, vice president, secretary and treasurer. Officers are usually also directors. In some states, but not Wisconsin, officers must be directors.

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

This process may be set by law, depending on the state. Regardless of what an association’s governing documents provide, he said any member is empowered to nominate a member in “good standing,” whether it be the owner themselves or another person. Depending on the state, “good standing” is often taken to be when someone is not delinquent on any assessments or other fees and has no outstanding association judgments.

Are nominations from the floor or write-ins allowed? In some states, associations may have flexibility regarding nominations from the floor and/or write-in candidates. In that regard, it is best to approach each situation carefully and review the association documents before making any decision. Miske said, “In Wisconsin, if there is nothing stated in the association documents, then write-ins would be allowed.” Generally, an association should not ban floor nominations or write-in candidates, otherwise it may find itself without enough candidates. In some cases, an association’s governing documents may allow for a closed slate prior to a meeting, in which case nominations from the floor would not be allowed.
Can an association ban self-nomination? Miske said, “Theoretically, yes, as there is no Wisconsin law that prohibits such an act.” However, a court, even aside from any law, would be very skeptical of an association banning self-nomination.

What is the procedure for a member who is not nominated by the nominating committee to be listed on the ballot? It depends on the documents of that particular association but generally, Miske explained, “There is nothing in the documents, and therefore the member should contact the board and advise that he or she wishes to be placed on the ballot, or what the process is for being placed on the ballot.”

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

Can associations adopt a rule that restricts certain people from becoming board members? Generally speaking, in order to enforce such a rule, it would have to be made part of the bylaws or declaration. Miske stated, “The common example, that appears to be enforceable, is prohibiting anyone from holding a director or officer position if they have a lien filed against their home by the association.”
Can an association request a background check on potential board members? Generally, a board does not have the authority to request background checks.

How far can an association go in vetting applicants? If the bylaws specify that the only qualification to be on the board is that one must be an owner of a home within the community, Miske said, then the association does not have the authority to vet anything other than a person’s status as a homeowner. In order to make it legal to vet candidates for other reasons, it may be acceptable to amend one’s bylaws to provide for that, as long as no law prohibits it.

During the actual campaign phase of an election, do associations need to provide equal access to association media for candidates to campaign? This may be governed by state law, but if an association is providing one candidate with a certain platform or access to association facilities, Miske advised it should really do so with all other candidates.

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

Can associations require members to register in order to vote in a board election? Most governing documents would state that everyone who owns a lot and is in good standing can vote, Miske said. A board could require owners to register in order to vote if that stipulation is put into the bylaws. An association may also be able to require voters to sign in prior to voting. However, there is a lot of skepticism from courts regarding the ability of boards to regulate elections and to limit the democratic process. It is also hard to imagine a scenario whereby an association could lawfully utilize voter registration fees as a way to generate additional revenue, he added.

How does the ballot process work and what does it involve? The ballot process differs from state to state and community to community. In general, nominations are received and candidates are announced. Then, owners receive their ballot, fill it out and submit it according to the methods allowed by the association. In Wisconsin, ballots can be submitted in person or by proxy, Miske said, “unless the bylaws or articles of incorporation prohibit or limit proxy voting.” (See Section 181.0724 Wis. Stat.) The votes are collected at the end of voting and are counted by the election judges. Election judges are selected prior to voting, and they must not be a candidate in the election or related to someone who is.

Who has access to election results? There may be governing document provisions or statutes that address access to election results, but they are usually accessible by the election judges, the board and the property manager. The candidates and their representatives may also be present for the counting of the votes. If other members are interested in reviewing the ballots and proxies, they may submit a request to the association, Miske said, “which should be granted with safeguards to make sure ballots aren’t changed or added to, or go missing.” Ballots and proxies are kept for a certain period of time after the election, according to an association’s governing documents, but they are not usually kept in the association’s records indefinitely. Miske explained, “If the documents don’t give a time frame, the board should consider amending the documents to add a provision that states that the documents will be retained for only three months, or some similar timeframe.”

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

What’s the process for validating a proxy vote? Some states, like Wisconsin, have no provisions at all, he said. However, there are other states that limit proxy voting and make it more difficult to establish a valid proxy. Proxies can also be invalidated if the owner decides to attend the meeting and vote in person.

Is the use of proxies limited at all? It ultimately depends on the association’s bylaws or articles of incorporation. “If they are not banned in one of those documents, then they are allowed,” Miske said.

Cumulative voting allows for a member to cast their number of allotted votes for a single candidate, he explained. For example, if there are three seats up for election and four candidates, a member could vote for one candidate up to three times or for one candidate twice and another candidate once, etc. Cumulative voting may or may not be allowed according to an association’s governing documents. State law may also regulate or otherwise prohibit such voting. “In Wisconsin, cumulative voting is allowed provided the articles of incorporation or bylaws provide for it,” Miske said. (See Section 181.0725 Wis. Stat.)

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

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

The Fair Housing Act & Civil Rights

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

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

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

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

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

Associations need to be very careful and certain when denying these kinds of requests. If an association is found to have unreasonably denied a request or discriminated against someone, they will be responsible for not only damages but the attorney’s fees and costs of the injured party as well. “This makes violation of the FHA a very substantial and expensive penalty,” Miske stated.

The Department of Housing and Urban Development (HUD) is responsible for enforcing the FHA related to associations. Each state has its own enforcement mechanism as well. A resident who believes their association has committed a violation could file a charge with either their state mechanism or the HUD office. If HUD believes there has been discrimination or that it is likely that there was discrimination, he said, it may proceed with a lawsuit against the association on behalf of the resident. If not, the resident may still file a lawsuit against the association on their own. “HUD is extremely resident friendly, so your association should take this into account when determining what course of action it decides to take in any particular instance,” Miske said.

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

Are FHA violations considered civil violations or criminal acts? FHA violations are almost always civil violations, and not criminal. In very rare situations, FHA violations could also be criminal if they violate the civil rights amendments or otherwise violate a state or federal criminal statute, Miske noted.
What constitutes problematic wording in a covenant or rule made up by the association? A rule made by an association may prove problematic if it contains anything that differentiates between residents based on one of the protected classifications. Miske explained, “A common problem exists when associations attempt to differentiate use of facilities based on age, often referring to children not being allowed or adult times. These types of provisions should be carefully reviewed by your association’s attorney before being adopted.”
In and of itself, an act of discrimination is not necessarily illegal. People discriminate all the time; for example, we discriminate when we purchase one type of car over another or hire one person instead of another. It is only when it is directed at a protected class that the act becomes problematic, he noted. A clear example of such a violation would be a rule that prohibits children from riding the elevator. Furthermore, an association could be held responsible if it does not address discrimination between residents if it becomes aware of the issue.

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

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

What are considered reasonable accommodations or reasonable modifications for people with disabilities? For example, one would think it a reasonable modification for a wheelchair-bound resident to request the addition of a ramp to one of the common area buildings. However, if an engineer determines that the desired ramp would not be safe or feasible, that same request might not be reasonable. Otherwise, Miske said that associations are required to give disabled residents the reasonable accommodations (e.g., designating certain common element parking near the common area building as handicapped) that are necessary to afford them equal use and enjoyment of their home and the services provided by the association, especially if it does not impose an undue burden on the association.

Religion is an area of potential legal concern relative to civil rights. For example, many associations ban residents from displaying anything in a common element hallway, while someone’s religion may require a religious display in such a location, like a mezuzah.

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

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

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

Can an association prevent a sex offender from renting a house in the association? Individual owners decide how they handle their private homes, including to whom they rent. It is feasible, Miske said, for those owners to choose to not rent to sex offenders, without any association involvement or putting itself at risk for discrimination.

It is very difficult and extremely risky for an association to regulate who is allowed to rent. If a community amends its bylaws to provide for the association having more of a stake or interest in the rental of homes, Miske said, “for example, by requiring some specific background check or credit score, the effect of such a rule may have a disparate impact on a protected class and therefore violate the law.”

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

In other associations, rules should be passed that encourage or prohibit conduct, not ones that reference children or adults. As an example, Miske said if the community has a gym, children should not be banned outright. Instead, rules should prohibit the type of conduct that they don’t want, and then they should enforce that rule.

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

Can an association question a resident about the prescription or medical note for that animal? The association can indeed question a resident about the prescription or medical note, Miske said, unless their disability is obvious. Such medical notes need to meet the specifications required by law, and the association can require residents to provide justification for their emotional support or service animals under many instances, he said. The association cannot question the severity of the disability, but they are allowed to ask about the relationship between the disability and the required accommodation.

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

Can associations restrict the size of these animals? “Essentially, no,” Miske said. It is difficult for associations to impose size and height restrictions on service or comfort animals. The association needs to show a legitimate reason for any restrictions on these animals if it wants to try to enforce them. Again, many of these decisions must be made on a case-by-case basis, and it is often better to simply allow such accommodations.

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

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

Is it common or even permissible for associations to require that the animals are photographed when they are first brought onto the property? If, for instance, a disabled person’s service animal won’t sit for a picture, does the association then prevent that person from having the animal? Associations must handle each case with care, erring on the side of caution when making decisions, Miske advised. If an association requires animals to be photographed, then all animals within the community must be photographed, not just certain ones. “We have used the term ‘animal’ as opposed to ‘pet’ throughout this section, because the FHA does not view service or support animals as pets. Therefore, by definition, any prohibition on ‘pets’ would not apply to such animals,” Miske explained.

Construction Defects

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

The first thing an association should do if a construction defect is found is to evaluate whether it creates an immediate risk and determine if it is in fact a defect, Miske advised. This is done by contacting an expert for a professional opinion. The next steps would be to determine the full nature of the deviation, the cost associated with its repair, and whether or not any consequential damages exist or will later result because of it.

Once the defect has been fully assessed, it may then be necessary to contact the developer. The developer should be contacted and advised of the problem if the association believes the developer may be able to remedy it, and if it is in the best interest of the community for the developer to do so. Giving notice provides the developer with a chance to fix the defect, or at least witness the defect firsthand. “This is important so as to avoid any argument by the developer of spoliation of evidence—fixing or changing something without giving the developer or at fault party the opportunity to inspect the alleged defect,” Miske said. Notice is often given through certified mail, or however stated in the sales contract. Almost all states have a statute of limitation outlining at what point an association may be unable to recover from the developer or at fault party. Miske explained, “But this period may be adjusted based on when the defect was or should have been discovered. These types of issues, especially if they are large in scale or costly to remedy, likely require an attorney experienced in construction defect litigation to represent the association.”

Defects found in any of the common property elements are to be handled by the association, and they are generally determined to be either the responsibility of the association or the developer. “If the defect is exclusively found in a particular unit or home, then such a dispute may not involve the association, but rather be something that the developer and particular member need to resolve based on the association documents and their sale documents. Members would generally have both express and implied warranties as possible means of recovery,” Miske said. Implied warranties generally last much longer than the period of any express warranty.

An association has the fiduciary responsibility to maintain, repair and protect the common elements of the community, even if some are found to have been built incorrectly. Emergency repairs, especially where the safety or health of its residents are involved, must be made quickly. Miske elaborated, “At the same time, these emergency repairs should be well documented and the alleged at fault party, if there is one, should be notified as soon as possible of the defect and be offered the opportunity to be present for the repair to avoid the spoliation of evidence defense mentioned earlier.” He continued, “The association will need to make decisions based on a number of competing factors, including: (1) obtaining bids to make the correction; (2) providing notice to any allegedly responsible party; (3) making the repairs so that the defect does not cause additional damages (the association’s duty to mitigate its damages); and (4) the need to keep its residents safe.”

Allowing defects to worsen could both breach the association’s fiduciary duty and increase the amount of damages that need to be recovered. If the developer outright refuses to fix the defect, then the association will have to act to the extent that it is responsible for the defect. “As part of the negotiations with any developer or responsible party, an association needs to be mindful of the fact that most construction defect lawsuits will take at least three years to fully resolve,” Miske noted.

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

Often, a developer will claim that a warranty has expired and that the alleged defect is really a maintenance issue, or that the statute of limitations has expired. “Although these defenses may be true, an association should have an experienced construction defect litigation attorney look into all potential means of recovery, including implied warranties and insurance policies,” Miske advised.

Arbitration in construction defect claims may or may not be mandatory and varies by state. Though it may not be mandatory, it is allowed if all parties involved in the claim agree to arbitration. The arbitration process is similar to that of a court proceeding, except without a jury. Arbitration is also a way for many businesses to try to reduce its losses, its time in litigation, and the attorney fees of the litigation, so it is often a developer’s preferred method for resolving a claim. Miske said it is becoming increasingly popular for developers to mandate arbitration, instead of litigation, in the association’s declaration or bylaws. Arbitration is usually more expeditious in obtaining a result, he noted, but can be just as expensive as litigation, since the arbitrator(s) is generally also paid.

Transition or Turn Over

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

Here is a non-exhaustive list that Miske provided:

1- Hire an attorney to represent the association who is not associated with the developer.

2- Get a punch list of any issues that the owners and association have relative to construction.

3- Determine the status of the finances.

Here is another non-exhaustive list provided by Miske:

1- Hire an attorney who is not associated with the developer, if you have not already done so.

2- Consider hiring an experienced accountant to review:

  • Prior invoices to determine if some of those paid by the association were really the responsibility of the developer from a construction, warranty or other standpoint.
  • Analyze if prior charges to the members were appropriate.
  • Prior year tax filings.
  • Prior budgets to determine if developer followed, including whether assessments were consistent with the budgets.

3- Hire an engineer to review any construction defect, warranty and/or maintenance issues.

4- Consider hiring a professional reserve company to prepare a:

  • Reserve Study (to determine what amounts need to be budgeted and placed in a reserve fund to replace the capital improvements of the association in the future based on their current condition).
  • Transition Study (to determine what defects the engineer sees based on non-destructive testing and his or her estimate to repair those items).
  • Retrospective Reserve Study (to determine what funds should have been put in the reserve account during the period of declarant control).

5- Send out a survey to all owners relative to any issues they had or are having with the developer.

6- Obtain from the developer:

  • All corporate records.
  • All tax returns.
  • All financial records for each member.
  • All information for each member (name, address, email, phone number, etc.).
  • Any development agreement with the local municipality and a copy of any bond or other funding referenced in any such agreement.
  • The construction plans and specifications, or a copy of them.
  • All warranties in writing for any construction or personal property.
  • All maintenance and repair records for common elements.
  • A list of all contractors with contact name, phone number, email and address, who worked on the project and exactly what work they did.

If any issues relating to the items set forth above or other issues arise, the first step is generally to present the nature of the issues to the developer and see how they respond. “Communication at this stage is important for both sides, as litigation is always expensive for everyone,” Miske stated. “If the issues are substantial and can’t be amicably resolved, then your attorney should share with your board the options available to it.”

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

Can anything be done by the board before the actual transition date? Prior to transition, Miske said that the members of the developer’s board each have a fiduciary responsibility to address any defects discovered. In fact, the developer’s board has the same fiduciary responsibilities as the post-transition board. When members of a developer’s board are sued after transition, it is often for failing to resolve any defects or other such concerns. Thus, Miske advised that associations should document each problem and how they were addressed. Individual owners do not have much say in the matter prior to transition, as the board is still under the control of the developer.

Is there ever a situation where a developer will pay expenses out of their own pocket in order to keep assessments artificially low? Yes, Miske said, and that is frequently the case. “The developer often sells lots based on the low assessments,” he added. However, case law exists at the national level which states that it is in violation of the board’s—developer and non-developer—fiduciary duty to keep assessments artificially low. (See Raven’s Cove Townhomes, Inc. v. Knuppe Development Co. (1981) 114 Cal.App.3d 783.) Furthermore, in some states, though not Wisconsin, it is required that the developer fund an association’s operations in a certain way throughout the course of the development, and to make disclosures regarding the same.

Homeowners do not have the right to inspect a developer’s financial records, though they do have the right to inspect their association’s records. A developer is also required by each state to file certain documents pertaining to the approvals for building and selling homes, Miske said. Those records are presumably available to the public, including owners, through an open records request.

If the developer enters into a contract on behalf of the association, what happens after the transition? Is the association held responsible for that contract? Perhaps, he said, but it would depend on with whom the contract is made and their relationship with the developer. Ideally, these kinds of contracts are addressed on an individual basis. Contracts instated prior to the transition may be valid for up to a certain period of time, depending on the state. It is recommended that all active contracts be reviewed by the new board after the transition.


Contact Info:

Daniel Miske
Husch Blackwell LLP
555 E. Wells Street, Suite 1900
Milwaukee, WI 53202
(414) 978-5311

Wisconsin Finance

Association Loans

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

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

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

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

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

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

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

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

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

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

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

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

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

Financial Management, Adhering to a Budget and Financial Warning Signs

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

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

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

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

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

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

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

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

There are also two types of budgets:

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

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

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

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

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

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

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

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

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

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

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

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

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

Extra money goes into reserves.

Calculating Association Assessments

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Contact Info:

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

Wisconsin Insurance

Joel Davis, CPCU, CIC, CIRMS

Joel Davis, CPCU, CIC, CIRMS

Community Association Underwriters of America

Association Insurance: Ensuring You’re Protected

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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


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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Contact Info:

Joel Davis, CPCU, CIC, CIRMS
Community Association Underwriters of America (CAU)
2300 North Barrington Road, Suite 400
Hoffman Estates, IL 60169
(847) 278-8810

Wisconsin Accounting

Michael P. Mullen, CPA

Michael P. Mullen, CPA

Michael P. Mullen, CPA, PLLC

Association Accounting and Budgets

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 Michael P. Mullen, CPA, who is the owner of Michael P. Mullen, CPA, PLLC, to answer these questions and enlighten readers on other important accounting topics. He has offices in Wisconsin, Minnesota and Florida.

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

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

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

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

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

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

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

It’s the fund that accounts for all of the association’s operating revenue and expenses. Your operating fund balance, at the end of the year, is like the retained earnings in the business world (a for-profit entity). It’s the net of the profits and losses for all the operating years since the association’s inception.

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

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

Wisconsin statutes require that condominium associations maintain a reserve fund and that those monies be kept separate from operating fund monies activity. “They should also do a physical inspection of the property each year,” Mullen said. “This is important to make sure that the correct amount designated towards major future repair and replacement expenses are incorporated into the reserve portion of the budget.”

As mentioned earlier, condominium associations in Wisconsin are required to maintain a reserve fund.. But are there any other requirements when it comes to reserves for associations in Wisconsin?

According to Mullen, there are several other requirements. In general, replacement reserves must be included in the annual budget, and the amount allocated should be enough to reasonably replace the association’s aging components over their estimated remaining useful lives and their estimated future replacement costs. Mullen noted that associations cannot use reserve funds for operating expenses. An association can, however, use their reserves as security when seeking a loan.

Lastly, if the association finds itself with surplus funds after providing for common expenses and its budgeted reserves, it can either credit it to reserves or use it to reduce future assessments for the unit owners. This is typically determined by the board, unless the association’s declaration addresses it.

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

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

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

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

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

In Minnesota, as well as certain other states, associations still need to file a state tax return, and depending on which type of federal return is selected, it dictates which state form is required. Minnesota’s tax rate is 9.8% regardless of which form is filed, Mullen noted.

A word of caution should be taken into consideration when filing as a regular corporation (Form 1120) where there is a net membership income. Mullen explained that that excess can be exempt or deferred under the Internal Revenue Rule 70-604, which states that if there are excess assessments over expenses, the excess should either be refunded to the members (not recommended) or applied to the following year’s assessments (recommended). The election must be made by the membership and before the tax return is filed.

Wisconsin Statute Chapter 703 (Condominium Ownership Act), contains provisions for having an independent CPA perform an audit of the association’s financial statements at the end of the fiscal year.

According to Mullen, Wisconsin law requires that any audit or review be performed by a CPA who is licensed according to the AICPA requirements. The CPA must also be independent of the association and cannot be a member of the association, or employed by the association’s management company, declarant or their affiliates.. 

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

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

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

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

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

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

What are some of the warning signs that theft or fraud is occurring? One warning sign is when a board member or a management company, who is the only signer on the bank account, prevents online access to the bank statements. “That is a fraud indicator,” Mullen said. “They’re 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 more than usual, or living beyond their means,” he said. He also warns about board members who express they have financial concerns of their own, or for a family member. A person experiencing a desperate financial situation could be a potential threat for committing fraud against the association.

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

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

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

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

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

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

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

Contact Info:

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

Wisconsin Reserves

Reserve Studies

In order to answer these questions, and provide other important details on this topic, we spoke with Todd M. Walter, P.E., PRA, RS, Vice President of Engineering at 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 Walter. 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 under taken as large capital projects, such as roof and siding replacements. Although it is ideal for associations to have sufficient reserves for items such as these as they are needed, that is not always possible. In instances where reserves fall short, associations are faced with three undesirable options: 1) impose a special assessment on the co-owners, 2) borrow funds for the capital project from a bank, or 3) postpone 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 re- paired 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 reserves will be there when the association needs them.

Reserve studies have evolved over the years to where they are available 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 that the association is responsible for maintaining,” said Walter.

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

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

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

Walter 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 per- forming the reserve study. Last is the life and valuation estimate. This is where the reserve professional’s engineering team determines the useful life, the remaining useful life — or better stated, how much longer the component will last before it has to be replaced — and the repair or replacement cost of each component.

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

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 Walter. The reserve professional could also find possible unbudgeted or over-budgeted items. “We like to look at the entire operating budget, which includes the reserve budget,” he said. There are two reasons for doing this. One is to make sure that all property is accounted for and nothing was omitted from both budgets. The second reason is to ensure that no items were double counted and in both budgets. “When that happens, the association is obviously over-assessing,” he said.

Another major benefit of a reserve study, when followed by the association is that it will eliminate, or at least greatly reduce, the possibility of special assessments. “Picture yourself as part of a young couple who recent- ly 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 Walter. Reserve studies make it easier for home- owners 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 Walter.

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 of 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 Walter.

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 Walter. 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. – Take Minnesota for example. “The Minnesota Common Interest Ownership Act requires associations to reevaluate the adequacy of budgeted reserves at least every three years. This requirement applies to townhomes, planned communities, cooperatives and condominiums,” said Walter. According to Walter, other states that have statutes that involve either funding reserves, establishing reserve accounts, or rules relating specifically to reserve studies include: Florida, Michigan, Ohio, Minnesota, Nevada, and others. Virginia requires a professional reserve study every five years. “The key thing that we’ve found over the years is that the number of states that are enacting legislation is growing. There is clearly a trend toward more legislation, not less,” he said.

Walter 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 Walter. The engineer needs to be able to see the roofs and pavement in order to assess their conditions, so if there is snow and ice on these surfaces that isn’t melting, that would cause a delay. Also, the scheduling time varies for different companies, so associations should ask potential reserve professionals about their timeframes and schedules.

There are four general funding strategies for association reserve 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 Walter. 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 projected 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 Walter. “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.” Walter 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.

Walter 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 Walter. 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, Walter 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.

Walter 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 sometimes it’s not anywhere to be found,” said Walter. When it comes time to do it, the association will struggle to find the funds to do it, or take the money from the reserve account even though it wasn’t part of the reserve budget.

For the most part, the reserve funds should be kept in their own separate account. Statutes regarding this are different in each state, and the laws are frequently changing, so associations should ask their accounting and legal professionals about this. “It’s really a legal question, and I’ll defer to the attorneys,” said Walter. However, he pointed out an example of how Wisconsin specifies reserve funds be kept. “State statute 703.163 states that the declarant of a condominium that is created on or after November 1, 2004, shall establish a statutory reserve account when the condominium is created. In addition, the annual budget shall provide for reserve funds,” he said. Other states allow using reserve money for other expenses, but specify the funds must be paid back to the reserve account within a strict time frame. Another factor in deciding how to keep and use reserves is the strategy the reserve study provider used to fund the reserve account. “One method, known as the cash flow method or pooling method, pools all of the future replacement costs into a pool. The pool of funds is used to conduct the replacements in the order that they come due,” said Walter.

Walter 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 reserve account with the objective that the reserve account will never fall into a deficit position or below a set minimum amount.

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

At some point, if a reserve account has been overfunded over a period of time, the board could then reduce the regular common fees assessed to the owners. However, associations should beware of and avoid overfunding the account. “The negative aspect of overfunding is that the current owners are paying more than their fair share into the reserve account. This means that, as the current 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 Walter. So, in essence, when you overfund, the current owners are paying toward a future fee reduction that, if they move, they will never be able to enjoy. And additionally, owners who purchase later in this timeline will not be contributing the same level of funding toward the reserve account as current owners.

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

According to Walter, the prices vary on reserve studies, and there is even software that associations can purchase to do simplified, though not very reliable, reserve studies. However, cost should not be the main factor in choosing a reserve study provider. He also does not recommend relying on do-it-yourself software for this important service. Walter 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 coming home every night,” he said. For the most part, board members are neighbors in the communities they serve, and they should treat the decision about how to pursue maintaining proper reserves in terms of how it would affect their neighbors and themselves.

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, which included the founders of Reserve Advisors,” said Walter. 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.

Walter said that reserve studies have changed in many ways over the past few decades. He explained, “We’ve seen a lot of changes over the years. In the early days, we found that most people who were doing reserve studies were property managers or board members because there wasn’t a reserve study industry yet. Property components were just beginning to wear out and associations clearly weren’t prepared for that. They’d take projections from contractors and guesstimate the future replacement costs in very unscientific ways. We saw accountants trying to get their arms around the question of how to fund for replacements. People were using different terminology in different parts of the country. Some were providing engineering inspection reports that were invasive in nature, providing more information than a board would ever need to plan for the future. Others were providing common element replacement forecasts without any kind of funding plan, which didn’t really help when it came time to budget. They still called these reserve studies, even though half of what we expect from reserve studies today wasn’t even included.” Walter said in the mid-1990s, CAI invited a handful of reserve study providers to meet and develop national reserve study standards and consistent terminology so boards and managers would have a basis from which to compare providers and have reasonable expectations of what they were buying. “Along with that came the Reserve Specialist designation pro- gram 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, Walter foresees the industry expanding. “In addition to more states enacting legislation to ensure that associations are protecting their members’ investments in their homes, the new generation of managers and boards are reshaping the way they use reserve studies. A demand for information in real-time is driving the industry towards delivering additional tools that allow for interactive planning. Associations today 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 Walter

Contact Info:

Todd Walter, PE, PRA, RS
Reserve Advisors, Inc.
70 Birch Alley • Suite 240
Beavercreek, OH 45440

Wisconsin Disasters


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

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

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

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

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

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

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

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


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

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

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

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

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

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

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


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

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

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

Contact Info:

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

The views expressed in our site do not necessarily reflect the views of AssociationHelpNow or Brainerd Communications, Inc. Answers and advice do not constitute legal or other professional advice. Consult your legal, accounting and other professionals to assess any situation before taking action. Brainerd Communications, Inc. reserves the right to edit questions and comments.