HOA: Just Because You Can Doesn’t Mean You Should
YIKES, HOW ARE WE GOING TO PAY FOR THAT? (AND WHAT IF WE’RE LUCKY AND THERE’S LEFTOVER CASH?)
We all know that property deteriorates, and it’s no fun at all, but sometimes you have to replace a roof or repair a foundation. If we’re really unlucky, a building may burn down, or fall into a sinkhole caused by a developer’s shortcuts in construction.
Associations ordinarily have power, of course, to regulate the maintenance, repair, replacement and modification of the common elements and to make additional improvements to them. Almost all have a duty to do maintain, repair and replace them. Fulfilling this obligation requires funding.
In acting as or advising a board member or officer generally, but especially where financial issues are concerned, it is wise to refer to the standards of conduct imposed by Vermont law. Whether or not the association is organized as a nonprofit corporation, the standards set out in the Vermont Nonprofit Corporation Act apply to its board members and officers. This means that they must perform their duties in good faith, with the care an ordinarily prudent person in their position would exercise under similar circumstances, and in a manner they reasonably believe to be in the best interests of the association. In doing so, generally speaking, they are entitled to rely on the advice of professionals and committees as to matters within their expertise.
With that in mind, we’ll turn to funding sources and options.
Reserves.
With limited exceptions, residential common interest community association executive boards in Vermont must adopt and may annual amend budgets in order to fulfill their duties. Even those communities existing prior to the effective date of the Vermont Common Interest Ownership Act have such duty.
Budgets may include reserves, but are not required to do so. If reserves are included in budgets, the board must provide unit owners with a statement of the basis on which they are calculated and funded. Whether and what reserves are appropriate for a particular community must be determined by the board.
This begs the question: what are reserves? The statute does not define the term. By inference, however, it’s clear that reserves are funds collected in advance of anticipated expenditures. Ideally, an association will collect reserves based on the projected useful life of major components of the common elements, such as roofs, roads and parking areas, and will be prepared to maintain, repair or replace them when the time comes without difficulty.
Options other than reserves for unexpected expenses.
Unfortunately, many associations don’t maintain sufficient reserves. A board confronted with significant expenses and insufficient reserves has other avenues for fundraising, although employing them is more cumbersome than collecting reserves over time.
The primary alternative to adequate reserves is the special assessment or budget amendment increasing assessments. Both require that the board propose the special assessment or budget amendment, communicate it to the unit owners, and hold a meeting of the unit owners to ratify it. Under the Act, the proposal is ratified unless rejected at the meeting by a majority of unit owners other than the declarant, without regard to whether a quorum is present.
An association governed by the Vermont Common Interest Ownership Act has additional options including borrowing and providing security for loans, although these options are understandably more cumbersome. It may encumber or convey property, including common elements, if that action is approved by at least 80% of the votes in the association, including 80% of the votes allocated to units other than the declarant. (Additional restrictions apply to the sale or encumbrance of limited common elements.) Alternatively, the Board may – in the absence of a Declaration provision to the contrary – provide security for a loan by assigning the Association’s right to future income, including the right to receive assessments.
EXTRA FUNDS!
Let’s hope that you’re in the delightful position of having fewer expenses than anticipated: you’re at year end looking at a pot of unspent assessments. There will certainly be competing interests with respect to them: spend, save, or refund are probably the general categories of these interests.
Your options may be dictated by the governing documents or the statute. For associations governed by the Common Interest Ownership Act, the default is that surplus funds remaining after payment of common expenses and prepayment of reserves must be returned to the unit owners annually, or credited to them to reduce their future assessments, unless the declaration provides otherwise.
If your association has been particularly prudently managed, or just lucky, you may be in a position to hold the excess funds for some time.
The Act expressly allows associations, acting through their boards, to invest association funds, and doesn’t go much further. It leaves unstated the standard that applies to such decisions and how funds can be invested. The Official Comment to a later version of the Act, not yet adopted in Vermont, indicates that this was intentional: for most associations, the applicable standard will be the business judgment rule, rather than the prudent investor standard applicable to trustees. The same comment reveals that the drafters left to association boards to decide whether funds should be invested in cash or near-cash equivalents such as short term bonds (as anecdotal evidence suggested was most common) or long term capital growth investments. As with so many association governance questions, the answer is “it depends.”
What is clear in Vermont is that board members and officers are subject to the duties and standards described above, and that they are entitled, in exercising them, to rely on the advice of professionals as to matters they reasonably believe to be within the professional’s competence.
This article appeared in the July, 2023 edition of CondoMedia, the official publication of the New England Chapter of Community Associations Institute.
