|THE TEN COMMANDMENTS FOR BOARD MEMBERS|
WITH REGARD TO ASSESSMENT COLLECTION
by Beth A. Grimm, Esq.
his article is as much for the benefit of the general public that lives in HOAs, and the California legislature, because it stresses the difficulties Boards face in assessment collection and the extent of the laws in California related to just ONE ASPECT of running a homeowners association. It seeks to point out that although one hears stories of hard-hearted board members - one seldom sees the problem through the eyes of those volunteer board members who are just trying to do a service by assisting in the management of their homeowners association. Yes, its a dirty job - but someone has to do it!!
COMMANDMENT I: THOU SHALL COLLECT JUST ENOUGH MONEY FROM THE HOMEOWNER MEMBERS TO PAY BILLS THAT ARE AUTHORIZED UNDER THE GOVERNING DOCUMENTS.
Board Members in homeowner associations are volunteers. They are in essence running a business (often a corporation), as well as leading the community and acting as a municipal local government. The Civil Code, with regard to assessments, dictates exactly what the Board of Directors must do. It shall levy regular and special assessments sufficient to perform its obligations under the governing documents
and the Davis Stirling Act. (Civil Code Section 1366(a). However, it shall not impose or collect an assessment or fee that exceeds the amount necessary to defray the costs for which it is levied. (Civil Code Section 1366.1) This is a concept that is sometimes referred to as zero-based budgeting. It is a very difficult task to collect just enough money to pay the bills of the Association, without over-budgeting or under-budgeting. If the Association collects too little, it can get in trouble with the Owners-because that is the source to which it must return to collect more money (or other important services that would otherwise benefit this group).
However, if it collects too much, it can also get in to trouble. In order to avoid tax ramifications as to the money collected for maintenance obligations, it must pass just the right resolution at the end of the year or risk having to pay taxes on the overage collected. Being guardians of the Associations funds, a Board of Directors has to tip toe lightly through the myriad of requirements not only for collection of assessments, but for treatment of them within association accounts and distribution in favor of costs. If, at or near the end of a fiscal year, the Association does not present the appropriate resolution to the homeowner members to deal with any overages collected in assessments, that money is subject to being taxed by the IRS (Resolution 70-604). Some legal practitioners advise that the resolution simply needs to say that the money should be carried over into reserves. Others give the opinion that the Association members should be given a choice, i.e., that the money be rolled over into the reserves or that it be refunded. Other practitioners include a third option that the money be used to offset against operating expenses for the coming year. All of this gets very confusing for Board Members. And then there is the BIG problem of apathy in getting Owner responses to a ballot measure. Luckily, volunteer Boards of Directors do have the right to rely one expert advice even if it differs among experts, so that would be my advice to seek the advice of a legal professional knowledgeable with regard to use of homeowner association assessments to determine the proper resolution for your Association.
This Commandment (requiring zero-based budgeting) becomes critical down the line if every effort is not made to collect assessments from each and every Owner.
COMMANDMENT II: THE BOARD OF DIRECTORS SHALL PREPARE A BUDGET EACH YEAR, AND DISTRIBUTE TO ALL OF THE HOMEOWNER ASSOCIATION MEMBERS. (Civil Code Section 1365 &1365.5)
The Board of Directors is expected to arrive a the correct assessment amount by using a planning tool called a pro forma budget. Naturally, the Board Members will look to prior years expenses, increases that might be expected, bids and proposals that are given to the Association, information from outside sources and resources, what is authorized and/or required by the governing documents, the reserve study that is required by law to be done for the association, and what kinds of things need to be accomplished in the coming year. The budget is required by law to be distributed to Owner members not less than 45 nor more than 60 days before the beginning of the fiscal year. This gives Board Members a mere 15 day window period in which to distribute the budget each year. The budget also includes the reserve study (see next Commandment), and disclosures that must be made include assessment collection procedures, an ADR summary, insurance information, special assessments that may be under consideration by the Board because of unforeseen problems or discovery of costly deferred maintenance, lawsuits, etc.
COMMANDMENT III: THE BOARD OF DIRECTORS IS RESPONSIBLE FOR PLANNING (in the form of a Reserve Study) FOR ALL MAJOR EXPENSES OF THE ASSOCIATION (Civil Code Section 1365 & 1365.5)
Reserve studies are required foremost associations, except those whose replacement value of major components that would be included is equal to or greater than one-half of the gross budget of the association which excludes the reserve account for that period in time. The Reserve Study basically consists of two parts, i.e., the component study and the funding plan. The component study essentially lists the major improvements, facilities, building components, etc., that the Association is obligated to maintain, repair and replace under the governing documents. The items that are included in the component study are those that have are maintaining useful life of less than 30 years. Once this list is formulated, the Board is responsible to present to the membership a funding plan which is intended to cover the costs of these major components (including the maintenance, repair and replacement) over the coming 30 years. This reserve study is most often (and most advisably) completed by someone or some firm that is familiar not only with the laws in California related to reserve studies, but with various aspects of construction, industry costs, and unique aspects of homeowner associations. The reserve study (required to be done at least once every three years) has an inspection component as well. The improvements listed in the reserve study are supposed to be the subject of a reasonably competent and diligent inspection.
Creating a funding plan over a 30 year period is certainly not an exact science. There are a variety of reserve study preparers. As a part of the reserve study, the Board is expected to disclose to the membership the level of funding that is supported in the reserve study. In other words, the Board of Directors must give the members a percentage figure which tells the members how much money the association has saved related to the reserve study components compared to how much money should have been collected, for each passing fiscal year. Some statistics that have been presented to the legislature (as disclosed at a recent public hearing) that indicate that the average figure in associations surveyed for percentage funded of reserves is 60%. Some people get in up-in-arms about this, but when you think about it, most homeowners who live in single family homes probably dont have more than 60% of the money they need socked away to make a major replacement to their home of any kind. However, the downfall for Boards of Directors is that they have a fiduciary duty to protect the property values and this percentage funded is one aspect that can affect property values in a homeowners association. Therefore, it can be said that a Board of Directors has a higher duty to all of the membership (than each does to himself or herself) to save conservatively and get as much money put away as reasonably possible, striving for the 100% funded mark.
COMMANDMENT IV: THE BOARD OF DIRECTORS MAY NOT INCREASE ASSESSMENTS IN ANY GIVEN FISCAL YEAR WITHOUT APPROVAL OF THE MEMBERSHIP IF ALL TECHNICAL ASPECTS OF THE BUDGET NOTIFICATION PROCESS ARE NOT TECHNICALLY PERFECT.
The Board of Directors has a heavy burden. In addition to all of the requirements disclosures for the membership, increasing assessments is directly conditioned upon doing everything correctly and proper. If the Board of Directors does not finalize the budget and reserve study so that it can be mailed out to the members within the brief 15 day window period that comes 45 to 60 days before the fiscal year begins, the associations can become hamstrung in making necessary assessment increases, unless the requisite percentage of members approved the assessment increase or an emergency arises that could not be foreseen that requires an assessment. The Board fulfillment of its fiduciary duty can easily be affected by mistakes made by others. Sometimes associations have a difficult time getting figures back from reserve study preparers, CPAs, and others, who have been asked to participate in the budget process and provide the Board with expertise. Sometimes things get lost in mail. Sometimes computer programs crash. Sometimes Boards simply dont know the rules. A whole years worth of diligent budget preparation can be sabotaged by failure to comply with or fully understand the law.
COMMANDMENT V: THE BOARD MUST BE DILIGENT IN ITS EFFORT TO COLLECT ASSESSMENTS FROM ALL OWNERS.
Under Commandment No. I, one Can see that zero-based budgeting requires Board Members to be extremely diligent in their pursuit of the assessment collection from each and every Owner. Since the Board is expected to collect just enough money to pay the bills, and contingency accounts can be questioned not only by the owners, but the IRS, failure on the part of any particular owner to pay their assessments places a direct and unequivocal burden on the rest of the members of the Association. Periodically, in the news, and hearing testimony was given before the legislature, questions arise as to whether non-judicial foreclosure is a reasonable process for collection of assessments. Although that will be discussed in more detail below, Board Members need a fast and efficient remedy, and sometimes a heavy hammer, to help members realize and understand how important payments of assessments are to the Association (and thereby see the incentive to fulfill their own obligation). Some owner members treat payment of assessments like payment of doctor or dentist bills, or non-priority items (payable only after all other essential bills get paid). Some members withhold assessments because they are unhappy with the way the Association is maintaining the properties, assuming they have that right in a manner similar to tenants in a landlord -tenant situation. The fact of the matter is that the legislature has seen fit to give homeowners association boards strong authority to collect assessments, including liening the property and bringing a judicial or nonjudicial foreclosure action for unpaid assessments. Should assessment collection be consistent with a mortgage obligation? Probably – at least that would likely be the feeling of any assessment-paying Owner.
A homeowner association Board of Directors also has the right of collection through Small Claims Court actions and some send accounts out for collection to association collection agents. Those sorts of things adversely affect the credit rating of Owner members, again, and serve as of incentive to pay, but probably not the level of losing ones home. If a Board of Directors does not diligently collect assessments from all owners, it has to find the money to pay the bills from other sources. This means other budgeted expenses have to suffer, borrowing from the reserves may be needed, or the Association may have to go back to all the members to collect the shortfall.
COMMANDMENT VI: THOU SHALL FOLLOW ALL TECHNICAL REQUIREMENTS WHEN ATTEMPTING TO COLLECT DELINQUENT ASSESSMENTS THROUGH THE LIEN AND FORECLOSURE PROCESS.
Foreclosure, judicial or nonjudicial, is not an easy process. Boards of Directors are expected to understand the foreclosure laws so they can make prudent decisions, and the laws are technical and difficult. Civil Code Section 1367 requires an association to follow a number of steps in preparation of a lien and submittal to a member. The Association must send a pre-lien letter that contains certain information and gives Owners a chance to pay. If the Association records alien, it must provide a copy of that recorded lien to the homeowner. People who do not do collections on a daily basis dont know how to meet the technical requirements of the lien or maneuver through the system to make sure that the legal requirements are in full compliance. Then, Boards must comply with Civil Code Section 2924 and all of its many subsections in recording and acting upon the lien. Very generally, this requires notification to all of the persons or entities holding senior deeds of trusts, mortgagees, or other recorded interests on the property, of the intent to foreclosure. This is to give the people who are holding senior deeds of trust and mortgages (those higher in priority), the opportunity to payoff the Associations debt and protect their own interests. All notices must be by certified mail, and without going into additional detail related to the mortgage statutes, suffice to say that most Board members could not possibly know what all the technical legal requirements are, nor be able to follow them without paying an attorney or a lien specialist of some kind to pursue the rights under the governing documents for non-judicial foreclosure. If a court or the legislature were to takeaway the right to pursue non-judicial foreclosure, it would be taking away perhaps the biggest "hammer that forces Owners to get serious about paying assessments, people who might otherwise take that obligation a little too lightly. I hear individuals complain about the foreclosure option, saying the Board should not have that much power but the in all my years of doing collections, a very, very small percentage (less than 1%) ever went to foreclosure. That is certainly not the usual first choice of an Association Board of Directors (nor should it be). The first choice of the Association Board of Directors is to collect the money levied assessments so that it does not have to look to the other diligent homeowners to cover the short fall. A board can be sued by other homeowners to for failure to fulfill its duty in collecting assessments. This is the basis and requirement for diligent collection of diligent assessments.
COMMANDMENT VII: THOU SHALL AVOID INCONSISTENT TREATMENT OF OWNERS AND SHALL NOT WAIT MORE THAN FOUR YEARS TO COLLECT ON DELINQUENT ACCOUNTS.
Boards can look at payment plans for Owners who fall into delinquency, but most legal practitioners advise judicious use of this entitlement. Inconsistent enforcement of the governing documents, according to Chubb Insurance Company (who used to write Directors and Officers liability coverage and used to sell the most policies in that area) constitutes the largest percentage of claims on the Associations insurance Directors and Officers Liability Coverage Policy. This means that if some Owner claims poverty or special circumstances, and cannot afford to pay their homeowner assessments, that Board still has to be wary of offering them a special payment plan. If they offer a payment plan to one homeowner and not to another, the other could assert an inconsistent treatment claim which could come back to bite the Association. So, Boards of Directors have to be extremely careful not to treat people inconsistently or unfairly. If the Association has hardship policies which allow some homeowners special dispensation in regard to paying off assessment accounts, there should be documentary backup, as well as authority to do that in the Associations collection policy. Due consideration should be given in any situation where someone claims a hardship or special circumstance, but if the Association allows too much of that, then again, the other assessment-paying homeowners have to pick up the slack.
But on the flip side, most Board Members would not have any way of knowing it but if they let an assessment delinquency accrue past four years, they lose rights under common contract law to collect amounts more than four years old. The CC&Rs can be viewed as a contract (including agreement by purchasers to pay assessments). Of course, if the Board accesses its rights in non-judicial foreclosure in a situation where their annual assessments of $100 or less, it makes the Board look pretty darn heartless for sending a matter to collection that might end up costing $1,000 or more for processes to collect when the debt is only $400. However, turning its head the other way is not really a viable option for a homeowner association Board of Directors that is attempting to diligently pursue its duty.
Furthermore, Boards of Directors also have to know that the law does not entitle them to collect fines the same as it would entitle them to collect assessments. Civil Code Section 1367, as amended effective January 1, 1999, actually prohibits homeowner associations from collecting fines through the non-judicial foreclosure process which requires a lien. Homeowner association Boards, if provided in the governing documents, may lien and pursue non-judicial foreclosure for collection of assessments that relate to maintenance cost items of the Association, if the governing documents specifically authorize same. That is just another technicality on top of many technicalities.
COMMANDMENT VIII: THOU SHALL NOT FORECLOSE AND SKIM RENT.
Believe it or not, there is a statute in California (not in the Davis-Stirling Act) that would also punish Boards of Directors for taking a unit back at foreclosure (for the debt due in assessments and collections costs), and then skimming the rents, without paying senior encumbrances or deeds of trust. (Civil Code Section 890 et seq.) That statute puts an association at risk who in the first year after assuming title to a unit (because no one purchased it at the foreclosure sale) collects rents from the tenant, uses the money for back assessments or maintenance purposes, and does not pay the first mortgage that is senior to the Associations lien. So, when you look at this big picture and the potential penalties for skimming rents, you can see why an Association would not have much incentive to foreclose a persons property. In addition to the rent skimming prohibition, Boards of Directors also can have a very difficult time selling properties that have been foreclosed, especially if The loan is upside-down, because anyone who purchases takes subject to the first mortgage or any liens or encumbrances that are senior to the Associations. In addition, title companies as a general rule are quite skeptical of non-judicial foreclosure procedures by homeowner associations. Many have expressed that they do not want to depend upon an analysis of the rights of non-judicial foreclosure, so in many instances, Boards of Directors have to wait six months after the foreclosure sale to give owners a chance to take whatever action might be available to them in regard to the foreclosure sale, and then institute a quiet title action in Superior Court to gain legal title to the property so that it will then be insurable by the title insurance company. Hence, those who believe that Boards of Directors are chomping at the bit to sell properties that are subject to delinquencies are just off base. If a property does go all the way to foreclosure, and there is considerable equity in the property, most homeowners are ultimately able to get help from someone prior to actual sale, through a loan or family assistance, or are able to work out a payment plan (if they are willing to make payments, as opposed to just taking the position believing that the Board has no power) which is a misconception. If a Board does take a property to a foreclosure sale and there is equity, chances are it will sell at the foreclosure sale and the Association will get its money. People who believe that Associations generally make huge profits by foreclosing on delinquent properties is simply misguided. In addition to all of the above, some foreclosures end up in litigation because the association, when it attempts to evict the person who thinks is still the owner, gets in to a big legal dispute. No, those who believe that Boards of Directors are anxious to foreclose are just wrong, as a rule. Certainly, the horror stories hit the news, and abuse of power can happen in any given situation where one party has more than the other, but even many of the news stories relating to what are perceived and presented as misguided and horrendous foreclosure situations simply leave out many of the facts, namely that the homeowner refused to pay assessments for one reason or another or refused to even make an attempt to work on the assessment account by making payments.
COMMANDMENT IX: THOU SHALL NOT APPLY MONEY COLLECTION FROM OWNERS TO OLDEST BALANCE DUE, UNLESS THAT BALANCE IS FOR ASSESSMENTS ONLY.
Another way that Boards of Directors can be hamstrung is a change in the collection procedures and lien and foreclosure laws that took place as of January 1, 1999, which prevents homeowner associations from treating assessment accounts in the fifo accounting method. stands for first in - first out. Associations would generally like to apply all moneys paid by homeowners to the oldest balance due, like credit card companies do, especially when that balance includes assessments, late fees, interest, collection costs, attorneys fees, or fines. Boards see the as a way to make sure that homeowners dont simply pay the monthly assessment account, and forego paying late fees, interest, collection costs, attorneys fees, and fines. But, Boards run afoul of Civil Code Section 1367 when they take assessment moneys paid by owners and apply it to the oldest balance due, unless that balance is for assessments. Civil Code Section 1367 says that Boards must apply assessment payments to assessments before they apply it to any other costs. Sometimes this leaves the Board in a position of having to consider foreclosure for late fees, interest, collection costs, attorneys fees, or fines. News reporters often have a heyday" with that, making it sound outrageous.
COMMANDMENT X: THOU SHALL KNOW ALL OF THE ABOVE.
To recap, Boards are expected to collect just enough assessments to cover all expenses in a world where everything goes up in cost, often unexpectedly. If the Board does not pursue collection of assessments diligently, it can be sued by paying owners. If it collects too much assessment money and does not properly handle the overage, it can subject the association to payment of taxes. If it wants to foreclose to collect assessments, it has to engage in a myriad of technical requirements. If it retrieves a property for assessments, it can run into problems collecting rents and using the money to make up the shortfall. It may have difficulty selling the property to recover money because of title insurance issues. If it sues or forecloses for what outsiders consider petty amounts, it is subject to bad press. If it sits on its fingers, it loses rightis to collect at all.
If a Board of Directors violates any of the above Commandments, the Board can be found in breach of its fiduciary duty, and expose the Association and itself to legal action, damages, or injunctive relief. For a volunteer Board Member who does not have time to attend the 100 seminars needed to teach all of the above, it is a hefty burden to carry, and additional tinkering by the legislature or the courts can further undermine the authority to collect assessments. It poses a threat to common interest development living in California. Municipalities and local governments are very happy to transfer the responsibility for infrastructure and other generally provided services to the homeowner associations. Most everyone is concerned about affordable living; and yet the technical burdens and requirements for homeowner association Boards of Directors dictate a need for more and more professional help, which of course, costs the Association money. If there is to be any legislative tinkering with assessment collection practices, hopefully it will be a thoughtful, reasoned, and educated process that does not undermine every associations ability to survive and thrive. Legislators – heed this call. Dont hobble the Associations unnecessarily based on emotional testimony! Everyone, watch the process and pay attention to the fact that there are two sides to every issue!
As for Boards of Directors, it cannot be stressed enough that you need professional help to engage in homeowner assessment collections, and help is available, even on a no-cost basis (where costs of collection are charged directly to homeowners without up-front costs to the association).
Article by Beth A. Grimm, Bay Area Attorney, practicing exclusively in the area of homeowner association law, member of the ECHO Legal Panel and Chair of the East Bay Resource Panel, Statewide Public Relations Chair of CLAC (California Legislative Action Committee – Community Associations Institute), and frequent contributing author, as well as author of two books and a newsletter addressing homeowner association issues – and host of http//www.californiacondoguru.com – a site of more helpful articles.
By Beth A. Grimm, Attorney. A "service oriented" attorney and member of ECHO and CAI and various other industry organizations in California and nationally, host of the website www.californiacondoguru.com; two Blogs: California Condominium & HOA Law Blog, and Condolawguru.com Blog, and author of many helpful community association publications which can be found in the webstore on her site.