Request for Consultation


Complaints are all too common in California about Boards borrowing from or using reserve funds for expenditures other than repairs or maintenance of components for which the funds are collected. No doubt, it is difficult making ends meet for HOAs. The expenses are rising, the members expect the dollars to stretch into appreciable services, and Boards are in many cases facing a double-edged sword. They want to keep the assessments down if they can, but are facing rising costs in many areas. Among those rising costs are insurance, utilities, administration and services. Compliance with ever increasing legislative requirements is also an ongoing concern.

At the same time, the laws are toughening up on reserve planning, borrowing and spending.

Borrowing from homeowner association reserve accounts is comparable in seriousness to borrowing from your children's education investment accounts or from your own retirement investment accounts. If you have specific monies set aside for these things in IRAs or other investment accounts, you know there are controls against taking money out - very stringent controls - more stringent controls than on an association's reserve accounts. You just should not do it unless: (1) it's absolutely necessary, (2) you follow the legal requirements, and (3) you have a plan to pay it back. If you continue to borrow without regard to these factors, it will likely catch up with you and your family. If a Board of Directors continually relies on the reserves as a "back up bank", it will likely catch up with the members.

If a Board is facing double or triple insurance premiums, which has been a common occurrence in recent years, without sufficient warning to allow for prudent budgeting, the money has to come from somewhere. Some boards deal with this by imposing an emergency assessment (not ruling on the legality here, just saying it happens). Others borrow from the reserves. Others respond by asking the owners asking to approve an assessment for the cost. Because of delays and special voting requirements taking effect July 1 of this year, balloting owners for approval of assessments has become quite a bit more difficult, time consuming and costly, so Boards may try to avoid this remedy for those matters they think they can define as an emergency.

The budget is a flexible tool, the Board's best "guestimate" of what the expenses will be for the coming year. It is based on past experience and future estimates of expenses. Contingency accounts are common. Sometimes there is enough flex in this"guestimate" to allow for unexpected increases. However, "robbing-Peter-to-pay-Paul" is a syndrome that cannot continue from year to year. If a Board exercises this practice, the Board members can get into trouble both as owners (who have to pick up the monetary slack along with all the other owners) and as Board Members (who could have personal liability as fiduciaries). Intentional raiding of reserves could expose a Board Member to serious losses. Negligence is accidental and carelessness may be forgivable, but continuing these practices after noting the resulting problems can cause a Board Member to cross over into the realm of punitive remedies (meaning a judgment against you that punishes that conduct, and rewards a victim beyond actual losses), or to be without a paid defense (if intentional conduct like ignoring laws and prudent choices is proved).

The issue of reserve spending is a hot topic and its time to focus on that. For starters, it is important to know that there are legal restrictions in California on borrowing (found in Civil Code Section 1356/1365.5), such as:

"1365.5(c) (1) The Board of Directors shall not expend reserve funds for any other purpose than the repair, restoration, replacement and maintenance of major components which are the obligation of the association, or related litigation.

(2) However, the board may authorize the temporary transfer of moneys from a reserve fund to the association's general operating fund to meet short-term cash flow requirements or other expenses, if the board has provided notice of the intent to consider the transfer in a notice of meeting, which is specified in California Civil Code Section 1363.05. The notice shall include the reasons the transfer is needed, some of the options for repayment, and whether a special assessment may be considered. If the board authorizes the transfer, the board shall issue a written finding, recorded in the board's minutes, explaining the reasons that the transfer is needed, and describing when and how the moneys will be repaid to the reserve fund. The transferred funds shall be restored to the reserve fund within one year of the date of the initial transfer, except that the board may, after giving the same notice required for considering a transfer, and, upon making a finding supported by documentation that a temporary delay would be in the best interests of the common interest development, temporarily delay the restoration. The board shall exercise prudent fiscal management in maintaining the integrity of the reserve account, and shall, if necessary, levy a special assessment to recover the full amount of the expended funds within the time limits required by this section. This special assessment is subject to the limitation imposed by Section 1366. The board may, at its discretion, extend the date the payment on the special assessment is due. Any extension shall not prevent the board from pursuing any legal remedy to enforce the collection of an unpaid special assessment.

The intent of sections (1) and (2) is to establish legal limits on use of reserve monies and prevent borrowing unless the Board provides notice to the owners of the intent to borrow and discusses and takes action at an open meeting. Associations may borrow from the reserves to meet unanticipated operating shortfalls. (If the shortfall was anticipated, it should have been resolved in the budget process.) If reserve monies are used other than for the express statutory purposes (repair, restoration, etc. of major components that are the responsibility of the association to maintain) then these sections require accountability by the stated notices, discussion of the matter an open board meeting, the requirement of written findings to be reflected in the minutes and "documentation". The statute does not define "documentation" needed to delay restoration of funds beyond the one-year period. All I can say is that a court will want to see documentation if there is a challenge and it had better be there, and had better explain in understandable terms what happened.

Questions as to this statute arise as to what constitutes a legitimate borrowing including disagreements over the words "short-term cash-flow requirement", and to what extent may funds be used for additional, new, or added capital improvements (necessary or unnecessary). that are not in the reserve study.

Professionals sometimes disagree on the exact intent embodied in the "one-year" payback time which changed in 1995 from the previous "three-year" payback deadline. Questions arise as to the effect of borrowing from reserves on the "disclosures" required by Section 1365 and 1365.2.5. Associations contemplating borrowing from reserves should consult knowledgeable professionals. This is an area where legal claims may arise. Board members have a higher duty than the average member who bugs the Board with questions or serves on a finance committee. A fiduciary is a person that is in a position of trust with regard to responsibility for the assets of others. This person is subject to liability if that trust is breached or the person lets the assets diminish under his or her control.

The statute (Civil Code Section 1365.5) goes on to say:

(d) When the decision is made to use reserve funds or to temporarily transfer moneys from the reserve fund to pay for litigation, the association shall notify the members in the next available mailing to all members (pursuant to Corporations Code Section 5016 which includes newsletters, etc.) of the transfer of funds and of the availability of an accounting, which must also be prepared. This accounting must be done on at least a quarterly basis (unless the governing documents required a more stringent standard) and it must be made available for inspection by the members at the association office.

Many Boards fall short on the "pre-borrowing" requirement of notice to owners and in the preparation of an accounting. That is probably because they are unaware of the law. If Boards knew of the requirement, most would probably follow it. Most Boards do not try to break the law; they are simply ignorant of it. Often they find out after the fact that they have missed a step, and then the Owner(s) who pointed out the error sometimes want the borrowing rolled back. Fixing it is not the easiest thing in the world. If an expenditure was legitimate, and the Board borrowed from the reserves to pay a necessary expense, and an Owner points out the error, one option is to alternately seek a special assessment due and payable immediately from all Owners. That is not a very desirable alternative remedy and if often happens then that the owners prefer that the Board just move on with the business at hand.

Finding the money to operate an HOA in today's world is not easy. Boards are caught between owners who want to keep the assessments low, and owners who want sufficient money in the bank when it comes time for big expenses so that the Board does not have to borrow and impose assessments. Costs are ever rising for HOAs, just as they are for everyone else. In many cases, HOA owners still enjoy amenities they could not enjoy if they had to pay for them as individuals in a single family home. But the dollar isn't stretching like it used to. And of course, there are the cases where Boards that have access to money in the bank use it to fund a project that was not approved by owners, that was not in the budget, and that was not even discussed in open meetings before it was paid for or contracted out, precluding owners from having any knowledge or opportunity to object.

Perhaps you read the article published last year that I wrote about reserve allocation loans to fund repairs and capital improvements. It appears on the website. That can either be viewed as a disturbing trend or a way out for the many, many associations that did not save enough money to fund a major rehabilitation or reconstruction project. Good planning is of the utmost importance.

copyright 2006, Beth Grimm, all rights reserved

Beth A. Grimm is a Pleasant Hill-based attorney representing HOAs and homeowners in common interest developments. Check out website for more information on reserves and other common issues facing HOAs and for articles, classes, publications and other available resources.

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.