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Determining Size of Assessments for
Common Interest Developments
What Are The Legal Requirements? Is there a Model?

By Beth A. Grimm, Esq.

Budgeting, allocating assessments, noticing the members, collecting assessments.... it is all getting very complicated for homeowner association boards of directors. Costs are rising, the economy is tightening up, and the "squeeze" is on. Expect the fallout.

The board of directors of a homeowners association has a considerable task in estimating the budget for a homeowner's association. You may recall an earlier article written by me entitled "The Ten Commandments of Assessment Collection." that was published in the ECHO Journal years ago (and that is now available on my website at www.californiacondoguru.com. That article explained the nature of "zero-based" budgeting (as required for homeowner associations) in more detail. Suffice it to say that this method of budgeting more or less expects the amount collected to equal anticipated expenses.

There is little room for unanticipated expenses in the regular assessment stream. Providing for substantial contingency funds in the budget carries at least two negative aspects:
(1) it makes the IRS suspect and threatens the association with the possibility of an      unsuccessful defense in an IRS audit; and
(2) it makes the members suspect in wondering why a big surplus is needed.

On the other hand, recent history in California (the past 5-6 years) has shown that unanticipated increases in necessary services and utilities (like insurance costs, PG&E costs, and water costs) are becoming more the norm than the exception. In 2002, after the Northridge quake, insurance costs for many associations went up 50 to 500 percent, often providing less coverage than prior policies. Then again, in 2005 the property coverages doubled, tripled and quadrupled. Last year, utilities costs again skyrocketed because of oil and propane costs. And last year as well, Hurricane Katrina caused a shortage of, and therefore a surge in costs of, building materials.

And currently, HOAs in California are experiencing severe problems with earthquake insurance coverage again. If they can get it, it's extremely cost prohibitive. These unanticipated expenses consistently derail the budget process for associations and trigger increasing complaints from the membership’Äîpeople who are facing increased costs of living themselves and an economic downturn in this state.

But the budgeting process has to be done! It is guided by the governing documents for the association [Articles of Incorporation, bylaws, and Covenants, Conditions and Restrictions (CC&Rs) and Civil Code Sections (and subsections of) 1365, 1365.2.5 and 1366]. Civil Code Section 1367 and 1367.1 deal with collection of delinquent accounts.

Some people think that the Department of Real Estate (DRE) regulates costs of associations. While it does publish suggested budgetary amounts that are commonly used by developers, those figures do not necessarily provide realistic guidance for a mature association. When a common interest development is "born", the developer often formulates a budget relying on DRE estimated costs. The developer's firsthand interest is to satisfy the DRE requirements and get the initial governing documents, budgets and plan approved. However, my experience, shared by many practitioners that provide services to mature associations, is that the developer budgets for a new association are often low, such that the Boards often have to raise the assessments after all of the units are sold and the developer is out of the picture. There are many reasons for this situation. Sometimes the developer did not include all of the components that were ultimately constructed in the budget or reserve study; sometimes, a developer who runs into extra expenses to maintain the properties in a first class, presentable condition, pays these costs out of his or her own pocket to keep the assessments from going up for purposes of marketability. The assessments do factor into the loan commitments and a high assessment can be a deterrent to sales. There can be a number of reasons, but developer budgets are often "low balled."

For mature associations, the governing documents and the series of Civil Code Sections 1365 and 1366 are the regulations that guide the budgeting and assessment processes. One would look to the obligations of the association under the governing documents, which should outline the expense items for operating (like water, sewage, garbage, electrical, gas, telephone, and other necessary utility service for common areas), maintenance obligations (like common area maintenance, painting, roofs, etc., as set forth in the CC&Rs), and contribution to the reserves (fences, siding, roof replacement, retaining walls, etc., as specified in the documents to be an association obligation).

The limitations that exist under California law, which are also often included in the governing documents, are the following (paraphrased Civil Code Section 1366(b)):

Annual/Regular Assessments. Under California law, and as reasonably required by need, the Board of Directors may for any fiscal year increase the annual regular assessments up to statutory maximum of twenty percent (20 percent) without a vote of the membership. For any increase exceeding twenty percent (20 percent), the Board must obtain the approval of a majority of a quorum ((the "quorum" being more than half of the Members) of the Members at a duly convened meeting or by written ballot where a majority responds. In an emergency situation as defined by Civil Code section 1366, these limits do not apply.

Special Assessments. Under California law, and as reasonably required by need, the Board of Directors may for any fiscal year impose special assessments for capital improvements or other necessary expenditures which in the aggregate do not exceed five percent (5 percent) of the budgeted gross expenses for that fiscal year. For any special assessment that exceeds five percent (5 percent), the Board must obtain the approval of a majority of a quorum (the "quorum" being more than half of the Members) of the Members at a duly convened meeting or by written ballot where a majority responds, except in an emergency situation as defined by Civil Code section 1366 where these limits do not apply.

Civil Code Section 1365 requires a board to distribute to the membership annually the "pro forma budget" for the coming year not less than 30 not more than 90 days before the beginning of each fiscal year. The pro forma operating budget includes the estimated revenue and expenses on an accrual basis, and the summary of the association's reserves based upon the most recent study. Civil Code Section 1365.5 requires the Board of Directors to get this reserve study done every three years, and review it every year to make adjustments as needed, and annually, a disclosure worksheet is required to be provided also. The worksheet projects the actual needs and funding plan including how the Board plans to raise the money for necessary expenses if the reserves are not fully funded (which is a common association problem). A diligent visual inspection of the components that the association is responsible to maintain must be done at the very least each time the reserve study is done, but it seems that having a visual inspection done every year would likely disclose problems before they are exacerbated by weather and the elements.

The operating expenses generally include management fees (if there is a paid manager), projected legal fees, and other administrative costs. In the past few years, the law has become so technically complicated that compliance costs have risen considerably. Associations need more help from professionals. The Boards cannot figure out all of the requirements on their own. As a guide though, at least as to maintenance, insurance, and reserve responsibilities, the CC&Rs usually specify the obligations of the association. Some are more clear than others. In the case of a condominium project (where all of the owners own the common area as tenants in common), more is required of the association than for a single family detached home development.

The amount of money that is to be put into the reserves depends upon the component list and plans for replacement, and the funding plan component of the current reserve study. Emergency assessments may be imposed for some expenses that could not be foreseen and therefore were not included in the budget process (mainly related to conditions with the buildings and property that could create a real hazard if not repaired soon). Certain findings are required in some instances. Associations should seek legal advice before assuming that an emergency assessment may be appropriate for any given situation. There are specific expenses contemplated for this treatment in Civil Code Section 1366(c), to the exclusion of costs not mentioned.

Once the board has determined all of the anticipated categories of expenses expected for the Association in any given year, it's task is then to estimate the costs for the coming year. Most boards rely on historical cost data for things like maintenance, management contracts, water and utilities. However, as we have all seen in the past few years, expenses for water, utilities, and insurance can increase drastically, without warning, based upon current "market" conditions. And many associations do not have adequate historic maintenance records such that costs and schedules are readily ascertainable. Many associations find that it is necessary to include an ever-increasing line item for legal expenses, where they may never had had to consult an attorney in the past. The Davis-Stirling Act (Civil Code Sections 1351 and following) is now so complicated that few associations can operate legally without the guidance of professional management and/or knowledgeable legal counsel.

Once the board of directors has the operating budget and the reserve information together, it needs to distribute a proposed budget to the owners not less than 30 nor more than 90 days before the beginning of the fiscal year. This process is almost ongoing although there is usually a "breather" for boards of associations operating on a calendar year basis in December. A board has to start early, by late summer or early fall, to get a meaningful package together. There are ramifications to "dilly-dally-behavior" because if the required information is not delivered with that time period, or if the budget package does not fully satisfy the requirements in Civil Code 1365 and 1365.5, then the association is prohibited from increasing the assessments for the coming year, unless the members approve the increase (it takes a majority of a quorum under Civil Code Section 1366). Sometimes, again, the emergency assessment requirements may help overcome this oversight but it is not a good idea to rely on it if the expenses were in the budget but for some other reason the Board did not get it out on time.

If a board complies with the budgetary disclosure requirements and distributes the budget, it can raise regular assessments up to 20 percent per year and/or impose a special assessment of up to 5 percent of the budgeted gross expenses for the fiscal year without a vote of the membership. The governing documents may state other requirements but I believe the language of the Davis Stirling Act controls with regard to assessment increases.

The board determines the assessment amount to be assessed to each owner by dividing the anticipated expenses among the units, per the allocation specified in the CC&Rs. The board does not have the option to charge one unit more than another, except when the assessment allocation in the governing documents is based on criteria other than an equal basis. In the some cases, the original CC&Rs set up a pro rata scheme and that is carried over to the updated CC&Rs, based on ownership interests. In others, there may be a pro rata scheme based on square footage (which sometimes proves to be incorrectly stated). In some associations, there are equal assessments for things like management and administrative costs, and other allocations for maintenance and insurance costs (often based on square footage). In some documents, some owners pay for certain amenities while others don't. The documents dictate the allocation. Neither California law nor the DRE has any control over that. Boards need to pay attention to the documentary assessment allocation; sometimes it is complicated but that is still no excuse to adopt unilaterally a simple method of equal allocation. As for the owners, most CC&Rs specify that no owner may avoid paying assessments because they do not use the recreational or other facilities. The CID model contemplates sharing of both the benefits and the burdens.

To recap, each assessment is to be imposed based on the budgeted expenses for the association, and on need as it arises. The members can approve any regular or special assessment as specified in the Civil Code that exceeds the legal limit imposed on the Board (by a majority of a quorum vote, noting that a quorum is defined therein as "more than half" of the owners).

There is no existing model or budget that works for every association, but there is a process that should be well-constituted (good planning processes) and documented in the association records. Obviously, the budget is just an estimate of expenses for the coming year and does not reflect actual expenses. At the end of each fiscal year, the board is required to distribute information relating to the actual income and expenses. Each year the budget is based on past history plus current knowledge about expenses. Sometimes events outside the Board's control completely derail the budget. Boards still have to cope with the requirement in Civil Code Section 1366 that says:

"Except as provided in this section, the Association shall levy regular and special assessments sufficient to perform its obligations under the governing documents and this title." [No matter how loud the owners scream or how sad their stories might be.]

The board cannot arbitrarily charge assessments according to what seems fair at the moment and should just not automatically increase them each year without providing or examining any backup documentation identifying the need for the increases. There needs to be a "process". When a pragmatic approach is taken, the questions about where all the money from the endless increases and special assessments is going can be answered with less stress involved. If Owners can see that the expenses are legitimate, they are less likely to complain.

Beth Grimm is a community association attorney in California. She is a member of the East Bay Resource Panel and the Legal Resource Panel and is author of various publications and books about condominium living and the law and a frequent contributor to the ECHO Journal.

© 2006, Beth Grimm, all rights reserved.

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.

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