HOW COULD THIS HAPPEN? -
WHAT CAUSES THE NEED FOR A HUGE
By Beth Grimm, Attorney
his article is about a serious set of problems that can develop with regard to any common interest development if a Board is "asleep at the wheel". I and other attorneys who practice common interest development law and professionals in the construction industry have been putting our heads together to try and find ways to help associations avoid crises such as those described on the following pages. Many of us are seeing more and more situations where homeowner associations are ending up finding that their buildings have not been maintained properly, that there are water penetration issues, and that homeowners are faced with increasingly large assessments, ranging from $1,000 to $70,000 or more per home. How does this happen?
We seem to see it most prevalently in associations that are either self-managed, or that have had managers who are not trained to help identify problems and point the board members to the right kind of experts. However, the problem is not always with the manager, or because of a lack of trained management. Sometimes the problem rests with a board that is adamant about keeping assessments low, in other words, penny pinching. I wrote an article about this a year ago about penny pinching that appeared in the ECHO JOURNAL and was widely circulated. It is available on my website at http://www.californiacondoguru.com. Sometimes the problem is related to penny pinching. Other times, the problem grows blindly like black mold behind a wall. Many times, this occurs because a Board ignores the warning signs. Who wants to open the door to a nasty can of worms when serving as a volunteer?
These kinds of situations seem to arise from failure to adequately maintain buildings and components, and failure to identify design or other problems that cause hidden damage, as opposed to some Act of God. What I find in many situations, after an investigation of the records and discussions with past board members, is that the signs were there, but they were ignored or overlooked, or handled improperly or inadequately. It is not only beneficial, but also critical, to consult the right kind of experts when the board is exposed to signs of a problem. These are problems that commonly occur:
1. Poor design in original construction - an association needs a design specialist to overcome poor design.
2. Complicated, integrated systems that result in many joints (i.e., more possible areas of water penetration) - an association needs a design specialist to overcome poor design.
3. Systems combining various materials that may or may not interact well (which can cause materials top fail) - again, when there is a problem (like a pesky or persistent leak?) the association needs the right kind of expert to identify the right kind of repair or "fix" for the complicated systems involved in common, connected housing.
4. Poor maintenance habits - like use of a "handyman" to fix things like water spots on the ceiling or water leaks that should at least be investigated by someone who knows how to protect an area from water penetration, and can recognize the "signs" of a potentially bigger problem.
5. A lack of meaningful inspections of property - what is often required is more invasive than a simple "visual" review and/or unsubstantiated reliance upon what any given board member or manager "surmises" is the condition of the buildings.
6. A lack of understanding of the importance of a good reserve study, concocted from a meaningful inspection of the components and assessment of their current condition, and acceptance of the "bad news" that often comes with the proposed funding plan generally (if not literally - on the Association's "Balance Sheet") constituting an "obligation", of the association.
BACK TO THE BEGINNING
Self managed associations, especially the smaller ones, tend to be run by volunteers who have neither the time nor the money to attend CID (Common Interest Development) seminars on a regular basis. Most of the smaller communities work just fine for 10 to 15 years after inception, but the problems crop up at the 15 to 30 year mark, when deterioration and problems tend to start with the buildings. The same can happen in larger associations. When the problems start, the backlash is often quite political, because the board finds out it has to ask neighbors for large sums of money to make repairs. The apathetic owners who have been paying assessments for years, and assuming that this "care-free" living thing is not so bad, come out of the woodwork. Some suggest they (or someone they know) can do the work a lot cheaper, whether or not they have the proper qualifications. Many (often including some or all of the board members) bristle at the thought that a good portion of the money required might go to the architect or construction manager who is willing to bid to oversee the project. Lawyers come in and advise use of professionals like these architects and construction management firms, and more and more money is needed. The owners receive frightening disclosures (or more frightening - no information at all until the big "hit" piece), and it just becomes chaotic. How do you avoid that?
WHY IS ALL THIS HAPPENING IN COMMON INTEREST DEVELOPMENTS, ARE CONSTRUCTION DEFECTS THE CAUSE?
Everyone wants to blame problems on something or someone. CIDs have unique problems. That's a fact. Steve Saarman, a construction expert in the field, described some of those unique problems quite aptly at a recent seminar. He simply said there is "so much room for failure in completed design of condominiums." This, he went on to explain, is because of the complicated nature of integration of systems. He described the difference between older style of architecture, which included longer eaves, rough intersections, less penetrations in the roofs, gutters without corners, and less chance of failure of systems - as compared to more modern architecture in common interest developments which often includes the following:
1. Shorter eaves.
2. Deck systems doubling as roofs for the units below.
3. Combination of materials used together to complete complicated corners and joints.
4. Need for more flashings because of the exposed corners and difficult areas.
5. Continuing integration of new materials designed to deal with a complicated nature of combined materials and more areas of possible water penetration, which materials often fail (in other words, use of untested materials over a long period of time).
6. Use of materials that prove not to work on the long term.
7. Quick (profit-driven) and unsupervised construction.
8. Failure of associations (boards and managers) to solidify and protect systems by keeping good records as to what is needed, what was done, what materials were used, drawings and specifications, etc., and failure to pass those onto subsequent boards.
9. Failure to execute repairs with attention to detail (hence, using the right kinds of experts to identify what is needed).
10. Failure in many cases of adequate warranties and competent construction, due to lack of supervision.
These things can be corrected. If association boards were more consistent, or transition of managers was more consistent; and records were kept of maintenance (present and past), emergency repairs, and major rehabilitation projects, warranties, etc., people coming on to the board after others have served would at least be able to know what happened, and at least be able to target the right parties if there are inadequacies in the construction and work that was done. They might even be able to identify the problems resulting from inadequate use of materials.
According to Mr. Saarman, generally the time when associations should start to take a very close look at the components are as follows:
Roofs - 20 to 25 years of age
Siding - 15 years
Windows - 20 years
Landscape - 20 years
This is likely to be the time when problems start with these components, if they have not already shown signs of wear and tear or serious failure in earlier years. Foundations should last the life of the building unless they are on impacted soil.
The Legislature has tried to improve matters by adding layers and layers of requirements relating to reserve studies, since the Davis-Stirling Act at Civil Code Section 1351 was enacted several years ago. Fairly recently, a requirement was added that associations must "cause" a diligent visual inspection of the buildings to be done. However, a visual inspection often overlooks problems that could otherwise be identified through destructive or more invasive testing. If an association fails to investigate further when signs of water leaks are identified in ceilings, trouble opening and closing doors is reported, leaks in windows are detected, cracks are noticed in the stucco, etc., it may end up facing a very large rehabilitation project and the magnitude of assessment described herein.
And there is the "poor choice of contractor" problem, like using a "handyman" to fix problems. Decks are common sources of serious problems. Leaky sliders that cause water intrusion into decks and units below are common source of problems. According to Mr. Saarman, caulk seems to be the "weapon of choice" of "handymen", and overuse of caulking compound often fails to create a long-lasting fix; in fact, it often complicates matters. A good example is a real-life scenario given where a handyman filled "weep-holes" in a deck that appeared to be leaking - to stop the water from running out of it on to the neighbor's patio below. The end result was that filling the weep-holes, which were designed to relieve the deck of standing water, forced the water to back up into the building, damaging the structure itself. Not only that, it "hid the problem" for years, and by the time those areas were opened, the damage was well beyond a simple repair.
To avoid this kind of situation, the association needs good guidance, either from the board (hopefully members can attend seminars on a regular basis, ask questions, listen carefully, and learn) or management (which hopefully is trained to identify problems, reach for the refer the right kind of experts for the right kind of work, and keep on top of potential problems) or the right kind of experts who can identify and overcome these problems.
WHAT DOES AN ASSOCIATION DO WHEN IT IS FACING A SERIOUS REHABILITATION SITUATION?
Many do the wrong thing. In any situation where an association is facing major reconstruction or rehabilitation, it will have to arrange (since costs are so difficult to estimate without the destructive testing) for more invasive testing or prototype repairs (such as taking one building, making the repairs, and then being better able to estimate the overall cost of the project). Experienced people should be consulted. Often, the board either engages people who do not have experience (to save money), like members of the association who may be contractors, and the problem is not fixed properly, or the board uses contractors who are married or related to someone in the association or on the board, but do not have the expertise with integrated buildings. The tendency seems to be to find a quick fix for the "symptom", not the cause. The board often simply decides to collect an assessment in the range of $1,000 to $5,000 from each member to "fix" the perceived problem. Then, 5 to 7 years later, the problem is "rediscovered," and is worse. This time, the board has to go back to the members for a $15,000 to $50,000 assessment not only to correct the work that was done before, but to correct the design problems that were not corrected in the prior construction project. By now, the problem is exacerbated, sometimes to a dangerous level, homeowners are up in arms, crazy with anger, and the word "recall" is bandied about. Those who purchased in the last 5 years are out to make someone pay (most likely target: the association/board). This is why it becomes chaotic. I see this time and again. In many associations, the size of the proposed and necessary assessments now have threatened the stability of the investment and may force people out of their homes. Owners are so crazed with anger, grief, fear, and that makes it very difficult to move forward.
Don't go there. In any association that does not have professional management, good maintenance records, and plans in process for ongoing checks and balances, that is the first goal. Make sure the right kind of analysis is done in conjunction with the reserve study. Ask about the methods for analyzing the condition of the properties. Work hard to fund the reserves adequately. Keep the owners in the loop about the financial health of the association. They are the body that is responsible for the funding and the shortfalls.
If "bad" things do happen and a problem as described or contemplated by this article happens in your association, get pragmatic and act responsibly. Assemble a "team" to move the project forward, usually including a manager or consultant or board liaison, a knowledgeable architect or contracting consultant, possibly a lender representative if the numbers dictate the necessity of outside funding, and a legal consultant. One common thread of responsibility for boards of directors in homeowner associations is to "protect and preserve" and sometimes (depending on the wording in the Association documents, "enhance" property values. Allowing deterioration of the buildings and improvements does not accomplish that goal. Failure to do so leads to breach of fiduciary duty claims, lawsuits, more expenses for the associations, more complication in the "fix-it" stages, and more grief for the owners and the board members.
In associations that are self-managed, small, can't afford management, and have a hard time getting and being able to pay for professional services, there is a "fallback" possibility. I usually see a lot of frustration on the part of the board. They are simply volunteers, unable to cope with hammering their neighbors for large amounts of money, the collection problems, dealing with the disruptions and the political pressure. Some good advice for those boards that plan to resign, and cannot fill the board positions, as their last act before resignation (which they always threaten to do) is, at the very least, to apply to the appropriate court to have a receiver appointed. I am not necessarily in favor of having a receiver control operations in an association, but it is one way to give someone else the power and responsibility to bring the buildings back into compliance. I always caution that receivers have a lot of power, which is backed by the courts, and don't have a problem imposing assessments and engaging in heavy handed collections, so it is not the best way to handle things, but likewise, it is not necessarily the worst either.
WHAT IS THE ULTIMATE REMEDY?
Associations need money to make major repairs. The first place to look is reserves (since components are often involved, and any "fat" in operating budgets). These may not be the ultimate choice for many reasons that Associations should discuss with legal counsel. Draining reserves to pay for repair of components that are not indicated for current repairs can threaten the marketability of the units, and cause other problems. Emergency assessments can be made without homeowner approval under certain circumstances that should be discussed with legal counsel. Boards are often forced to look beyond current assets for some source of money to avoid asking members for large sums of money at one time. Forcing owners into foreclosure is certainly not desirable. Volunteers do not need major collection problems adding another issue to the mix, and owners who can pay do not want to end up paying for those who cannot come up with a large sum of money. In these cases, associations often have an avenue in the form of commercial loans. There are several banks that will supply commercial loans, under the right circumstances. The first thing to keep in mind is that, however, the bank will not loan money in large amounts to an association that is a "bad risk."
WHAT DO LENDERS LOOK FOR?
At a recent seminar, Christine Lucas outlined the requirements for Union Bank, which are common to First Bank and others that are in the homeowner association lending business. Her suggestions included the following:
1. Communications: The associations need to get the lender involved early in the process when the possibility of a sizeable loan is being considered. There is much clean-up to be done, and special circumstances need to be identified. Obstacles need to be addressed early on, or money can be held up at the last minute, when it is needed to enable the board to sign a contract. The lenders have "checklists" that they are happy to provide to boards who are considering a loan.
2. Items That A Lender Requires And Looks At:
(1) Year End Financials: The lender looks for consistency in the year in financials. If there is inconsistency, it is important to explain. Perhaps there is an unusual situation that occurred in the past few years that can be explained, that was handled properly.
(2) The lender looks to see that the budget is on track, that there is a reserve study, and that there is effort to fund the reserve study (not necessarily to a 100%, but in healthy doses).
(3) The lender wants to know that the reserve study is in compliance with the law. The absence of a recent or recently updated reserve study, is a red flag to a lender, because it is the first indication that the association is not in compliance with the law.
(4) The lender wants to make sure that the association can meet other obligations during the life of the loan. The loan terms generally range from 1 year to 7 years, but can sometimes be extended to 10 years, and an association that can show good record keeping, ability to meet financial obligations, and financial stability. Lenders don't want to think that extra costs are going to come up during the loan, additional special assessments, or other items that will strap the association or the homeowners and present them from being able to repay the loan.
(5) The lender may ask for an update of the reserve study if it is two years old, done by the reserve study preparer, as opposed to the board.
(6) The lender will look at the delinquency report. Generally, if an association has more than 10% of the lots or units in delinquencies, that is a red flag and may prevent the association from being able to get a loan. If more than 10% of the homeowners are already in delinquency, it is anticipated they will have difficulty repaying the special assessment, which means that the other owners will have to make up the difference, and that is not good. Some associations may have a fairly large number of people that are 30 days overdue, because of various economic problems, but that not having been a chronic problem. If that can be explained, it may get the association over the hump with regard to the "10% rule."
(7) Lenders want to see proactive management, educated leaders, and that sort of thing.
(8) The lender wants to see that the governing documents are clear, that they see the association, and that the association is in compliance with the governing documents. Governing documents fairly often require that a vote of the membership be obtained for loan that requires some kind of security on assets or attachment to a lien. They common prohibit boards from entering into contracts of more than one year in length without a vote of the membership. They common require a vote of at least a majority of the membership to approve expenditures for capital improvements that exceed 5% of the budgeted gross expenses. All documents have to be considered, including the Articles of Incorporation, Bylaws, and CC&Rs;. A loan contract is more than one year in duration, so this is important.
3. Red Flags:
(1) A special assessment needing to be assessed to repay the loan that is over 20% of the value of the home.
(2) Insufficient reserves to repay a loan based upon reserve allocations.
(3) Not providing all items or satisfying all items in the checklist.
(4) Failure to obtain attorney certification letter (which specifies that the association is in compliance with the governing documents in California Law, that the requisite membership vote has been obtained, that the boards resolution for the special assessment has been approved, etc.).
(5) Special circumstances: Litigation - this often creates a problem because the duration of the litigation cannot readily be anticipated. á Co-ops with share holder and ownership involvement - loans often take longer to get through the processes. Size of association - associations under 20 units have various other difficulties, including (commonly) lack of professional management. Lenders may require that an association have professional management before they will loan to a small association. The bank does not want to have to oversee the loan, manage delinquencies, take care to prohibit mis-spending of money loaned, and collect from people moving out who do not pay the assessment.
The discussions in this article are just the tip of the iceberg of information that a Board needs in case the described series of events happens. Additional assistance may be needed with deciding whether "emergency assessments" under California law (Civil Code Section 1366(b)) are warranted; how to present information to the owners related to approval of a loan or assessment increase that exceeds the limits a board can impose without a vote of the membership; how to manage the construction issues that arise; how to deal with insurance questions; how to address the owners regarding move out costs, necessary unit entries; how to manage the political issues that will likely arise (threats of recall, disruption at board and owner meetings, and rumors, open criticism of processes, etc.); and last but not least, critical disclosure issues. These things are well beyond the scope of expertise of most volunteer board members.
Article by Beth A. Grimm, Bay Area Attorney, practicing exclusively in the area of homeowner association law, Statewide Public Relations Chair of CAI-CLAC (California Legislative Action Committee - Community Associations Institute), Chair of the East Bay Resource Panel of ECHO, and frequent contributing author to many industry publications, as well as author of two books and a newsletter addressing homeowner association issues - and host of other items. Check her the website http//www.californiacondoguru.com for 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.