What to do when you can’t avoid it!
By: Roy Helsing
Most Boards of Directors understand that reserve funds are “reserved” for the maintenance, restoration, repair and replacement of the common area components. They can also be used to pay for legal fees related to construction defect litigation. Using them for any other reason is simply in violation of the Civil Code.
But sometimes, the association can be in a position where it is temporarily out of money. That can be because of either:
– Unexpected circumstances. Examples might be a lawsuit against the association resulting in unexpected legal fees, or a surprise increase in utility rates, or any other unanticipated expenditure that affects cash flow to the point where bills can’t be paid from the operating account.
– Poor planning. Yes, some associations do kid themselves that it is their job to not increase assessments, in spite of evidence that costs have gone up.
– Seasonal variations. Perhaps the annual insurance premium is due in the second month, so only 1/12 of it has been collected for the year, or the association is on a mid-calendar fiscal year and there are huge water costs in July and August – but they will not be expected to be that high for the entire year.
In the first two instances, the Board has a positive duty to take actions to raise the revenue. This can accomplished by raising assessments, or by special assessments, or perhaps through a bank loan. In the third case, the solution is pretty obvious – the money will be there by the end of the year, but simply is not available at the moment.
No matter what the reason, the immediate problem is that the association is out of money in the operating account and must still pay the bills. Actions such as allowing the utilities to be turned off, or ceasing to maintain the common area, are simply not viable (and most likely a breach of the Board’s fiduciary duty).
Fortunately, Civil Code Section 5515 allows the Board to make a temporary transfer of Reserve Funds to meet short-term cash flow requirements. Please note the emphasis on “short-term” – this is not a long-term solution as you will see, because removing money from the reserve fund means that money is not available for the future projects for which it was intended. However, before you borrow certain requirements must be met.
First, you must provide notice to the membership of your intent to consider transferring (borrowing) in a duly noticed open Board meeting. Said differently, you need to provide at least four days’ notice of a meeting of the Board and on the agenda you need to indicate that you are going to “consider” this transfer. That notice must contain the reason you need to do this, the repayment options available, and whether or not the Board may be considering a special assessment. (A special note of caution: reserve money is reserve money from the time the homeowner pays their assessments. The fact that it has not yet been deposited in the reserve account does not mean that portion of the assessment is not “reserve” money so it can be spent for something else. Failing to make the budgeted reserve contributions because that money was used for something else is a borrowing from the fund.)
Second, if at the meeting the Board authorizes the transfer it must issue a written finding that explains the reason the transfer is needed, and describing when and how the moneys will be repaid to the reserve fund. This finding must be published in the minutes of the meeting. Clearly, the intent here is to make sure the borrowing is only “temporary”, that the membership knows of the borrowing, and that there is a plan to pay the money back.
The law is very clear that the temporarily transferred funds shall be restored to the reserve fund within one year of the date of the borrowing. It does provide that if it becomes impossible to repay the fund in one year, the association has another option. Again, it must first notify the membership in the agenda of a properly announced open meeting that it is going to consider this difficulty in the meeting. In the meeting it can make a finding that another “temporary delay” would be in the best interest of the association provided that finding is supported by documentation. Note, however, that it is again only “temporarily” delaying the restoration – the Board cannot simply decide that it is not going to restore the funds.
If you have a situation where you need to temporarily transfer money from the reserve fund, make sure the steps required for notice and findings are followed. If you honestly do not feel you are going to be able to restore the funds in one year, you should talk to legal counsel concerning your options. A temporary borrowing is fine if done properly for small amounts. If, however, you significantly under-budgeted, or you have a significant unplanned event the solution is most likely NOT to make a temporary borrowing from the reserve (including not making your monthly deposit to the reserves). Trying to hide significant economic issues by using reserve money is typically the start down a very dangerous path with no good outcome.
The Helsing Group, Inc.
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