Understanding the Ramifications of a Homeowners Association’s “Loss of Corporate Status”

Most homeowners associations are corporations that are organized under the laws of the state in which the association is located.  A corporation is a distinct legal entity that the state laws allow for which includes shareholders (or members in the case of a homeowners association) who are the owners of the entity, a board of directors that manages the entity, and officers that are elected annually by the directors. Other types of legal entities that are not suitable for the operation of a homeowners association include limited liability companies, partnerships, limited partnerships and joint ventures.

A corporate entity is created by the filing of various documents, including the Articles of Incorporation, with a governmental agency within the state such as the Secretary of State. That agency imposes various requirements concerning the documents that must be filed upon formation of the corporation and at periodic intervals (typically annually) after the formation of the entity.  The proper formation of a corporation vests the entity with the power to exist and conduct business.

The technical requirements relative to the formation of a corporation are taken care of by the developer of the common interest development that is going to be operated by the homeowners association. During the developmental stage of the association, the developer controls the operations and is responsible for doing whatever is required to keep the corporate entity in good standing in accordance with the applicable state laws.  Following formation, the developer continues to control the association’s board of directors for a period of time.  During that period, the developer continues to take care of the preparation and filing of the documents that are required to be filed with the state in order to maintain the corporation’s legal status as a corporate entity and continue to legally operate as a corporation. When a certain percentage of properties that make up the association are sold by the developer, the responsibility for compliance with the state laws pertaining to corporate filings with the state’s governing agency shifts to the individuals that become the directors of the association as a result of the annual elections by the association members.  

Because the association’s directors are elected each year, the composition of the association’s board frequently changes and the responsibility for keeping up with all of the required filings  in order to maintain the proper corporate status is passed on from board to board. Unfortunately, through this process over a period of years, it is not uncommon for the successor directors to assume their roles of responsibility without knowledge or understanding of the annual filings with the agency that governs corporations within their state that are required in order to maintain the corporate status of the homeowners association.  As a result, the deadlines for filing required documents are missed and, because the documents that are required to maintain the corporation’s legal status as a corporation are not filed, the entity may lose its status as a corporation. The loss of corporate status triggers serious consequences to the association such as the suspension of the corporation’s power to continue to conduct business. If the issues that resulted in the suspension of powers are not corrected in a timely manner, the association could forfeit its status as a legal corporate entity.

During the period of suspension or loss of corporate status , the corporation is stripped of its corporate powers, rights and privileges. As a result, the corporation cannot continue to conduct business as usual such as entering into contracts, taking action to enforce its governing documents or to collect delinquent assessments, or to initiate or defend a lawsuit. In addition, contracts that are entered into may be voided by the other party to the contract and corporate privileges, such as protection against liability on the part of the association’s officers and directors are lost. A loss of corporate status will also result in the imposition of financial penalties and, potentially, a loss of the corporation’s name.

It is critical for the directors of a homeowners association to properly maintain the corporation’s legal status as a corporation at all times.  A breach of this duty could result in personal liability on the part of the directors for failure to make timely filings and the resulting consequences to the association.  Information on the current status of a corporation is available to the public on the website of the state agency that governs corporations. That agency is typically the Secretary of State.  Thus, by going to the agency’s website,  anyone can follow links to access the information on the particular association in question.  

The following is a screen shot of a page from the California Secretary of State’s website that provides an example of how the current corporate status of a homeowners association can be viewed by members of the public. This screen shot was a random selection that displays information on 14 different associations.

Note, that out of the 14 associations that are displayed above, 9 of the associations are listed as being “SUSPENDED” and 1 association is listed as “FORFEITED.”  This extremely high percentage of homeowners associations that have legally lost their corporate status is representative of the large number of homeowners associations that are currently operating  illegally.  It is likely that most of these associations are not even aware of the loss of their corporate status,  and sooner or later they are in for a rude awakening.  Each of said corporations will ultimately have to deal with the ramifications that result from the loss of their corporate status.

It is highly recommended that the management personnel for homeowners associations, or concerned members of the association, investigate the legal status of their association. If they discover that their association is listed as anything but “ACTIVE”  (or whatever comparable term is used by the state agency), immediate action should be taken to correct the situation.