HOA Directors Have Multiple Duties Relative to Reserve Funds

A basic duty that is imposed on virtually all homeowners associations by state laws and/or governing documents is the duty to maintain the association’s common areas. As the association is merely a legal entity or vehicle for the association to conduct its business, the actions that are necessary to properly operate that business entity are undertaken by the individuals who are elected or appointed to the association board of directors—thus the duty to maintain the association’s common areas falls on the association’s directors.

The basic duty to maintain the association’s common areas necessitates the proper performance by the directors of multiple additional duties relating to reserve funds that are earmarked to be used for the maintenance, repair, and replacement of common area components. Such additional duties include: (i) conducting reserve studies; (ii) establishing budgets; (iii) levying assessments; (iv) collecting the assessments and funding reserves; and (v) spending the reserves.

Duty to Conduct Reserve Studies

The only way that association directors can know how much money should be held in reserves for the proper maintenance of the association’s common areas is to conduct periodic reserve studies and to update them on an annual basis. The duties that are imposed on an association’s board of directors relative to reserve studies are defined by the association’s governing documents and/or applicable state laws. It follows that, proper performance of their duties requires the directors to be familiar with the requirements relative to reserve studies that are contained in the state laws and their association’s governing documents.

Irrespective of the size of a homeowners association, the preparation of a reserve study should always be done by experienced consultants that are retained by the association. Individual board members should interface with the consultants, but should not be the people who prepare the reserve study as the proper preparation of a reserve study requires expertise in identifying all the various components that make up the association’s common area, knowledge of the useful life of each component, and knowledge about the value of each component and the cost of repairs and replacements. Aside from needing properly trained people to perform these functions, it is prudent to have independent third-parties who have no relation to the homeowners association prepare the reserve study. A properly prepared reserve study should then be reviewed and adjusted by the association’s directors annually based on guidelines that are provided by the experts who prepared the study.

A properly prepared reserve study will enable the association’s directors to determine the appropriate amount of money that needs to be collected from the homeowners each month or quarterly, in order to maintain the required reserves that will enable the association to properly maintain the association’s common areas.

Duty to Establish a Budget

Aside from knowing the amount that is required to properly fund the association’s reserve account, the directors must also know what all of the other expenses are for the association’s annual operations. Directors, with the assistance of management personnel or other qualified people, should prepare a pro forma operating budget each year that reflects all expenses for the year, inclusive of the amounts that are required to be contributed to the association’s reserve account. Because homeowners associations are typically nonprofit organizations, the budget must be prepared in a manner that equalizes the association’s income and expenses. In other words, the total annual income for the association, less all of the association’s expenses, will equal in zero (no profit and no loss). The pro forma budget is then placed on the agenda for a board meeting where it is reviewed, discussed, and acted upon (typically approved).

Duty to Levy Assessments

In order to fulfill their duty to maintain the association’s common areas, and also be able to fund the association’s business operations, the association’s directors must impose monetary assessments on the members of the association which are generally required to be paid monthly, or quarterly. The approved budget is the basis for determining the total amount that must be collected from the homeowners over the course of the year in order to properly operate the association and maintain its common areas. Because state laws and/or association governing documents typically contain limitations on the amount that the assessments on members can be increased annually, it is important for the directors to be aware of any such limitations. Necessary increases in excess of those limitations must be approved by the homeowners. In addition to the anticipated normal expenses, associations periodically experience unexpected occurrences that require funds that were not included in the approved budget. Generating those funds often necessitates action by the association’s directors to impose an additional special assessment on the members. Limitations concerning the imposition of special assessments will also be found in state laws and in an association’s governing documents.

Duty to Collect Assessments and Fund Reserves

Because merely imposing assessments on association members does not put money in the bank, the association’s directors also have a responsibility to collect the assessments from the association’s members. Once collected, the portion of the collected funds that was budgeted for funding the association’s reserves must be deposited into the association’s reserve account. Because a percentage of homeowners will experience situations in their personal lives that may interfere with their ability to pay the assessments that they owe to their association, association directors should incorporate into their budgets an allowance of uncollectable assessments and for the costs of collecting from delinquent homeowners. Absent such allowances, the association will collect less funds then are required to pay all expenses and fund the reserve account and end up not making the proper deposits into the reserve account, or not paying certain required expenses. This is a recipe for disaster and association directors should never allow such a situation to perpetuate itself.

The collection of assessments from association members also necessitates having procedures in place to follow when homeowners become delinquent. The association should have an established written policy that clearly explains the procedures that will be followed to collect assessments that are owed by the association’s members and that policy must be provided to all members annually and upon request. Those policies and procedures should include the imposition of late charges and interest, collection alternatives such as using collection agencies and attorneys, filing court actions, and imposing and enforcing liens against the separate interests owned by the delinquent members. All collection activities must be in compliance with applicable state laws and restrictions that are contained in the association’s governing documents.

Duty to Properly Spend the Reserve Account Funds

The purpose of establishing and funding reserve accounts is to ensure that the association has the funds available for necessary maintenance, repairs, restorations, and replacements of the common area components when needed. State laws and/or governing documents may also permit the use of reserve funds for litigation that involves the repair, restoration, maintenance, or replacement of major components that make up the association’s common area.

Establishing and maintaining the reserve account is of no benefit to the association if the directors are not willing to spend the money when it is needed for maintenance, repairs, restorations, and replacements of the common area components. The association’s directors’ duty to maintain the common area mandates that the allocated reserve funds be utilized for their intended purpose, subject to permitted short-term borrowing of those funds for other purposes in accordance with applicable laws and provisions in the association’s governing documents.

Conclusion

Homeowners’ association directors should understand the various duties that are imposed upon them in connection with the establishment and spending of association reserves. Every year, the association’s directors should review the requirements relative to reserve funds that are imposed by the laws of the state in which the association is located and by the association’s governing documents. Being aware of such requirements and the various duties discussed above that pertain to reserve funds will facilitate proper management of the association, reduce conflicts relative to reserve funds, and maintain maximum property values for the association and its members.