HOAs Must Have Controls and Follow Proper Procedures For The Use of Reserve Funds

A prudent board of directors should have a dual signature requirement for withdrawal of funds over a specified minimum dollar amount (or for distributions outside the amount set forth in its budget) from any of its accounts. When it comes to funds that are on deposit in an association’s reserve account, such safeguards are not only prudent, but they may also be mandated by state statutes that impose limitations on the ability of association directors to access and spend the association’s funds that are held in reserve for specific limited purposes. The controlling state statutes and/or the association’s governing documents will define reserve accounts or funds to include any monies that the association’s board has identified for use to defray the association’s reserve account requirements and funds received and not yet expended or disposed of from the resolution of a construction or design defect claims or lawsuits. Typically, the withdrawal of funds from an association’s reserve accounts requires the signatures of a least two board members, or one member of the board of directors and one officer of the association who is not a member.

State laws and an association’s governing documents typically limit the spending of reserve funds to items necessary for the repair, restoration, replacement, or maintenance of major components, and/or for litigation involving the repair, restoration, replacement, or maintenance of major components. An association’s governing documents should describe the major components that the association is obligated to repair, restore, replace, or maintain. The association’s governing documents should also contain provisions that describe the extent of the board’s authorization to spend reserve funds on construction defect lawsuits involving defects that are found to exist in those components for which the reserves are being maintained.

Because an association’s reserve accounts typically contain large sums of funds that are being accumulated, it is common for associations to periodically borrow reserve funds for the purpose of meeting short-term cash flow needs. The ability to borrow from a reserve account and utilize the funds for an unauthorized purpose requires authority that comes from state statues and/or the association’s governing documents. Such authority will specifically authorize an association’s board of directors to permit the temporary transfer of funds from a reserve account to a general operating account when needed to meet short-term cash flow requirements or other expenses, providing the association’s board of directors has first provided proper notice to its members of a meeting of the association’s board of directors at which the board will consider the transfer and use of the reserve funds. Such a notice should include: (i) a statement of the reasons why the use of reserve funds is necessary; (ii) the available options for the repayment of the borrowed funds to the reserve account and whether a special assessment may be considered; and (iii) a description of when and how the borrowed funds will be repaid to the reserve account.

An association’s board of directors that contemplates the need to borrow funds from a reserve account should be familiar with the requirements that are specified in the applicable state statutes and in the association’s governing documents. Before any funds are transferred from a reserve account, those requirements that are imposed by the statutes and the governing documents must be complied with. Additionally, when an association authorizes the transfer of reserve funds to an operating account, the board of directors must properly document its authorization through written findings that are recorded in proper minutes and resolutions. The findings must specify the reasons for borrowing the reserve funds and describe when and how the borrowed funds will be repaid to the reserve account.

Once the borrowing of funds from a reserve account has been properly authorized, the association’s board of directs must make certain that the funds are repaid to the reserve account in accordance with the terms that were specified when the authorization was sought. Any delay in repayment or alteration of the approved terms for the repayment of the reserve funds must be properly authorized and permitted by applicable state statutes and the association’s governing documents. If it is necessary for an association’s board of directors to seek a change in the terms of repayment of borrowed funds to the reserve account, the matter should be addressed by the board in a properly noticed meeting at which the directors make specific findings that are documented in written minutes and an appropriate resolution that the change in repayment terms is necessary and would be in the best interests of the association.

If the repayment of funds that have been borrowed from a reserve account on the terms that were approved cannot be accomplished, it may be necessary to levy a special assessment on the association’s members to recover the funds that must be repaid to the reserve account. In said event, the association must follow the procedures that are mandated by state statutes and the association’s governing documents relative to the levy of special assessments on the members.

An association’s board of directors has a duty to exercise prudent fiscal management in the maintenance of the association’s reserve funds. Board members should be familiar with the requirements that are imposed by state statutes and their association’s governing documents relative to the establishment, funding, use, and preservation of the reserve funds that are vital to the long-term success of the association. The improper use of reserve funds and the failure to maintain necessary reserves for their intended purposes will most certainly lead to future problems for the association.