Reserves: An Option, a Tool, or a Necessity by Curtis G. Kimble

 

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Reserves: An Option, a Tool or a Necessity?

Any good leader of a major corporation (which most HOAs are) knows to utilize and rely on the input of professionals.  To that end, I recently came across some comments regarding reserves from different HOA industry professionals that I didn’t really expect to hear, so I wanted to share them.

“We are in a situation where too many well-intentioned board members and managers are feeling pressure to have a strong reserve fund (more than 70 percent funded) or low reserve contributions at their associations. They want the association to look good to buyers and lenders. But at what cost?

“Reserve planning is based on estimating future costs and repairs. It’s natural to feel optimistic about the future, but board members and managers shouldn’t hide the facts. If you think “a new roof surely won’t cost that much” or “the paint will easily last another five years,” too much optimism can come back to bite you when there isn’t enough money in the reserve fund to cover expenses.

“A community association’s reserve balance doesn’t care about the board’s good intentions, and the building’s components don’t care about the board’s optimism. The reserve balance is what it is, and components will fail whether you have the money saved or not. Facilities are surprisingly expensive to maintain.”

From HOA insurance and risk management specialist, Joel Meskin, Esq., CIRMS:

“Having insured over 75,000 community associations nationwide, I have taken the position that a properly done and funded reserve study is one of the best and most effective risk management tools available to community associations. By having an effective reserve study, many claims that we see daily would never be made against associations.”

And finally, from a post by HOA lending specialist Alan Seilhammer:

“A community association must always first keep in mind that the correct step to take in paying for capital maintenance improvements is to build adequate reserves based on a professionally prepared reserve study that is updated periodically. If the association has not taken that basic step, what is left are only painful and more costly options:  special assessments and long term financing. I have yet to hear a valid argument as to why building a proper level of reserves over time is not the least cost option or the fairest option spread across all unit owners that enjoy use of the building common elements for varying periods of time.

“Needless to say, building appropriate levels of reserves has been the exception versus the rule. Enter the financiers. A very important lesson to appreciate in obtaining a loan for a capital maintenance project is that the loan is not to fund the project. The loan is in reality replacing the lack of reserves that should have been in place so the association could self-fund the project.”

A healthy reserve fund doesn’t just help the value of homes and their ability to be bought and sold, it’s an important risk management tool. Nor are reserves an option or alternative to a special assessment or a bank loan.  As a lender very frankly and non-self-servingly stated, a loan (or a special assessment) really just replaces the lack of reserves that should have been there in the first place.

Curtis G. Kimble

Fiduciary Duty

Because association reserves perhaps play a more important role than any other issue, with the exception of insurance, in the long term viability of a homeowners association, I’m hard pressed to find an issue that triggers the concept of fiduciary duty more than the decision of whether or not to fund an association reserve account and in what amount to fund it.

Every board member is legally bound by a fiduciary duty to his or her association.  It is the duty to act in good faith and in the best interests of the association.  This means a board member cannot put his or her own interests before those of the association.  This duty imposed by law is a very powerful tool.  It is not taken lightly by the courts and breaching this duty subjects a board member to personal liability.

If there’s one thing I’ve learned in my years of practice in HOA law, it’s that the individual owners don’t always have the best interests of the association in mind. It’s usually the other way around, they are concerned with their own best interests. There’s nothing wrong with that, it’s human nature…As an owner of a home within an HOA myself, I personally have no interest in what the other homeowners in my HOA think about whether to fund a reserve account and in what amount to fund it.  The only individuals who are legally obligated to put the association’s best interests before their own are the members of the board.  The individual homeowners are free to put their own interests first, to be selfish and short sighted, to take the attitude that they may not live here in a few years, so why should they fund expenses ten or fifteen years down the road.  Board members are not.  They are bound by fiduciary duties to the association as a whole.  If board members breach this duty, that’s a different issue and there are remedies for that.  But, as a homeowner, I want that duty to be attached to decisions regarding funding of reserves.

As an attorney who has had to repeatedly deal with the fallout and consequences of inadequate or nonexistent reserve accounts, I hope the collective wisdom of a majority of homeowners at a meeting will allay my above concerns as this new law goes into effect.

Curtis G. Kimble