Reserve Studies Minimize Liability

These days it seems that boards are being barraged by many issues that weren't even considered only a few years ago.  Lawsuits and claims of financial mismanagement are taking place on a daily basis.  They are at best a nuisance, and at worst very costly and stressful.

Over the years, homeowners volun­teered to serve on the board because they had expertise and skills from pro­fessional careers that were applicable to the association.  Examples include attorneys, accountants, engineers, and business managers.  Boards comprise people with these skills as well as other owners who are simply concerned about protecting their most important investment - their home.  This ap­proach generally worked well in the early years of the association industry.  Today, however, community associa­tions are being managed more like a business with the help of outside con­sultants such as attorneys, engineers, and accountants who specialize in community association property.  One example is planning for future capital repairs with an adequate reserve fund.

Now more than ever, associations are using the services of independent engineering firms that specialize in 20 to 30-year reserve studies.  A profes­sional reserve study determines accu­rate, supportable annual reserve con­tributions necessary for the repair or replacement of common property as it wears out over the development's life.

Professional reserve studies are de­signed to eliminate special assessments by ensuring that sufficient funds are available when property components need to be repaired or replaced.  Elimi­nation of special assessments offers peace of mind to owners and reduces claims of financial mismanagement.

Why are community associations being managed like businesses?  Homeowners typically view their home as a financial investment that they expect to appreciate in value just as they would any other investment, such as stocks, bonds, or Certificates of Deposit.  More important, associa­tions are increasingly emulating busi­ness management because of the fiduciary nature and responsibility of as­sociation boards.

Lawsuits and claims of financial mismanagement have driven state gov­ernments to protect citizens who are a part of community living.  Regulatory pressure from state governments has increased dramatically in recent years regarding the fiduciary obligations of boards and managers.  Examples in­clude licensing and certification of property managers and more state leg­islation such as Chapter 400 in Mas­sachusetts, the Illinois Condominium Property Act, and Florida's Condo­minium Act Chapter 718 that govern association management (for boards and management companies).

These laws and others are designed to ensure that associations are reserv­ing appropriate levels of funding for common element replacement.  Some state statutes call for "reasonable" or "adequate" reserve funds, while oth­ers such as Michigan require that the association "shall maintain a reserve fund which, at a minimum, shall be equal to 10 percent of the association's current annual budget on a noncumu­lative basis." While regulations vary from state to state, there is a strong trend toward more legislation rather than less.

The purpose of condominium re­lated legislation is to protect current association members and prospective buyers, and to ensure that the associa­tion is properly managed.  Questions of fiduciary responsibility date back at least as far as the early 1980s in Cali­fornia case law with the landmark Raven's Cove decision, which dis­cussed the fiduciary responsibilities of directors of a nonprofit organization, namely, the association.  On January 20, 1981, The Court of Appeal, Tay­lor, P.J., held that: "...Where owners' association's original directors... failed to exercise their supervisory and mana­gerial responsibilities to assess each condominium unit for an adequate re­serve fund ... former directors of the association breached their fiduciary duty and were individually liable to the association for said breach..."

Thus, important case law came into being which affects the individual liability of condominium directors and officers.  One may wonder what his "fiduciary duties" are or "why should I be concerned if I am covered by D&O liability insurance?" As a director of a community association, your actions (or inactions) have an impact on your and the members’ financial well-being now and in the future.  Your association's insurance premiums could escalate as a result of D&O litigation.