HOA Legi-Slate

An association that maintains adequate reserves will find itself in the enviable position of having the funds necessary to cover the unenviable (and usually eventually unavoidable) costs of undertaking major maintenance and replacements of the community's common elements. Three potentially unappealing options face associations who haven't planned ahead by adequately reserving: 1) do nothing and allow the situation to deteriorate further, decreasing property values; 2) impose a special assessment; or 3) attempt to secure a loan, which will need repayment eventually. Even before a common element needs replacement, a lack of adequate reserve funds can hurt the ability of prospective buyers to obtain financing. In addition, some insurance companies have expressed reservations about renewing the master insurance policies of associations with underfunded reserves.

Although it's difficult to disagree that an adequately funded reserve fund benefits associations and owners, it's not as easy to determine the best way to achieve this result. Many association's governing documents impose a duty on the board to maintain the common elements and to budget reserve funds for this purpose. Currently, the Colorado Common Interest Ownership Act (CCIOA) does not have a requirement that associations maintain reserve funds or conduct a reserve study to determine how much money should be set aside to meet projected needs. The idea of having state law mandate reserves appeals to those who believe that such a requirement would protect owners and property values. However, this idea meets with well-reasoned opposition:

• Mandatory reserve levels are an inappropriate "one-size-fits-all" solution to a non-uniform problem. Some associations may have owners that can easily absorb a special assessment if one is necessary, while other associations have owners to whom a special assessment would prove to be a significant financial hardship. Both associations do not have the same need for reserve funding.
• Defining "adequate reserves" with appropriate detail in a statute would be an inappropriate - and futile - task for the state legislature. Leaving the term too loosely defined would most likely render the requirement meaningless and trying to create a "catch-all" definition would be extremely challenging, given all the specific factors that determine an individual association's reserve needs.

The drafting committee of the Uniform Common Interest Ownership Act is considering an amendment to the uniform act that would require association declarations to state whether the association is required to maintain reserves, and, if so, how this obligation must be met. (Note: CCIOA is Colorado's adoption of the uniform act with amendments made to it to meet Colorado's unique needs.) This amendment parallels another suggested solution - having associations disclose to its members and buyers the replacement requirements of the association and how much money the association has in reserve. (CCIOA currently requires associations to disclose annually its annual financial statements, including any amounts held in reserve - but not the association's reserve needs.) Presumably, requiring an association to disclose its reserve needs would necessitate the association to have a reserve study, having the effect of making reserve studies mandatory.

The question of reserves is an interesting, complicated one, and one that eludes an easy answer. Although we don't have a definitive answer on how to solve the problem of underfunded reserves, we do strongly encourage associations to take the necessary steps to protect their community by not ignoring the need to have a reserve fund and to contribute to it appropriately.

Michigan has had a state-mandated reserve requirement since 1978, that states simply:

559.205 Reserve fund.
Sec. 105. A reserve fund for major repairs and replacement of common elements shall be maintained by the associations of co-owners. The administrator may by rule establish minimum standards for reserve funds.

Under the regulations you will find:
R 559.511 Reserve fund for major repairs and replacement of common elements. Rule 511. (1) The bylaws shall provide that the association of co-owners shall maintain a reserve fund for major repairs and replacement of common elements in accordance with section 105 of the act. The co-owners' association shall maintain a reserve fund which, at a minimum, shall be equal to 10% of the association's current annual budget on a noncumulative basis. (Note: this was established to make sure developers collected and put in something, but it should never be used as a reserve guideline)
(2) The funds contained in the reserve fund required to be established by section 105 of the act shall only be used for major repairs and replacement of common elements.
(3) There shall be set aside the amount of funds required by subrule (1) of this rule by the time of the transitional control date. The developer shall be liable for any deficiency in this amount at the transitional control date.
(4) The following statement shall be contained in the bylaws: "The minimum standard required by this section may prove to be inadequate for a particular project. The association of co-owners should carefully analyze their condominium project to determine if a greater amount should be set aside, or if additional reserve funds should be established for other purposes."

Since its adoption, those of us who have spoken or written about reserves have hammered home Regulation 4, that it is up to the board to see that the reserves are adequately funded. We've defined "adequate" as "sufficent when the need arises" and quoted "Raven's Cove" as to potential liability, and reminded them that they aren't licensed engineers or architects, so they need expert help in defining the need.

Since then I have found very few condo associations that have had to resort to an additional assessment or loan for repairing or replacing common elements. Need new roofs, the money's there, resurface the roads, no problem. Maybe that's one of the reasons we don't seem to have very much litigation compared to other states.

I wish I could say the same for the HOA's which don't have the benefit of a law mandating reserves. Additional assessments and financial hardship seem to be the norm.

"One-size" doesn't have to fit all, but simple, straightforward statement requiring reserves will go a long way in preventing financial hardship.