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November 2013
One HOA reported in a blog post that it made a "temporary transfer" of reserve funds for litigation. Is that permissible? What other unusual uses are permissible? Also, how do you know when your condo or homeowners association must repay its reserve funds for an expense? Are there time limits on how quickly it must be repaid? Here we answer those questions.
Use Reserves with Abandon?
This is common, and associations can generally use reserves for any reason, says Bob Diamond, a partner at the law firm Reed Smith in Falls Church, Va., who helped write the Washington, D.C., condo act in 1976 and worked on the Uniform Condo Act, which 24 states have adopted.
But there's a catch. "The catch in dealing with reserves is that you don't pay income tax on reserve funds," says Diamond. "So if you use them for an improper purpose, like to cover ordinary operating expenses, you convert your reserves into taxable income. However if you properly structure your use for the money, like by making a loan to your operating fund, you can use that cash for anything you want. But you have to pay it back. I'd advise any board to consult with their accountant and maybe their lawyer to make sure they structure that properly to protect the nontaxable nature of the reserve funds."
Randy Opotowsky, a partner at The Steeg Law Firm in New Orleans, who represents 15-20 associations at any given time, agrees. "You can use reserves for pretty much anything the board deems appropriate," he says. "You may get yourself involved in litigation and may have to do a special assessment or pull from reserves. That would be something for which you could pull from reserves. The standard for doing this is probably a little higher than a reasonable man standard and a little less than a fiduciary obligation. The Louisiana condo act just says you can have and provide for reserves. It doesn't say money held there must be used for replacement of building components or capital improvements. So if funds get low, associations end up using reserves on a short-term basis until they replenish them or do a special assessment."
State Statute Specifically Says OK
Other states, however, do expressly provide for the use of reserves in nonreserve situations. "In Washington, you can do a temporary transfer of reserve funds, and in most other states there's a provision for this as well," according to Kevin Britt of The Law Office of Kevin L. Britt, who specializes in representing associations in Seattle. "Boards can withdraw reserve funds to pay for, as the Washington statute says, unforeseen or unbudgeted costs unrelated to the maintenance of the reserve components. So if something happens you just didn't provide for in your reserve fund already, you can withdraw funds."
Washington boards do need to follow proper procedure. "You have to record it in the minutes to give notice to owners that it's been done," explains Britt. "And you have to adopt a repayment scheduled within two years. That's the other wrinkle. Under our state law, you have to pay it back within two years unless—there's an exception here—that would impose an unnecessary burden on owners."
What happens if owners think boards are using reserves too freely? "The Washington statute doesn't provide any specific remedy other than suing to overturn the board's decision and getting your attorneys' fees for the lawsuit back," says Britt. "If a board took out reserve funds when it shouldn't have and an owner wanted to do something about it and force them to return those funds, the mechanism is to file a lawsuit. Then the owner can get his attorneys' fees repaid if he wins."
Other Issues to Consider
It's also wise to keep an eye on reserves to be sure you're not limiting owners' resale opportunities because of low funding. "For associations that are subject to Fannie Mae guidelines," explains Opotowsky, "I've been counseling them that their reserves need to be 10 percent of their budget because that's what Fannie Mae and others are looking at now. So if you pull funds from reserves, you'd better replace those funds pretty quickly.
"We also urge bigger buildings to do a reserve study every five years to see if they're on track to replace their main components at the end of the useful life of those components," adds Opotowsky. "If not, they'll pay one way or another. I tell them people like me look at projects for prospective buyers, and having a low assessment isn't always a good thing. I also look at whether reserves are healthy for the market. Associations shouldn't have a reserve of 10 cents per square foot when the market is 50-60 cents per square foot. And in higher-end properties, reserves are as much as $1 per square foot."
With the option right there in front of boards, it's a wonder boards don't pull from reserves more often. But most boards take their job seriously. "I think boards are pretty careful about this," says Britt. "Typically what happens is my clients will say, 'Do you think we can take out money for this exception?' If I'm telling them no, they don't do it."
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