HOA Law Blog

LAWFORHOAS.COM

SWEDELSON & GOTTLIEB LEGAL UPDATE
2005-2006 ANNUAL DISCLOSURE ISSUES
__________________________________________________________
BUDGET AND DISCLOSURE DEADLINE: DECEMBER 1, 2005

It’s November and community managers and board members are hard at work preparing their association’s budgets and other required disclosure documents.

There are important legislative changes effective in 2006, some of which will affect what disclosures are required.

As Swedelson & Gottlieb does each year, we are providing you with our updated Annual Budget and Disclosure Checklist (the “Budget”).

The provisions of the California Civil Code governing community developments require that community associations provide members with an ever-growing list of disclosure information. Much of the information required by the Civil Code must be distributed to homeowners within a 60-day window “not less than 30 days nor more than 90 days” prior to the beginning of the association’s fiscal year. (Yes, that’s the law as of 2005.)

For those community associations operating under a fiscal year that coincides with the calendar year, the Budget and other disclosures must be distributed not later than December 1, 2005.

For those community associations whose fiscal year commences on a date other than January 1, 2006, the information in this newsletter should be utilized at the applicable time by calculating the appropriate calendar deadlines prior to the commencement of the new fiscal year.

The California Civil Code also mandates the distribution of a “pro forma operating budget” which must include, among other things, information regarding the association’s expenses, income, and reserves. The Civil Code also requires that associations annually provide members with other information about the association and their membership rights. We address these requirements in our checklist which follows.

For more information, including updates on applicable statutes, you can print a copy of our newsletter explaining the changes in the law by accessing our internet blog at www.hoalawblog.com or e-mail us at Info@sghoalaw.com to request a copy be sent to you via e-mail.

The remainder of this newsletter addresses suggestions for dealing with specific issues relating to the association’s budget and disclosure obligations.

BUDGETING FOR BAD DEBT

Although we have enjoyed several years of phenomenal growth and appreciation in real estate, experts indicate that we are likely to see a softening of the real estate market beginning in 2006. While the experts also believe that at least 50% of homeowners have significant equity in their properties, a large percentage of new homeowners who have bought or refinanced within the last year, or so, have taken advantage of the creative
loans that are in the market. Many of these homeowners have either obtained 100% financing or interest-only financing and have very little equity in their properties. When their variable interest rates start to climb, it is likely that some of these homeowners will not be able to afford the payments for the financing of their condominium or house.

A recent Los Angeles Times news article pointed out the potential for many homeowners to lose their homes through foreclosure. The article quoted a woman who had recently purchased her condominium with 100% financing with a variable interest rate. The woman stated that she could barely make the payments and did not know what she would do if her interest rate increased.

Many of us who have been in real estate-related industries for many years remember when interest rates were higher, property values fell, and many homeowners found themselves in a situation where their mortgages were more than the market value of their homes. There are likely to be some homeowners who will not pay their assessments or who lose their properties to their senior lenders in foreclosure. In that instance, the associations may not be able to collect the delinquency from them. It would be prudent for associations to work a bad debt allowance into their budgets beginning with fiscal year 2006.

BUDGETING FOR COST OF DOCUMENT INSPECTION BY OWNERS

Effective July 1, 2006, new Civil Code Section 1365.2 greatly expands the types of documents homeowners are entitled to inspect. Homeowners will not be limited merely to inspecting financial reports, but will be able to see bank statements, cancelled checks, contracts and other financial documents. An association has an obligation to redact, which means to edit a document to omit confidential and/or privileged information, such as information relating to the names of employees, social security numbers, account numbers, etc. Unfortunately, the Legislature only allows an association to charge a homeowner $10.00 per hour, for a maximum of $200.00, for preparing and providing the requested documents. It is expected that some associations will require an attorney’s assistance in the proper preparation of confidential and/or privileged documents that may be requested by a homeowner.

Although associations are only allowed to charge homeowners $10.00 per hour, up to $200.00, for its to prepare requested documents, which costs include attorney services, management companies may charge the associations their extra hourly fees for their services, if required. Additional fees charged by management for these services are probably justified, and associations are encouraged to add additional monies into their budgets for these additional management services. The amount that should be budgeted depends upon the size of the association and the history of the association’s homeowners’ requests for documents.

ANTICIPATING SPECIAL ASSESSMENTS

The California Civil Code also details what is required to be stated or presented in an association’s budget and financial reports. In addition to the budget and other required financial disclosures, the Code requires that associations, through their boards of directors, prepare a statement as to whether “the association has determined or anticipates that the levy of one or more special assessments will be required to repair, replace or restore any major component or to provide adequate reserves therefore.” The Civil Code now imposes greater disclosure obligations regarding reserves and the precise amount of increased assessments for the association’s fiscal year.

Associations need to take a good, hard look at their proposed budgets and anticipated expenses for the new fiscal year and determine whether any special assessments will be required.

This has been an issue with several associations where the board knew, or should have known, of the need for a special assessment to fund the cost of a common area repair, or replacement project, for which there were no monies in reserve, but failed to advise the members.

Many associations are purposely choosing to under-fund reserves and rely on special assessments for common area repair or replacement projects under the theory that the homeowners who will benefit immediately from the repair should pay for it. While such a practice may be in technical compliance with Civil Code requirements because an association is not required to establish reserves, the 2005 changes to the Civil Code require that the board of directors carefully review what projects it believes will need to be undertaken and determine whether the association has sufficient funds or will require a special assessment and make the appropriate disclosure.

Some associations are disguising assessment increases by calling them “special assessments.” Rather than increase the regular assessment, some associations are levying special assessments of a set amount, per month, to fund repair programs or reserves when, in reality, this money should be part of the regular assessments. Such a practice could be challenged by homeowners. In order to be in compliance with Civil Code mandates, it is appropriate to present this information in the budget.

LEAKS, MOLD, AND DEFECTS

When the budget is being finalized, some associations are also uncovering issues, such as water leaks, mold and construction defects, of which the board has knowledge. Even if the board is not anticipating making any major repairs to deal with the problems (although these days, they probably should), disclosure of these issues should be made. Technically, it could be said that the issues fall between the cracks in the California Civil Code and a line item for the repairs should either be included as a reserve item or the board should disclose, at some point, that they anticipate a special assessment to repair or fix the problems. To avoid conflict, the board should make full disclosure of what major repair issues it is dealing with, especially if the board anticipates that the cost of repair will affect the association’s budget. Full financial disclosure should be made so that the board is representing the association’s true financial condition.

The failure to disclose the cost of repair for defects, water damage or mold repair projects continues to be a problem for associations that anticipate such work. Although not every expenditure can be calculated or anticipated in advance, if a board is going to borrow from reserves (that is, use reserve money for work not designated as a reserve item), then it must disclose that it is borrowing from the reserves, along with the board’s plan for repayment of the borrowed reserve money.

MOLD AND INSURANCE DEDUCTIBLES

Community associations should develop and distribute a “deductible policy” setting forth the association’s policy for dealing with insurance claim deductibles. The policy should state, for example, that, if the claim originates as a result of an element that is the homeowner’s responsibility, such as a broken flex line or leaking sink fixtures, then the homeowner is responsible for the deductible. If the cause of the damage is related to an element over which the association has maintenance and repair responsibilities, the association would be responsible for the deductible. Such a policy can be included with the insurance disclosures and reflect the amount of the deductible(s).

If the association adopts a deductible policy that includes a significant deductible, it should be disclosed to the members along with a reminder to homeowners to obtain their own insurance policies to cover any gaps in the association’s coverage.

Associations should adopt a mold policy in addition to their maintenance and repair policies. Often associations wind up in disputes with homeowners over who is responsible for what maintenance and repairs.

One component of the policy is that homeowners should be apprised that, if they do not report water damage claims within twenty-four (24) hours, the association cannot be held responsible for any resulting mold because the association was not given a timely

opportunity to remediate the water damage before mold developed.

DISCLOSURE OF ALLEGED VIOLATIONS
OF GOVERNING DOCUMENTS

There is another important disclosure that some association boards are failing to make: escrow notification of alleged violations of association governing documents. Although not part of the annual disclosure obligations, not only can this disclosure assist the association in CC&R and Rules and Regulation enforcement, but the association’s failure to make such a disclosure may adversely effect an association’s enforcement rights.

Along with all other documents delivered to escrow on behalf of an owner, the California Civil Code requires associations to provide a copy or summary of any notice previously sent to an owner that sets forth any alleged violations of the governing documents which remain unresolved at the time of the request. This means that associations are obligated to disclose to prospective owners any CC&Rs or Rules and Regulation violations alleged to have occurred on a homeowner’s property. Disclosure may compel the seller to correct the violation, as the prospective buyer will not want to inherit the problem.

NEW DISCLOSURES FOR 2006

ASSESSMENTS AND FORECLOSURES NOTICE OF SECONDARY ADDRESS AND PAYMENTS

Effective in January 2006, the Civil Code will be revised and the process of collecting assessments will substantially change. In addition to restricting when and how an association can lien and foreclose, the new law requires new disclosures. See the checklist that follows.

For a copy of an article detailing the changes, please contact us at Info@sghoalaw.com.

NOTICE

As of January 1, 2006, each association is required to provide annually an updated notice to the homeowners that outlines some of the rights and responsibilities of common interest development property owners and the associations. It is suggested the notice be provided with the association’s other mandatory disclosures.

SECONDARY ADDRESS

New for 2006, the Civil Code requires that associations notify homeowners of their right to submit a secondary address to the association for the purpose of collection. Such notification must be sent to the homeowners and associations should likely not wait until 2006, but rather, provide this notice at the same time that the other 2005-2006 disclosures, budget, etc., are distributed.

Although the Civil Code only requires that associations notify homeowners of their right to provide secondary addresses for the purpose of collection notices, Civil Code Section 1365.1(c) also gives homeowners the right to give a secondary address for general notices and obligates the associations to send all correspondence and legal notices to the secondary address. Civil Code Section 1367.1 requires that secondary address notices for collection purposes be mailed in a manner that confirms receipt whereas, Civil Code Section 1365.1 provides that secondary address notices may be sent by facsimile or mail, with no requirement of confirmation of receipt. It is not clear whether this discrepancy is the result of poor drafting on the part of the California Legislature or whether the Legislature intended to make a distinction between notifications for purposes of collection and other notices, although we believe it is the former.

For a copy of this newsletter in PDF format to copy and distribute to clients and associates, please contact us at Info@sghoalaw.com.

Click here to download the Annual Disclosure Checklist.

Once again, it’s time for community managers and board members to begin preparing association budgets as well as preparing to distribute other required disclosure documents. As we do each year, Swedelson & Gottlieb is pleased to provide you with our updated Annual Budget and Disclosure Checklist.

The provisions of the California Civil Code governing community associations require that you provide members with an ever-growing list of disclosure information, including the “pro forma operating budget,” which must include, among other things, information regarding the association’s expenses, income and reserves.

Other required disclosures include information concerning owners’ rights as members of the association. Much of the information required by the Civil Code must be distributed to homeowners within a 60-day window “not less than 30 days nor more than 90 days” prior to the beginning of the association’s fiscal year.

For those community associations operating under a fiscal year that coincides with the calendar year, the disclosures must be distributed not later than December 1, 2006. For those community associations whose fiscal year commences on a date other than January 1, 2007, the information in this newsletter should be utilized by calculating the appropriate calendar deadlines prior to the commencement of the new fiscal year. Keep in mind that there are important legislative changes effective in 2007, some of which will affect what disclosures are required.

BUDGETING FOR BAD DEBT

As indicated in last year’s Annual Budget and Disclosure Checklist, we advised that real estate experts expected real estate sales and price increases to slow down and foreclosure activity to rise in 2006 due to the large number of risky 100% financed “interest-only” and variable interest rate mortgages retained by buyers, and we advised you to consider budgeting for the likelihood that some owners would not pay their assessments. Indeed, the California real estate market is in a slowdown and foreclosures have tripled from September 2005 to September 2006, which includes a 19% increase from August to September alone. We are optimistic that our Association Lien Services company will continue to successfully collect delinquent assessments, but if a home is foreclosed on by a senior trust deed, it is not always possible to collect assessments. Do the words “upside down” mean anything to you? For those of us who have been around awhile, back in the old days (before 1995), many owners found that they had no equity as the value of their homes were less than their loans. Many let their homes go as they were “upside down.”

As this trend shows few signs of weakening and there are still a large number of high-risk mortgages encumbering California real estate, we continue to advise you to allow for a reasonable amount of bad debt in your 2007 budgets.

BUDGETING FOR COST OF DOCUMENT INSPECTION BY OWNERS

As of July 1, 2006, new Civil Code Section 1365.2 greatly expanded the types of documents homeowners are entitled to inspect. Now, homeowners are not limited merely to inspecting financial reports, but are able to see bank statements, cancelled checks, contracts and other financial documents. An association has an obligation to redact, which means to edit a document to omit confidential and/or privileged information, such as information relating to the names of employees, social security numbers, account numbers, etc. Unfortunately, the legislature only allows an association to charge a homeowner $10 per hour and a maximum of $200 for preparing and providing the requested documents. It is expected that some associations will require an attorney’s assistance in the proper preparation of confidential and/or privileged documents that may be requested by a homeowner.

Although associations are only allowed to charge homeowners $10 per hour (up to $200 total) to prepare requested documents, which costs include attorney services, management companies may charge the associations their extra hourly fees for their services, if required. Additional fees charged by management for these services are probably justified, and associations are encouraged to add additional monies into their budgets for these additional management services. The amount that should be budgeted depends on the size of the association and the history of the association’s homeowner requests for documents.

ANTICIPATING SPECIAL ASSESSMENTS

The California Civil Code also details what is required to be stated or presented in an association’s budget and financial reports. In addition to the budget and other required financial disclosures, the Code requires that associations, through their boards of directors, prepare a statement as to whether “the association has determined or anticipates that the levy of one or more special assessments will be required to repair, replace or restore any major component or to provide adequate reserves therefore.” The Civil Code now imposes greater disclosure obligations regarding reserves and the precise amount of increased assessments for the association’s fiscal year.

Associations need to take a good, hard look at their proposed budgets and anticipated expenses for the new fiscal year and determine whether any special assessments will be required.

This has been an issue with several associations where the board knew, or should have known, of the need for a special assessment to fund the cost of a common area repair, or replacement project, for which there were no monies in reserve, but failed to advise the members.

Some associations are purposefully choosing to under-fund reserves and rely on special assessments for common area repair or replacement projects under the theory that the homeowners who will benefit immediately from the repair should pay for it. While such a practice may be in technical compliance with Civil Code requirements because an association is not required to establish reserves, the 2005 changes to the Civil Code require that the board of directors carefully review what projects it believes will need to be undertaken and determine whether the association has sufficient funds or will require a special assessment and make the appropriate disclosure.

Some associations are disguising assessment increases by calling them “special assessments.” Rather than increase the regular assessment, some associations are levying special assessments of a set amount, per month, to fund repair programs or reserves when, in reality, this money should be part of the regular assessments. Such a practice could be challenged by homeowners. In order to be in compliance with Civil Code mandates, it is appropriate to present this information in the budget.

DISCLOSURE OF ALLEGED VIOLATIONS OF GOVERNING DOCUMENTS

There is another important disclosure that some association boards are failing to make: escrow notification of alleged violations of association governing documents. Although not part of the annual disclosure obligations, not only can this disclosure assist the association in CC&R and Rules and Regulation enforcement, but the association’s failure to make such a disclosure may adversely effect an association’s enforcement rights.

Along with all other documents delivered to escrow on behalf of an owner, the California Civil Code requires associations to provide a copy or summary of any notice previously sent to an owner that sets forth any alleged violations of the governing documents which remain unresolved at the time of the request. This means that associations are obligated to disclose to prospective owners any CC&Rs or Rules and Regulation violations alleged to have occurred on a homeowner’s property. Disclosure may compel the seller to correct the violation, as the prospective buyer will not want to inherit the problem.

THE NEW ELECTION LAW AND ITS IMPACT ON ASSOCIATION BUDGETS AND DISCLOSURES

As you hopefully are aware, as of July 1, 2006, California Civil Code Section 1363.03 sets forth the requirements that community associations are required to follow for association elections and certain other votes by association members (if this is news to you, please visit our blog and see our updates at www.hoalawblog.com). Some associations can expect to incur additional costs relating to printing of envelopes, ballots, election materials and potentially fees to retain an independent third party as inspector of election, such as an accountant, to provide the services needed during a membership vote. While you may avoid some of these expenses by finding a willing volunteer to serve as inspector of election, associations should examine their alternatives and budget accordingly.

The new election law creates additional disclosure responsibilities for associations. Election rules adopted pursuant to Civil Code Section 1363.03 are operating rules and must be sent to the members for a 30-day review period prior to adopting or changing the election rules. Associations must also give notice that the board has adopted the election rules within 15 days of their vote to adopt the rules (the procedure described in Civil Code Section 1357.130 for operating rules listed in Civil Code Section 1357.120). Additionally, within 15 days of an election, the board must publicize the tabulated results of the election in a communication directed to all members.

NEW REQUIREMENTS REGARDING INITIATION OF FORECLOSURE

The changes to California Civil Code §1365.1 and §1367.4 now require that delinquent assessments amount to at least $1,800 or are one (1) year delinquent prior to initiating foreclosure.

Associations are prohibited from foreclosing on an assessment lien unless either: (1) The amount of the assessments owed (not including costs, interest, or accelerated assessments) is $1,800 or (2) one (1) year of delinquency has passed on any unpaid assessments.

Note that payment plans do not stay the running of the one (1) year of delinquency. Here’s a tip - when levying a large special assessment, do not levy with monthly payments. Instead, have the whole amount of the special assessment due in thirty (30) days, or offer a payment plan as an accommodation. This protects the Association against an owner that sells, allows for acceleration if there is a default, and provides other benefits.

BOARD OF DIRECTORS MUST VOTE TO RECORD A LIEN

California Civil Code §1367.1(c)(B)(2) now requires that a majority of the Board of Directors must vote to decide to record a lien at an open Meeting (not Executive Session). The decision of the Board must then be recorded in the minutes of the meeting.

Note that there is no language in the statute that requires that the owner remain anonymous at this point in the proceeding, but there are requirements that the owner’s information be kept confidential in the minutes of the Executive Meeting that votes on whether to notice the sale. There is, however, the potential liability for slander (spoken) or libel (written in the minutes). Do not use the owner’s name.

David C. Swedelson
Sandra L. Gottlieb

Click here to download the Annual Disclosure Checklist.