Are California Homeowner Associations Required to Create Reserve Accounts?

By David Swedelson, senior partner, SwedelsonGottlieb, California condo lawyer and HOA attorney

“Homeowner Associations Are Not Required to Create Reserve Accounts?” This was the title of a recent Los Angeles Times column on community association law written by two individuals who I do not believe are really community association legal experts (one is an attorney, and the other went to law school, so why the Times has them writing this column is not understood). Their lack of HOA legal expertise is evidenced by their inane and often incorrect responses to the questions they are responding to.

I often question if the questions are real, as in over 25 years of representing California community associations, I have never encountered or even heard about some of the fact situations that they claim they are responding to. Other times, I just chuckle and shake my head (literally), as I cannot believe their responses to the questions. Usually, they are very cynical, and typically they suggest that owners sue their condo or HOA association and its board. More often than not, I am concerned that owners at community associations are reading the incorrect information that they publish and are relying on the poor advice.

Here is an example of what I am talking about, in their response to the following question on October 9, 2011:

Question: Is there anything in the Davis-Stirling statute that requires minimum reserve funding and a professional reserve study?

Here is their response, and my comments (in italics):

Answer: There is no requirement in the Davis-Stirling Act (DSA) [the “Act”] (Civil Code sections 1350 to 1378) that associations create or maintain reserve accounts in any amount. [This is true and accurate.]

The DSA does require that associations with existing reserve accounts, regardless of the amount, provide titleholders [The Act calls them “owners”; so do I and just about everyone else that represents or works with California community associations] with all of the information detailed in Civil Code section 1365. [This is not an accurate statement of California law. What they should have said is that boards of California community associations are required to disclose whether or not their associations have existing reserve accounts and, among other things, their association’s reserve requirements, what money is required for future repair and/or replacement of common area components such as the roof, paint, etc., no matter whether they have or do not have existing reserve accounts.]

The DSA also does not require a professional reserve study. Many so-called reserve study businesses work to persuade associations that they must maintain a specified dollar amount in their existing reserve accounts, but unless an association has them or wants to create them, they are not required. [Really?! This is not what the Act states. These professionally prepared reserve studies are just that, professionally prepared. And because community association boards usually do not have the expertise to do their own reserve study, and as they properly carry out their business judgment responsibilities by relying on the advice of their experts, where else are they going to get the information that they need to comply with the disclosure requirements of the Act than by causing, as the Act requires, reserve studies to be conducted by a reasonably competent and diligent visual inspection?]

Associations that want to start a reserve account and continue to fund it will find in the DSA the necessary notices that must be given to titleholders [owners] and the methods for determining what is to be reported to owners in terms of collections and payments. These standards should be read in their entirety and fully understood before creating any reserve account or reserve funding mechanism. [I agree that every board member should be aware of the requirements of the code, and one reading of Civil Code Section 1365.5 will tell them that they need help complying with the Act, that they cannot comply without expert assistance.]

Regardless of whether a reserve account is created, the board still has a duty to conduct frequent, diligent visual inspections and determine the current estimated replacement cost, estimated remaining life and estimated useful life of each major component. [The board has to conduct frequent inspections? This is NOT what the Act states or requires. Here is what CC 1365.5 states, and note the sections I have bolded (as well as my comments)]

e) At least once every three years, the board of directors shall cause to be conducted a reasonably competent and diligent visual inspection [Note the Act does not say that the board will do the inspection; it says the board will cause a competent and diligent inspection] of the accessible areas of the major components that the association is obligated to repair, replace, restore, or maintain as part of a study of the reserve account requirements of the common interest development, if the current replacement value of the major components is equal to or greater than one-half of the gross budget of the association, excluding the association’s reserve account for that period. The board shall review this study, or cause it to be reviewed [Meaning that someone other then the board will prepare the study], annually and shall consider and implement necessary adjustments to the board’s analysis of the reserve account requirements as a result of that review.

The study required by this subdivision shall at a minimum include [And note these requirements, as most if not all, board members are not qualified to perform these acts]:

(1) Identification of the major components that the association is obligated to repair, replace, restore, or maintain that, as of the date of the study, have a remaining useful life of less than 30 years. 
(2) Identification of the probable remaining useful life of the components identified in paragraph (1) as of the date of the study. 
(3) An estimate of the cost of repair, replacement, restoration, or maintenance of the components identified in paragraph (1). (4) An estimate of the total annual contribution necessary to defray the cost to repair, replace, restore, or maintain the components identified in paragraph (1) during and at the end of their useful life, after subtracting total reserve funds as of the date of the study.
(5) A reserve funding plan that indicates how the association plans to fund the contribution identified in paragraph (4) to meet the association’s obligation for the repair and replacement of all major components with an expected remaining life of 30 years or less, not including those components that the board has determined will not be replaced or repaired. The plan shall include a schedule of the date and amount of any change in regular or special assessments that would be needed to sufficiently fund the reserve funding plan.

And now back to the Times article…

Check to see whether your association’s covenants, conditions and restrictions require a reserve account. If so, follow the law as set forth in the DSA. [Huh? This is not correct. Compliance with the Act is not conditioned on whether the CC&Rs require a reserve account, and many older sets of CC&Rs do not even mention reserves.] Although some association boards may look on reserve funds as their own petty cash or slush fund, this is not the purpose of a reserve fund. [Correct and accurate statement.]

Reserve funds are not recoverable when an owner sells a home or loses it to foreclosure. If the funds are not used during the owner’s time at that association, the money paid into the reserve by the owner becomes a nonrefundable gift of the owner’s cash to the association and is not tax-deductible. [This is nonsense. Owners do not pay money into reserves; reserves are part of an association’s budget and are funded through the assessments owners pay. Reserves belong to the association and are part of the assets of the association that pass to the new owner upon sale.]

What is the lesson here? Rely on the advice of real community association legal experts, as not everything you read in the newspaper or on the Internet is true or accurate. Be sure to confirm that the source of the information is really an expert.

David Swedelson can be contacted at:

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