Tag Archives: Reserve Funding Plan

Reserve Account (Generally)

An association’s “reserve account” means both of the following:

“Moneys that the board has identified for use to defray the future repair or replacement of, or additions to, those major components that the association is obligated to maintain.” (Civ. Code § 4177(a).)

“The funds received, and not yet expended or disposed of, from either a compensatory damage award or settlement to an association from any person for injuries to property, real or personal, arising from any construction or design defects.” (Civ. Code § 4177(b).)

The reserve account is thus separate and distinct from the association’s operating account that contains funds used to carry out the association’s day-to-day operations.

Withdrawal, Spending & Disclosure Requirements
Boards are required to “exercise prudent fiscal management in maintaining the integrity of the reserve account.” (Civ. Code § 5515(e).) Failing to do so could not only jeopardize the financial viability of the association and the property values of its members, but could also constitute a breach of the board’s fiduciary duties. (Raven’s Cove Townhomes, Inc. v. Knuppe Dev. Co. (1981) 114 Cal.App.3d 783, 800-801.)

Associations are therefore subject to numerous statutory requirements that serve to:

Limit the purposes for which funds may be expended from the reserve account;
Regulate the procedure through which a board may authorize the temporary transfer (borrowing) of funds from the reserve account without the membership’s approval; and
Require every association to perform a reserve study, and to then use that information to prepare a reserve funding plan and make various reserve disclosures to the association’s membership.

Financial Transfers Requiring Written Board Authorization
Transfers from the association’s reserve account over certain thresholds require written board authorization. (See “Financial Transfers Requiring Written Board Authorization.”)

Reserve Account Expenditures

The health of a HOA’s reserve account is vital to protecting the financial viability of the association and the property values of its members. HOAs are therefore required to perform reserve studies, make various reserve disclosures, and are subject to limitations on the purposes for which funds may be expended from the reserve account.

Spending Restrictions
A board may not spend reserve funds “for any purpose other than the repair, restoration, replacement, or maintenance of, or litigation involving the repair, restoration, replacement, or maintenance of, major components that the association is obligated to repair, restore, replace, or maintain and for which the reserve fund was established.” (Civ. Code § 5510(b).)

Exception: Temporary Transfer (Borrowing) of Reserve Funds
Notwithstanding the above, a board may authorize the temporary transfer of funds from the reserve account to the association’s operating account in order to “meet short-term cash flow requirements or other expenses” without a vote of the membership. (Civ. Code § 5515(a).) The procedure through which the board may validly authorize such a transfer is subject to several requirements (i.e., provide notice of the intent to consider the transfer, issue a written finding as to why the transfer is needed and how the borrowed funds will be restored within one (1) year, etc.). (See “Borrowing Reserve Funds (Reserve Transfers).”)

Signature Requirement
The withdrawal of funds from the reserve account requires the signatures of at least two (2) persons. Those persons must either both be directors, or one officer who is not a director and one director. (Civ. Code § 5510(a).)

Reserve Disclosures

The California Bureau of Real Estate (CalBRE) issued a warning in 2012 in response to a growing number of HOAs with inadequate reserve funds and the resulting problems encountered by those HOAs and their members (i.e., reduced maintenance capabilities, special assessment problems, declining property values, difficulties in securing loans, etc.). These concerns motivated the California Legislature to, in addition to the pre-existing obligation for HOAs to perform reserve studies, increase the number of disclosures HOAs must make on an annual basis regarding their reserve accounts.

Disclosures
The required reserve disclosures are provided to the association’s membership as part of the association’s annual budget report that is prepared pursuant to Civil Code Section 5300, and include all of the following:

Reserve Summary – the association’s reserve summary prepared pursuant to Civil Code Section 5565. (Civ. Code § 5300(b)(2).) The reserve summary is used to disclose the level of deficiencies in the association’s reserves expressed on a per unit basis. (See “Reserve Summary.”)
Reserve Funding Plan – a summary of the reserve funding plan adopted by the board pursuant to Civil Code Section 5550(b)(5). (Civ. Code § 5300(b)(3).) The reserve funding plan indicates the way in which the association will fund the required annual contribution to the reserve account, and includes a schedule of the date and amount of any increases in regular or special assessments that will be needed to sufficiently fund the reserve funding plan. (See “Reserve Funding Plan.”) The summary of the reserve funding plan must also include a notice to members that the full reserve funding plan is available upon request. (Civ. Code § 5300(b)(3).)
Deferred Maintenance Items – a statement as to whether the board has determined “to defer or not undertake repairs or replacement of any major component with a remaining life of 30 years or less, including a justification for the deferral or decision not to undertake the repairs or replacement.” (Civ. Code § 5300(b)(4).)
Anticipated Special Assessments – a statement as to whether the board, consistent with the reserve funding plan, “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 therefor. If so, the statement shall also set out the estimated amount, commencement date, and duration of the assessment.” (Civ. Code § 5300(b)(5).)
Reserve Funding Mechanisms – a statement as to the mechanism(s) by which the board will fund reserves to repair or replace major components, including assessments, borrowing, use of other assets, deferral of selected replacements or repairs, or alternative mechanisms. (Civ. Code § 5300(b)(6).)
Procedures for Calculation and Establishment of Reserves – a general statement addressing the procedures used for the calculation and establishment of those reserves to defray the future repair, replacements, or additions to those major components that the association is obligated to maintain. The statement must include, at the least, reserve calculations using the formula described in Civil Code Section 5570(b)(4), and may not assume a rate of return on cash reserves in excess of two percent (2%) above the discount rate published by the Federal Reserve Bank of San Francisco at the time the calculation was made. (Civ. Code § 5300(b)(7).)
Assessment and Reserve Funding Disclosure Summary form – the annual budget report (whether delivered in full or in summary form) must also be accompanied by the Assessment and Reserve Funding Disclosure Summary form that is prepared pursuant to Civil Code Section 5570. (Civ. Code § 5300(e).)

Disclosure Timeframe
The above disclosures that are included within the annual budget report must be distributed to the association’s members within thirty (30) to ninety (90) days before the end of the association’s fiscal year, regardless of any provisions to the contrary contained in the association’s governing documents. (Civ. Code § 5300(a).)

Reserve Summary

Included within an association’s annual budget report is a reserve summary that is prepared pursuant to Civil Code Section 5565. (Civ. Code § 5300(b)(2).)

General Requirements
Pursuant to Civil Code Section 5565, the reserve summary (1) must be based on the association’s most recent reserve study, (2) must be based only on assets held in cash or cash equivalents, and (3) must be printed in boldface type, and include all of the following:

Current Estimates of Major Components – the current estimated replacement cost, estimated remaining life, and estimated useful life of each major component. (Civ. Code § 5565(a).)
Cash Amounts – as of the end of the fiscal year for which the reserve study is prepared, the reserve summary must include: (1) the current estimate of the amount of cash reserves necessary to repair, replace, restore or maintain major components, (2) the current amount of accumulated cash reserves actually set aside for those purposes, and (3) if applicable, the amount of funds received by the association in connection with a construction defect action. (Civ. Code § 5565(b).)
Percentage Funding – the percentage that the amount of cash reserves actually set aside for the repair, replacement, restoration or maintenance of major components equals the estimated amount of cash reserves necessary for those purposes. (Civ. Code § 5565(c).)
Reserve Deficiency – the current deficiency in reserve funding expressed on a per unit basis. This figure is calculated by subtracting the amount of cash reserves actually set aside for the repair, replacement, restoration or maintenance of major components from the estimated amount of cash reserves necessary for those purposes, and then dividing that result by the number of separate interests within the association. This calculation method may vary somewhat if the association has variable, as opposed to uniform, assessments. (Civ. Code § 5565(d).)

Inadmissible as Evidence of Improper Financial Management
The reserve summary is generally not admissible as evidence to show improper financial management on the part of the association. (Civ. Code §5300(d).)

Reserve Funding Plan

Subject to certain limited exceptions, every association is required to prepare a reserve study at least once every three (3) years with a review to be conducted annually to determine if adjustments are necessary to the association’s reserve account requirements. (Civ. Code §§ 5300(b), 5550(a).) One item of information that must be included within a reserve study is the reserve funding plan. (Civ. Code § 5550(b)(5).)

Purpose
As a component of the reserve study, the association is required to estimate the “total annual contribution” to the reserve account necessary to “defray the cost to repair, replace, restore, or maintain” the major components for which the association is responsible and which have a remaining useful life of less than thirty (30) years. (Civ. Code § 5550(b).) The way in which that “annual contribution” will be funded is indicated by the reserve funding plan. (Civ. Code § 5550(b)(5).)

Schedule of Required Assessment Changes
The reserve funding plan must 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.” (Civ. Code § 5560(a).)

Procedural Requirements

Adopted at Open Board Meeting – The reserve funding plan must be adopted at an open board meeting. (Civ. Code § 5560(b).)
Assessment Increases and Limitations – If the board determines that an increase in regular or special assessments is necessary to fund the reserve funding plan, any such increase is subject to the provisions found within Civil Code Section 5605 (i.e., the board may not, without membership approval, increase regular assessments by more than twenty percent (20%), or special assessments by more than five percent (5%)). (Civ. Code § 5560(c); See also “Limitations on Assessment Increases.”)

Disclosures
Information from the reserve funding plan is disclosed in the association’s annual budget report, as well as the association’s Assessment and Reserve Funding Disclosure Summary form prepared pursuant to Civil Code Section 5570. (See “Annual Budget Report” and “Reserve Disclosures.”)

Summary of Plan Included within Annual Budget Report
A summary of the reserve funding plan must be distributed to the association’s members each year as part of the annual budget report. (Civ. Code § 5300(b)(3).)

Right to Request Full Plan
The summary of the reserve funding plan must include a notice to members that the full reserve funding plan is available upon request, and that the association must provide the full reserve funding plan to any member upon request. (Civ. Code § 5300(b)(3).)

Reserve Study

Except as provided below, all associations are required to prepare a reserve study at least once every three (3) years with a review to be conducted annually to determine if adjustments are necessary to the association’s reserve account requirements. (Civ. Code §§ 5300(b), 5550(a).) Once the study is completed, the study is used to prepare and publish a reserve funding plan. The reserve funding plan is in turn used to prepare and publish the association’s annual budget report that includes various reserve disclosures.

Preparation/Review Requirements & Exceptions
Every association is required to prepare a reserve study at least once every three (3) years:

“At least once every three years, the board shall cause to be conducted a reasonably competent and diligent visual 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…” (Civ. Code § 5550(a).)

Exceptions
The only instances where an association would not be required to prepare a reserve study are when:

(1) There are no common area components that the association is obligated to repair, replace or maintain;

(2) The association is an industrial or commercial common interest development, not a residential common interest development; or

(3) The “current replacement value of the major components” is less than “one-half of the gross budget of the association, excluding the association’s reserve account for that period.” (Civ. Code § 5550(a).)

Annual Review & Adjustments by Board
The board is also required to “review [the reserve] study, or cause it to be reviewed, annually and shall consider and implement necessary adjustments to the board’s analysis of the reserve account requirements as a result of that review.” (Civ. Code § 5550(a).)

Required Contents of Reserve Study
Civil Code Section 5550(b) sets forth the following five (5) items of information which, at a minimum, must be included within a reserve study:

Major Components – The reserve study must identify 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 thirty [30] years.” (Civ. Code § 5550(b)(1).)
Remaining Useful Life of Major Components – The reserve study must identify the “probable remaining useful” of the major components identified in item #1 (above) as of the date of the study. (Civ. Code § 5550(b)(2).)
Estimated Costs of Major Components – The reserve study must include an “estimate of the cost of repair, replacement, restoration, or maintenance” of the components identified in item #1 (above). (Civ. Code § 5550(b)(3).)
Estimated Annual Contribution to Reserve Account – The reserve study must include an “estimate of the total annual contribution necessary to defray the cost to repair, replace, restore, or maintain” the components identified in item #1 (above) “during and at the end of their useful life, after subtracting total reserve funds as of the date of the study.” (Civ. Code § 5550(b)(4).)
Reserve Funding Plan – The reserve study must also include a “reserve funding plan that indicates how the association plans to fund the contribution” identified in item #4 (above) 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.” (Civ. Code § 5550(b)(5); See also “Reserve Funding Plan.”)

Reserve Account Required

There is no explicit statutory requirement for an association to keep and maintain a reserve account, though such requirements are commonly contained within the provisions of an association’s CC&Rs or bylaws. Even where such provisions are absent, the requirement to keep and maintain a reserve account is generally recognized to exist by virtue of related requirements found within the Davis-Stirling Act as well as California court decisions:

Required Special Assessments – Boards are required to “exercise prudent fiscal management in maintaining the integrity of the reserve account, and shall, if necessary, levy a special assessment to recover” funds expended from a reserve account. (Civ. Code § 5515(e).) Exercising prudent fiscal management of a reserve account would, by implication, require the establishment and maintenance of a reserve account.
Duty to Levy Assessments – An association has an affirmative duty to “levy regular and special assessments sufficient to perform its obligations under [its] governing documents and [the Davis-Stirling Act].” (Civ. Code § 5600(a); See also “Duty to Levy Assessments.”) Setting aside a portion of assessment funds in order to perform future repairs or replacements for which the association is responsible is arguably necessary in upholding this duty. Where a board fails to do so, it could constitute a breach of the directors’ fiduciary duties:

“…since the Association’s original directors…admittedly failed to exercise their supervisory and managerial responsibilities to assess each unit for an adequate reserve fund and acted with a conflict of interest, they abdicated their obligation as initial directors of the Association to establish such a fund for the purposes of maintenance and repair. Thus, the individual initial directors are liable to the Association for breach of basic fiduciary duties of acting in good faith and exercising basic duties of good management.” (Raven’s Cove Townhomes, Inc. v. Knuppe Dev. Co. (1981) 114 Cal.App.3d 783, 800-801.)

Not Subject to Fee Limitation Provisions – Civil Code Section 5600(b) does not allow for an association to “impose or collect an assessment or fee that exceeds the amount necessary to defray the costs for which it is levied.” In the case of Foothills Townhome Assn. v. Christiansen, a member of the association challenged a special assessment levied by the board to fund the association’s reserve account on the basis that such action violated the fee limitation contained within Civil Code Section 5600(b): the member argued that the special assessment “exceeded the amount necessary to defray the costs for which it [was] levied” because there was no explicit requirement for the reserve account to be funded in the first place. The Court rejected the member’s argument and held that restoring an association’s reserve account was a valid basis for levying the special assessment.
Reserve Study Requirements – The requirement to establish and maintain an adequate reserve account is further supported by the provisions under Civil Code Section 5550. In sum, those provisions require the board to perform reserve studies and to develop a reserve funding plan to address future repairs or replacements of all major elements with an expected remaining life of thirty (30) years or less.

Fees & Costs for Records

Every member of an association has certain rights to inspect and copy various association records. However, those rights are not absolute, as some records may be validly withheld or redacted by an association. Additionally, an association is entitled to charge a member for certain costs incurred in fulfilling the member’s records request (i.e., copying, mailing and redacting costs); however, the association is generally prohibited from charging the member a fee “that exceeds the amount necessary to defray the costs for which it is levied.” (Civ. Code § 5600(b).)

Copying & Mailing Costs
Where records are copied and mailed by an association in satisfaction of a member’s request, the association may charge the member for the direct and actual cost of copying and mailing the requested records. (Civ. Code §§ 5205(f), 4950(a).)

Redacting Costs
An association may charge the member “an amount not in excess of ten dollars ($10) per hour, and not to exceed two hundred dollars ($200) total per written request, for the time actually and reasonably involved in redacting an enhanced association record.” (Civ. Code § 5205(g).)

Informing the Member of the Anticipated Costs
An association is required to inform the member of the amount of copying and mailing costs, including estimated redacting costs, and the member is required to agree to pay those costs, before providing the member with the requested records. (Civ. Code § 5205(f)-(g).)

Costs for Electronic Transmission of Records
A member has the option of receiving specifically identified records “by electronic transmission or machine-readable storage media so long as those records can be transmitted in a redacted format that does not allow the records to be altered.” (Civ. Code § 5205(h).) In such cases, the “cost of duplication shall be limited to the direct cost of producing the copy of a record in that electronic format.” (Civ. Code § 5205(h).)

Director Record Inspection Rights

A member’s right to inspect and copy various association records is not absolute and may be limited in certain circumstances. (See “Records Not Subject to Inspection.”). However, Corporations Code Section 8334 gives each board member (each director of the association) the “absolute right at any reasonable time to inspect and copy all books, records and documents of every kind and to inspect the physical properties of the corporation of which such person is a director.” Thus, unlike regular members of an association, directors generally (1) are not subject to the requirements of Civil Code Section 5205 (i.e., do not have to pay for the costs in producing records), and (2) have broader record inspection rights than regular members (i.e., can inspect executive session minutes).

Limitations
Notwithstanding the term “absolute” under Corporations Code Section 8334, a director’s record inspection rights may still be limited in order to avoid conflicts of interest, to protect privacy concerns, and/or to protect the association from tortious acts and breaches of fiduciary duties by the director.

Avoid Conflicts of Interest:
“…a corporate director does not have the right to access corporate documents covered by the attorney-client privilege that were generated in defense of a suit for damages that the director filed against the corporation.” (Tritek Telecom, Inc. v. Superior Court (2009) 169 Cal.App.4th 1385, 1387.)

A director’s absolute right to inspect and copy corporate records “is subject to exceptions and may be denied where a disgruntled director announces his or her intention to violate his or her fiduciary duties to the corporation…” (Tritek at 1390.)

Protect Privacy:
A director’s record inspection rights may be limited by the association’s duty to protect the privacy rights of its members in their voting decisions. (Chantiles v. Lake Forest II Master HOA (1995) 37 Cal.App.4th 914, 927 (“…the Association had a duty to guard the privacy of rights of its members in their voting decisions…the Association’s refusal to allow [the director] the unfettered access to the ballots which he demands was not unjustified.”).)

Protect from Tortious Acts:
“Where the corporation determines that an unfettered inspection [by the director] will result in a tort against the corporation, it may decline the request for inspection.” (Havlicek v. Coast-to-Coast Analytical Services, Inc. (1995) 39 Cal.App.4th 1844, 1856.)

*Evidence must Establish Clear Intent to Commit Tort – The mere possibility that information could be used adversely to the corporation is not by itself sufficient to defeat a director’s inspection rights. The evidence must establish the director’s clear intent to use the information to breach fiduciary duties or otherwise commit a tort against the corporation, such that allowing inspection would produce an “absurd result”. (Fowler v. Golden Pacific Bancorp (2022) 80 Cal.App.4th 205, 211.)

Former Directors
A former director loses his/her broad record inspection rights once the former director loses his/her status as a sitting (current) director of the association (i.e., no longer serves on the board.) This is true notwithstanding the fact that the desired record pertains to a decision or action of the former director or of the board while the former director was serving:

“…current director status is required to pursue current inspection rights. This line of cases will not allow enforcement of any absolute director’s right of inspection to a former corporate director, when the reason for the inspection right (holding office and performing fiduciary duties as a director) no longer exists.” (Wolf v. CDS Devco (2010) 185 Cal.App.4th 903, 919.)

Membership List

A member’s right to inspect and copy various association records includes the inspection and copying of the association’s membership list. (Civ. Code § 5210(b)(6); Corp. Code § 8330.) The membership list would include the “name, property address, mailing address, [and] email address, as collected by the association in accordance with Section 4041” of all members except for those who have opted-out of the membership list pursuant to Civil Code Section 5220. (Civ. Code § 5200(a)(9).)

Purpose for the Request
The member requesting the membership list must state the purpose for the request, which must be reasonably related to his or her interest as a member. (Civ. Code § 5225.) If the board reasonably believes that the list will be used for another purpose, it may deny the member’s request. If the request is denied, in any subsequent action brought by the member pursuant to Civil Code Section 5235 the association will have the burden to prove that the member would have used the list for purposes unrelated to his interest as a member. (Civ. Code § 5225; Tract No. 7260 Association, Inc. v. Parker (2017).)

Liability for Misuse of Membership List
The membership list is a corporate asset of the association. (Corp. Code § 8338(a).) Pursuant to Corporations Code Section 8338(a), without consent of the board, the membership list may not be:

(1) Used to solicit money or property unless such money or property will be used solely to solicit the vote of the members in an election to be held by their corporation.

(2) Used for any purpose which the user does not reasonably and in good faith believe will benefit the corporation.

(3) Used for any commercial purpose or purpose in competition with the corporation.

(4) Sold to or purchased by any person.

Any person who misuses a membership list is liable to the association for any damage caused by the misuse, including punitive damages for fraudulent or malicious misuse of the membership list. (Corp. Code § 8338(b); See also “Misuse of Association Records.”) Where the association prevails in an action based upon the misuse of the membership list, the association may recover its costs and expenses, including reasonable attorney’s fees. (Corp. Code § 8338(d).)

Petition to Set Aside Request
Where an association believes the membership list will be used for an improper purpose, it may petition the superior court for an order setting aside the demand for the membership list. (Corp. Code § 8331.)

Copying & Mailing Costs
The association may bill the requesting member for the direct and actual costs of copying and mailing the membership list. The association must inform the member of the amount of the copying and mailing costs, and the member must agree to pay those costs, before the association copies and mails the membership list. (Civ. Code § 5205(f); See also “Fees & Costs for Records.” )

Deadline for Production
The membership list must be provided within the time frame specified in Corporations Code Section 8330 (ten (10) business days). (Civ. Code § 5210(b)(6); See also “Deadlines for Producing Records.”)

Email Addresses
Member email addresses are included within the scope of information contained on an association’s membership list, where such email addresses “were collected by the association in accordance with Section 4041.” (Civ. Code § 5200(a)(9).) Civil Code Section 4041 addresses the annual notice of owner contact information that each owner is required to submit to the association, and which the association must solicit from all members at least thirty (30) days prior to the distribution of the association’s annual budget report. (Civ. Code § 5200(a)(9).)

Membership List Opt-Out
Any member of the association may opt out of having their contact information included on the association’s membership list by notifying the association in writing of the member’s to be contacted by an alternative process. (Civ. Code § 5220.)

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