Category Archives: Finances

Financial Transfers Requiring Written Board Authorization

Civil Code section 5380 contains restrictions and requirements aimed at protecting the integrity of an HOA’s financial accounts. Included among those restrictions and requirements is a prohibition on transfers of certain amounts from an association’s reserve and operating account deposits without prior written approval of the association’s board of directors, as discussed below.

Transfers of Funds Requiring Written Board Approval
“Transfers of funds out of the association’s reserve or operating accounts shall not be authorized without prior written approval from the board of directors…” (Civ. Code § 5380(b)(6).)

Exceptions to Board Approval Requirement
Written approval from the board is not required where the amount of the transfer is less than the following:

Associations with 50 or less separate interests: written board approval is not required if the amount of the transfer is less than five thousand dollars ($5,000) or five percent (5%) of the estimated income in the annual operating budget, whichever is lower. (Civ. Code § 5380(b)(6)(A).)
Associations with 51 or more separate interests: written board approval is not required if the amount of the transfer is less than ten thousand dollars ($10,000) or five percent (5%) of the estimated income in the annual operating budget, whichever is lower. (Civ. Code § 5380(b)(6)(B).)

Financial Statement

At the end of an association’s fiscal year, the association’s CPA prepares a written report regarding the association’s financial condition. The information used in preparing the report includes management representations and statements concerning the association’s assets and liabilities, including any litigation that could have an adverse impact on the association (pursuant to FASB Statement of Financial Accounting Standards No. 5, Accounting for Contingencies).

Unless an association’s governing documents impose more stringent standards, the association must prepare a review of its financial statement in accordance with generally accepted accounting principles (GAAP) by a licensee of the California Board of Accountancy (CBA) for any fiscal year in which the gross income to the association exceeds seventy-five thousand dollars ($75,000). (Civ. Code § 5305.) Some sets of governing documents require an association to perform a formal audit of the financial statement, not merely a review.

Distribution of Review
A copy of the review of the financial statement must be delivered to all of the association’s members within one hundred and twenty (120) days after the close of the association’s fiscal year. (Civ. Code § 5305.)

Individual Delivery Required
The review must be delivered to all members by individual delivery. (Civ. Code § 5305.) This includes any of the following methods: (Civ. Code § 4040.)

First-class mail, postage prepaid, registered or certified mail, express mail, or overnight delivery by an express service carrier; or
E-mail, facsimile, or other electronic means, if the recipient has consented, in writing, to that method of delivery.

Capital Improvements

A capital improvement for a community association is generally understood to include any of the following:

A substantial and discretionary addition to the association’s common area; or
A substantial and discretionary upgrade to the association’s common area components or materials.

Authority to Construct Capital Improvements
There are no laws prohibiting an association from using its funds to construct capital improvements, nor are there any laws requiring the board of directors to obtain the membership’s authorization to construct capital improvements. However, such requirements are commonly contained within the provisions of an association’s governing documents (typically within its CC&Rs). Even where such provisions are absent, the board will likely need to obtain membership approval to generate the funds needed to construct the capital improvement (i.e., to levy a special assessment greater than five percent (5%) of the association’s annual budget). (Civ. Code § 5605(b); See also “Limitations on Assessment Increases.”)

Operating Account

All funds received by an association are deposited into the association’s operating account. A portion of those funds are then transferred into the association’s reserve account according to the association’s reserve funding plan.

Review Requirements
Included within the board’s financial review requirements is the review of information pertaining to the association’s operating account (i.e., review bank account statements, review current reconciliation of the operating account, etc.). (Civ. Code § 5500; See also “Financial Review Requirements.”)

Manager Deposits & Control of Account
Civil Code Section 5380 contains several requirements governing how funds received by a managing agent on behalf of an association must be deposited into certain bank accounts. (See “Deposit of Association Funds by Manager.”)

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

Financial Review Requirements

An association’s board of directors has the affirmative duty to:

Review a current reconciliation of the association’s operating accounts on a monthly basis; (Civ. Code § 5500(a).)
Review a current reconciliation of the association’s reserve accounts on a monthly basis; (Civ. Code § 5500(b).)
Review, on a monthly basis, the current year’s actual operating revenues and expenses compared to the current year’s budget; (Civ. Code § 5500(c).)
Review, on a monthly basis, the latest bank account statements for both the association’s operating and reserve accounts; (Civ. Code § 5500(d).)
Review an income and expense statement for both the association’s operating and reserve accounts on a monthly basis; (Civ. Code § 5500(e).)
Review, on a monthly basis, the check register, monthly general ledger, and delinquent assessment receivable reports; (Civ. Code § 5500(f).) and
Review the association’s most recent reserve study on an annual basis in order to consider and implement any necessary adjustments to the board’s analysis of the HOA’s reserve account requirements. (Civ. Code § 5550(a).)

Notwithstanding the above, the board has the duty to adhere to any more stringent financial review requirements that may be contained in the association’s governing documents. (Civ. Code § 5500.)

Financial Review by Board Independent of Board Meeting
The financial review requirements of Section 5500 discussed above may be met when every individual member of the board, or a subcommittee of the board consisting of the treasurer and at least one other board member, reviews the documents and statements described in Section 5500 independent of a board meeting, so long as the review is ratified at the next board meeting and that ratification is reflected in the minutes of that meeting. (Civ. Code § 5501.)

Bank Loans to HOAs

Authority to Obtain Loan
A HOA’s authority to obtain a loan (borrow money) is generally contained within the provisions of its governing documents—typically its CC&Rs or bylaws. Where such provisions are absent, the authority to obtain a loan is found in Corporations Code Section 7140(i). Section 7140(i) allows corporations to borrow money, subject to any limitations contained in the corporation’s articles or bylaws.

Membership Approval Requirements
Many sets of HOA governing documents contain provisions that require membership approval in connection with obtaining a bank loan for the HOA. Those approval requirements could extend to any of the following issues:

The approval of the special assessment needed to repay the loan over time (see “Limitations on Assessment Increases“);
The approval of the purpose for which the loan is being obtained (i.e., to construct a capital improvement); and/or
The approval required to authorize the board to enter into the loan agreement with the bank.

Qualification Issues
In order for a HOA to be approved for a bank loan, banks often require the HOA to provide the following items of information:

Financial statements and other information regarding the HOA’s overall financial health (i.e., number of delinquencies)
Verification that the HOA carries all of the insurance policies required under its CC&Rs
Verification that the HOA is in “good standing” with the California Secretary of State (i.e., filing income tax returns and paying taxes)
An written opinion from the HOA’s attorney verifying that the HOA has the authority to obtain the desired loan.

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.”)

Borrowing Reserve Funds (Reserve Transfers)

A HOA board is generally prohibited from spending 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); See also “Reserve Account Expenditures.”) Notwithstanding that limitation, the board may, without membership approval, 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.” (Civ. Code § 5515(a).) The procedure through which the board may validly authorize such a transfer is subject to the following requirements:

Notice of Intent to Borrow
The board must first provide notice of its intent to consider the transfer (borrowing) of reserve funds in a notice of board meeting. (Civ. Code § 5515(a).) The notice must include the reasons the transfer is needed, some of the options for repayment, and whether a special assessment may be considered in order to repay the borrowed funds. (Civ. Code § 5515(b).)

Written Finding Explaining Reasons for Transfer & Describing Repayment Method
If the board authorizes the transfer, the board must issue a written finding explaining the reasons the transfer is needed, and describing when and how the transferred funds will be repaid to the reserve account. (Civ. Code § 5515(c).) This written finding must be recorded in the minutes of the board meeting. (Civ. Code § 5515(c).)

Restoration of Funds within One (1) Year
The transferred funds must be restored to the reserve account within one (1) year of the date of the initial transfer. (Civ. Code § 5515(d).)

Exception: Option to Temporarily Delay the Restoration
Notwithstanding the above, the board may, after giving the same notice required for considering the transfer, temporarily delay the restoration. (Civ. Code § 5515(d).) Such a decision must be based upon “a finding supported by documentation that a temporary delay would be in the best interests of the common interest development.” (Civ. Code §5515(d).)

Reserve Funds for Litigation
When the decision is made to use reserve funds or to borrow reserve funds in order to pay for litigation “involving the repair, restoration, replacement or maintenance” of major components for which the association is responsible (i.e., construction defect litigation), the association is required to provide general notice of that decision, and of the availability of an accounting for those litigation expenses. (Civ. Code § 5520(a).) Additionally, the association is required to make an accounting of expenses related to the litigation on at least a quarterly basis, unless the governing documents impose more stringent standards. (Civ. Code § 5520(b).) The accounting must be “made available for inspection” by the association’s members at the association’s office. (Civ. Code § 5520(b).)

Special Assessment Concerns
The board must “exercise prudent fiscal management in maintaining the integrity of the reserve account, and shall, if necessary, levy a special assessment to recover the full amount of the [transferred] funds” within the time limitation discussed above. (Civ. Code § 5515(e).) Any such special assessment is subject to the limitations contained in Civil Code Section 5605 (i.e., the special assessment may not exceed five percent (5%) of the association’s annual budget without membership approval). (Civ. Code § 5515(e); See also “Limitations on Assessment Increases.”) The board has the discretion to extend the date the payment on any such special assessment is due, and any extension does not prevent the board from enforcing the collection of an unpaid special assessment. (Civ. Code § 5515(e).)

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).)

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