Category Archives: Topic Index

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).)

Personal Agriculture & Food Gardens

Civil Code Section 4750 provides homeowners within HOAs limited rights to use their backyards for “personal agriculture” (i.e., food gardens). It renders void and unenforceable any provision of a HOA’s governing documents that “effectively prohibits or unreasonably restricts the use of a homeowner’s backyard for personal agriculture.” (Civ. Code § 4750(b).)

“Personal Agriculture” & “Plant Crops” Defined
For the purposes of Section 4750, “personal agriculture” is defined as:

“…a use of land where an individual cultivates edible plant crops for personal use or donation.” (Civ. Code § 4750(a); Civ. Code § 1940.10(a)(2).)

“Plant crops” are further defined as:

“…any crop in its raw or natural state, which comes from a plant that will bear edible fruits or vegetables. It shall not include marijuana or any unlawful crops or substances.” (Civ. Code § 1940.10(a)(3).)

Limitations
The rights afforded to homeowners under Section 4750 are not absolute and are subject to the following limitations:

Personal Use or Donation Only – the definition of “personal agriculture” includes edible plant crops grown for “personal use or donation.” (Civ. Code § 4750(a); Civ. Code § 1940.10(a)(2).) “Personal agriculture” would therefore not include edible plant crops which are grown for sale or other commercial purposes.
No Marijuana or Unlawful Substances – the definition of “plant crops” does not include “marijuana or any unlawful crops or substances.” (Civ. Code § 1940.10(a)(3).)
Personal Property or Exclusive Use Common Area Only – Section 4750 extends only to the use of a homeowner’s backyard or a yard that is “designated for the exclusive use of the homeowner” (i.e., an exclusive use common area yard or patio). (Civ. Code § 4750(a),(d).) This language suggests that homeowners do not have the right to use the HOA’s general common areas (those common areas which are not exclusive use common areas) for personal agriculture.
“Reasonable Restrictions” Permitted – Section 4750 does not apply to provisions of a HOA’s governing documents “that impose reasonable restrictions on the use of a homeowner’s yard for personal agriculture.” (Civ. Code § 4750(c)(1).) The issue of “reasonable restrictions” is discussed further below.
Rules Requiring Clearance of Dead Plant Materials & Weeds – Section 4750 does not prohibit a HOA from applying rules and regulations “requiring that dead plant material and weeds…are regularly cleared from the backyard.” (Civ. Code § 4750(e).) However, those rules and regulations may not apply to “straw, mulch, compost, and other organic materials intended to encourage vegetation and retention of moisture in the soil.” (Civ. Code § 4750(e).)

“Reasonable Restrictions” on Personal Agriculture
Section 4750 does not apply to provisions of a HOA’s governing documents “that impose reasonable restrictions on the use of a homeowner’s yard for personal agriculture.” (Civ. Code § 4750(c)(1).) “Reasonable restrictions” are defined as:

“…restrictions that do not significantly increase the cost of engaging in personal agriculture or significantly decrease its efficiency.” (Civ. Code § 4750(c)(2).)

Unlike in the context of solar panels, the Civil Code does not define what types of restrictions on the use of a homeowner’s yard for personal agriculture that would result in a “significant” increase in cost or decrease in efficiency.

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.”)

Utility Services as “Major Components”
The term “major components” for the purposes of Section 5550 includes gas, water and electrical service to the extent the association is responsible for repair or replacement of those lines pursuant to Civil Code section 4775. (Civ. Code § 5550(c).)

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.

Directors Serving on Committees

There are no general legal restraints on a director’s ability to also serve on a HOA committee, unless the provisions of an association’s governing documents state otherwise. Some sets of governing documents may even require a board member (typically the board president) to serve as a member of every committee (referred to as an “ex officio” member). However, as discussed below, if there are a sufficient number of directors serving on a committee to establish a quorum of the board, it may trigger the need to comply with Open Meeting Act requirements.

Open Meeting Act Issues
HOA board meetings are subject to the requirements contained in the Open Meeting Act. A “board meeting” is defined as:

“…A congregation, at the same time and place, of a sufficient number of directors to establish a quorum of the board, to hear, discuss, or deliberate upon any item of business that is within the authority of the board.” (Civ. Code § 4090(a) (Emphasis added).)

Thus, if there are enough directors serving on a committee so as to establish a quorum of the board, and the committee heard, discussed or deliberated upon any item of business that is was within the authority of the board, the committee meeting would constitute a board meeting subject to the Open Meeting Act’s requirements (i.e., requiring notice of the meeting and the posting of an agenda). These concerns are especially relevant in the context of executive committees that are comprised entirely of directors.

Committee Member Qualifications

There is no law that establishes qualifications for persons wishing to serve on a HOA committee. There may be qualifications established in an association’s governing documents; however, those qualifications typically pertain to directors wishing to serve on the board, not to persons wishing to serve as members of a committee. (See “Director Qualifications.”)

Establishing Committee Member Qualifications
Absent contrary provisions in an association’s governing documents, committees are appointed by the board and serve at the pleasure of the board. (Corp. Code §§ 7210, 7212.) Serving at the pleasure of the board allows for the board to appoint and remove committee members at any time, and to also establish specific qualifications that persons must satisfy before being able to serve on a committee. Qualifications commonly utilized by boards in this respect include:

Being a member of the association
Being in “good standing” (i.e., not in violation of the governing documents, delinquent in assessments, etc.)
Not involved in litigation with the association
Attending a minimum number of committee meetings
Being a director (for executive committees)

Executive Committees – Directors Only
The only qualification that would automatically apply to committees is in the context of executive committees. Pursuant to Corporations Code Section 7212(b), only directors (members of the association’s board) are permitted to serve on executive committees.