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).)
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).)
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.”)
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).)
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.”)
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.
(a) The disclosures required by this article with regard to an association or a property shall be summarized on the following form:
Assessment and Reserve Funding Disclosure Summary
For the Fiscal Year Ending _____
(1) The regular assessment per ownership interest is $_____ per ____. Note: If assessments vary by the size or type of ownership interest, the assessment applicable to this ownership interest may be found on page _____ of the attached summary.
(2) Additional regular or special assessments that have already been scheduled to be imposed or charged, regardless of the purpose, if they have been approved by the board and/or members:
Date assessment will be due:
Amount per ownership interest per month or year (If assessments are variable, see note immediately below):
Purpose of the assessment:
_____
_____
_____
_____
_____
_____
_____
_____
_____
_____
Total:
_____
Note: If assessments vary by the size or type of ownership interest, the assessment applicable to this ownership interest may be found on page ____ of the attached report.
(3) Based upon the most recent reserve study and other information available to the board of directors, will currently projected reserve account balances be sufficient at the end of each year to meet the association’s obligation for repair and/or replacement of major components during the next 30 years?
Yes _____No _____
(4) If the answer to (3) is no, what additional assessments or other contributions to reserves would be necessary to ensure that sufficient reserve funds will be available each year during the next 30 years that have not yet been approved by the board or the members?
Approximate date assessment
will be due:
Amount per ownership interest
per month or year:
_____
_____
_____
_____
_____
_____
_____
_____
_____
Total:
(5) All major components are included in the reserve study and are included in its calculations.
(6) Based on the method of calculation in paragraph (4) of subdivision (b) of Section 5570, the estimated amount required in the reserve fund at the end of the current fiscal year is $____, based in whole or in part on the last reserve study or update prepared by ____ as of ____ (month), ____ (year). The projected reserve fund cash balance at the end of the current fiscal year is $____, resulting in reserves being ____ percent funded at this date.
If an alternate, but generally accepted, method of calculation is also used, the required reserve amount is $____. (See attached explanation)
(7) Based on the method of calculation in paragraph (4) of subdivision (b) of Section 5570 of the Civil Code, the estimated amount required in the reserve fund at the end of each of the next five budget years is $______, and the projected reserve fund cash balance in each of those years, taking into account only assessments already approved and other known revenues, is $______, leaving the reserve at ______ percent funded. If the reserve funding plan approved by the association is implemented, the projected reserve fund cash balance in each of those years will be $______, leaving the reserve at ______ percent funded.
Note: The financial representations set forth in this summary are based on the best estimates of the preparer at that time. The estimates are subject to change. At the time this summary was prepared, the assumed long-term before-tax interest rate earned on reserve funds was ____ percent per year, and the assumed long-term inflation rate to be applied to major component repair and replacement costs was ____ percent per year.
(b) For the purposes of preparing a summary pursuant to this section:
(1) “Estimated remaining useful life” means the time reasonably calculated to remain before a major component will require replacement.
(2) “Major component” has the meaning used in Section 5550. Components with an estimated remaining useful life of more than 30 years may be included in a study as a capital asset or disregarded from the reserve calculation, so long as the decision is revealed in the reserve study report and reported in the Assessment and Reserve Funding Disclosure Summary.
(3) The form set out in subdivision (a) shall accompany each annual budget report or summary thereof that is delivered pursuant to Section 5300. The form may be supplemented or modified to clarify the information delivered, so long as the minimum information set out in subdivision (a) is provided.
(4) For the purpose of the report and summary, the amount of reserves needed to be accumulated for a component at a given time shall be computed as the current cost of replacement or repair multiplied by the number of years the component has been in service divided by the useful life of the component. This shall not be construed to require the board to fund reserves in accordance with this calculation.
(Amended by Stats. 2016, Ch. 714, Sec. 8. Effective January 1, 2017.)
The summary of the association’s reserves required by paragraph (2) of subdivision (b) of Section 5300 shall be based on the most recent review or study conducted pursuant to Section 5550, shall be based only on assets held in cash or cash equivalents, shall be printed in boldface type, and shall include all of the following:
(a) The current estimated replacement cost, estimated remaining life, and estimated useful life of each major component.
(b) As of the end of the fiscal year for which the study is prepared:
(1) The current estimate of the amount of cash reserves necessary to repair, replace, restore, or maintain the major components.
(2) The current amount of accumulated cash reserves actually set aside to repair, replace, restore, or maintain major components.
(3) If applicable, the amount of funds received from either a compensatory damage award or settlement to an association from any person for injuries to property, real or personal, arising out of any construction or design defects, and the expenditure or disposition of funds, including the amounts expended for the direct and indirect costs of repair of construction or design defects. These amounts shall be reported at the end of the fiscal year for which the study is prepared as separate line items under cash reserves pursuant to paragraph (2). Instead of complying with the requirements set forth in this paragraph, an association that is obligated to issue a review of its financial statement pursuant to Section 5305 may include in the review a statement containing all of the information required by this paragraph.
(c) The percentage that the amount determined for purposes of paragraph (2) of subdivision (b) equals the amount determined for purposes of paragraph (1) of subdivision (b).
(d) The current deficiency in reserve funding expressed on a per unit basis. The figure shall be calculated by subtracting the amount determined for purposes of paragraph (2) of subdivision (b) from the amount determined for purposes of paragraph (1) of subdivision (b) and then dividing the result by the number of separate interests within the association, except that if assessments vary by the size or type of ownership interest, then the association shall calculate the current deficiency in a manner that reflects the variation.
(a) 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, 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, annually and shall consider and implement necessary adjustments to the board’s analysis of the reserve account requirements as a result of that review.
(b) The study required by this section shall at a minimum include:
(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.
(c) For purposes of this section, “major components” includes gas, water, and electrical service to the extent that the association is responsible for repair or replacement of those lines pursuant to Section 4775.
(a) Notwithstanding a contrary provision in the governing documents, an association shall distribute an annual budget report 30 to 90 days before the end of its fiscal year.
(b) Unless the governing documents impose more stringent standards, the annual budget report shall include all of the following information:
(1) A pro forma operating budget, showing the estimated revenue and expenses on an accrual basis.
(2) A summary of the association’s reserves, prepared pursuant to Section 5565.
(3) A summary of the reserve funding plan adopted by the board, as specified in paragraph (5) of subdivision (b) of Section 5550. The summary shall include notice to members that the full reserve study plan is available upon request, and the association shall provide the full reserve plan to any member upon request.
(4) 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.
(5) A statement as to whether the board, consistent with the reserve funding plan adopted pursuant to Section 5560, 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.
(6) A statement as to the mechanism or mechanisms 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.
(7) A general statement addressing the procedures used for the calculation and establishment of those reserves to defray the future repair, replacement, or additions to those major components that the association is obligated to maintain. The statement shall include, but need not be limited to, reserve calculations made using the formula described in paragraph (4) of subdivision (b) of Section 5570, and may not assume a rate of return on cash reserves in excess of 2 percent above the discount rate published by the Federal Reserve Bank of San Francisco at the time the calculation was made.
(8) A statement as to whether the association has any outstanding loans with an original term of more than one year, including the payee, interest rate, amount outstanding, annual payment, and when the loan is scheduled to be retired.
(9) A summary of the association’s property, general liability, earthquake, flood, and fidelity insurance policies. For each policy, the summary shall include the name of the insurer, the type of insurance, the policy limit, and the amount of the deductible, if any. To the extent that any of the required information is specified in the insurance policy declaration page, the association may meet its obligation to disclose that information by making copies of that page and distributing it with the annual budget report. The summary distributed pursuant to this paragraph shall contain, in at least 10-point boldface type, the following statement:
“This summary of the association’s policies of insurance provides only certain information, as required by Section 5300 of the Civil Code, and should not be considered a substitute for the complete policy terms and conditions contained in the actual policies of insurance. Any association member may, upon request and provision of reasonable notice, review the association’s insurance policies and, upon request and payment of reasonable duplication charges, obtain copies of those policies. Although the association maintains the policies of insurance specified in this summary, the association’s policies of insurance may not cover your property, including personal property or real property improvements to or around your dwelling, or personal injuries or other losses that occur within or around your dwelling. Even if a loss is covered, you may nevertheless be responsible for paying all or a portion of any deductible that applies. Association members should consult with their individual insurance broker or agent for appropriate additional coverage.”
(10) When the common interest development is a condominium project, a statement describing the status of the common interest development as a Federal Housing Administration (FHA)-approved condominium project pursuant to FHA guidelines, including whether the common interest development is an FHA-approved condominium project. The statement shall be in at least 10-point font on a separate piece of paper and in the following form:
“Certification by the Federal Housing Administration may provide benefits to members of an association, including an improvement in an owner’s ability to refinance a mortgage or obtain secondary financing and an increase in the pool of potential buyers of the separate interest.
This common interest development [is/is not (circle one)] a condominium project. The association of this common interest development [is/is not (circle one)] certified by the Federal Housing Administration.”
(11) When the common interest development is a condominium project, a statement describing the status of the common interest development as a federal Department of Veterans Affairs (VA)-approved condominium project pursuant to VA guidelines, including whether the common interest development is a VA-approved condominium project. The statement shall be in at least 10-point font on a separate piece of paper and in the following form:
Certification by the federal Department of Veterans Affairs may provide benefits to members of an association, including an improvement in an owner’s ability to refinance a mortgage or obtain secondary financing and an increase in the pool of potential buyers of the separate interest.
This common interest development [is/is not (circle one)] a condominium project. The association of this common interest development [is/is not (circle one)] certified by the federal Department of Veterans Affairs.
(12) A copy of the completed “Charges For Documents Provided” disclosure identified in Section 4528. For purposes of this section, “completed” means that the “Fee for Document” section of the form individually identifies the costs associated with providing each document listed on the form.
(c) The annual budget report shall be made available to the members pursuant to Section 5320.
(d) The summary of the association’s reserves disclosed pursuant to paragraph (2) of subdivision (b) shall not be admissible in evidence to show improper financial management of an association, provided that other relevant and competent evidence of the financial condition of the association is not made inadmissible by this provision.
(e) The Assessment and Reserve Funding Disclosure Summary form, prepared pursuant to Section 5570, shall accompany each annual budget report or summary of the annual budget report that is delivered pursuant to this article.
For the purposes of this article, the following definitions shall apply:
(a) “Association records” means all of the following:
(1) Any financial document required to be provided to a member in Article 7 (commencing with Section 5300) or in Sections 5565 and 5810.
(2) Any financial document or statement required to be provided in Article 2 (commencing with Section 4525) of Chapter 4.
(3) Interim financial statements, periodic or as compiled, containing any of the following:
(A) Balance sheet.
(B) Income and expense statement.
(C) Budget comparison.
(D) General ledger. A “general ledger” is a report that shows all transactions that occurred in an association account over a specified period of time.
The records described in this paragraph shall be prepared in accordance with an accrual or modified accrual basis of accounting.
(4) Executed contracts not otherwise privileged under law.
(5) Written board approval of vendor or contractor proposals or invoices.
(6) State and federal tax returns.
(7) Reserve account balances and records of payments made from reserve accounts.
(8) Agendas and minutes of meetings of the members, the board, and any committees appointed by the board pursuant to Section 7212 of the Corporations Code; excluding, however, minutes and other information from executive sessions of the board as described in Article 2 (commencing with Section 4900).
(9) Membership lists, including name, property address, mailing address, email address, as collected by the association in accordance with Section 4041 where applicable, but not including information for members who have opted out pursuant to Section 5220.
(10) Check registers.
(11) The governing documents.
(12) An accounting prepared pursuant to subdivision (b) of Section 5520.
(13) An “enhanced association record” as defined in subdivision (b).
(14) “Association election materials” as defined in subdivision (c).
(15) All inspector’s reports compiled pursuant to Section 5551.
(b) “Enhanced association records” means invoices, receipts, and canceled checks for payments made by the association, purchase orders approved by the association, bank account statements for bank accounts in which assessments are deposited or withdrawn, credit card statements for credit cards issued in the name of the association, statements for services rendered, and reimbursement requests submitted to the association.
(c) “Association election materials” means returned ballots, signed voter envelopes, the voter list of names, parcel numbers, and voters to whom ballots were to be sent, proxies, the candidate registration list, and the tally sheet of votes cast by electronic secret ballot. Signed voter envelopes may be inspected but may not be copied. An association shall maintain association election materials for one year after the date of the election.
“Reserve account requirements” means the estimated funds that the board has determined are required to be available at a specified point in time to repair, replace, or restore those major components that the association is obligated to maintain.
