Condo Law in California

QUESTION: We have a qualified board who seeks guidance from attorneys and experts when needed. Like most CIDs we have a small faction of owners who claim that almost every act by the board is illegal. They forced us into ADR, which cost us $28,000 in legal fees. There was no resolution and the dissidents walked away. Can we go after the dissidents for the legal costs or do we need to special assess our membership?

ANSWER: Unfortunately, you need to special assess your membership. Dissent is a healthy part of the political process but owners who view all boards as power-hungry law breakers are dead wrong. Moreover, they are harmful to their associations because of their constant disruptive behavior and litigation. It is even worse when they get themselves elected to the board. Once in control, they often impose the very destructive practices they alleged when they were off the board.

Recouping Fees. For better or worse, legal fees are part of an association’s “cost of doing business” and there is no way to recoup them unless a dispute goes to trial (or binding arbitration), the association wins, and fees are awarded to the association. Even then, awards are at the discretion of the judge or arbitrator.

FORECLOSURE AND THE ASSOCIATION’S CREDIT

QUESTION: Regarding your latest newsletter about an association taking over the mortgage via the foreclosure/sale process, your article mentioned that the bank will ultimately foreclose on the association if the mortgage is not paid by the association. What effect would this have on the association’s credit? We have a unit under water and the bank has been postponing the sale date for over a year now.

ANSWER: If the association takes ownership and the bank subsequently forecloses, it will not impact the association’s credit. The loan is in the prior owner’s name and the bank is foreclosing on the unit, not the association. The prior owner’s credit is harmed, not the association’s. Even if the association’s credit were somehow affected, it would be meaningless. Associations normally do not borrow money for consumer goods or to buy property. Typically, the only time they borrow is to make repairs. When that is done, the loan is secured by a special assessment approved by the membership.

Renting the Unit. You mentioned the bank’s continual postponing of the sale date. Too many banks are delaying foreclosures because they don’t want the property on their books nor do they want to pay the association’s monthly dues. As a result, they sit on their hands and do nothing. As I mentioned last week, associations can foreclose on the unit, take possession, and put a renter in the unit until the bank completes its own foreclosure. Because the bank will eventually foreclose, you cannot put the renter on a long-term lease. It should be month-to-month since the bank will want the renter to vacate at some point so it can get the unit ready for sale. To find a renter willing to lease for an uncertain time-period, you need to offer the unit at below-market rents.

Rent Skimming. Boards should be aware that the bank may demand the rents collected by the association per Civil Code 890. If a bank were to make a demand, the board must immediately turn over the rents. I’ve never seen it happen but it’s a possibility and boards should consult with legal counsel before proceeding.

MISLEADING CAMPAIGN

QUESTION: We are a large 55+ community. Elections for the board are coming up shortly. Two candidates were directors in the past but not currently. Their campaign literature is asking residents to “Re-Elect” them. There is potential for confusion, particularly among the very elderly. Is there any constraint, ethically, legally or otherwise against their asking to be “re-elected”?

ANSWER: It is unethical to intentionally wage misleading campaigns. They confuse more than just the very elderly. Those who wish to set the record straight have the right to point out the candidates’ misstatements to the membership.

CUMULATIVE VOTING

QUESTION: One of our members would like to use cumulative voting in our current board election. Our bylaws state that they must announce at the meeting that they will use cumulative voting. We vote by mail with the 2 envelope system so there is no meeting to announce before voting. Can he still use cumulative method and, if so, does he need to announce by another means or perhaps declare it on his ballot?

ANSWER: Since your governing documents allow cumulative voting, you must automatically “announce it” in the ballots you mail to your members. Declaring it at a meeting is no longer required. Civil Code 1363.03(b).

FEEDBACK

Litigious Owners. The comments in last Sunday’s Feedback section by “Phil A.” ring of the excuses used by our problem owners to justify their numerous lawsuits and the colossal waste of our members’ money. The comments you made in your Litigious Owners newsletter two weeks ago are spot-on and describe our HOA to the letter. Insurance companies are making it very difficult for HOAs by rewarding the chronically litigious for their bad behavior. -Caryn B.

Military Delinquencies. I strongly recommend that all of us extend an exemption from collections for those men and women serving our nation. My suggestion is that we also suspend late charges, costs of collection and allow the associations to book these funds as a receivable/asset to the reserves (the total of the deferred amounts). It is far too little for all of us to do in support of our under paid service personnel. -Doug C.

Barking Dogs. If you live in a homeowners association in California, you also live in a civil jurisdiction where the city or county has animal control regulations. They have the power to issue warnings, levy fines and take court action depending upon the severity of the infraction. That said, often times a dual approach can be taken whereby someone could contact both animal control AND the association. As the association may need to take a slower approach, the association can even use the animal control findings as part of its decision making process. -Kerry L.

QUESTION: The board foreclosed on a unit because of unpaid assessments. The trustee sale produced no buyers because the unit was “under water.” Apparently title to the unit transferred to the association. Because there exists a $345K mortgage on the unit, the bank will foreclose. If the bank forecloses, will the bank wipe out the association’s lien and its right to the unpaid assessments?

ANSWER: You don’t have to worry about the bank’s foreclosure wiping out the association’s lien and right to unpaid assessments–that already happened. When the association foreclosed, title transferred to the association (subject to the delinquent owner’s 90-day redemption rights). Once title transfers, the association’s lien is extinguished because it now owns the property. Its collection rights were also extinguished per the single action rule. The board cannot take any further action against the delinquent owner except to evict him/her from the unit once the redemption period ends.

Existing Mortgage. At the trustee’s sale, the association took ownership of the unit subject to the $345,000 mortgage. Because the unit has no equity, there is no economic value to the association in making payments to the lender. This means the lender will ultimately foreclose on the unit. Until then, the board could put a renter in the unit to help offset the lost delinquent assessments. Once the lender forecloses, title transfers to the bank and it starts paying assessments to the association.

More Foreclosures. There appears to be another wave of bank foreclosures on the horizon. That means associations will continue to suffer from delinquencies into the foreseeable future. Accordingly, boards need to be diligent about collecting assessments.

5% SPECIAL ASSESSMENT

QUESTION: Our monthly dues are $50.00 per month. We want to do a $25,000 special assessment which represents 7% of our operating budget for 2010. We will set up a 5-year repayment plan which will make the special assessment less than 5% for each of the five years. Do we still need a vote by the membership?

ANSWER: Yes, you need membership approval. Even though payment is spread over 5 years, the total assessment exceeds the 5% limitation set by statute. Therefore, it needs membership approval. In the alternative, the board could approve a smaller special assessment each year for the next five years.

MILITARY DELINQUENCIES

QUESTION: An owner in our association is on active military duty. He is behind in his HOA dues and is making no effort to make any payments. He is stationed in our town and lives in our association. How do we get this guy to pay?

ANSWER: The Soldiers’ and Sailors’ Civil Relief Act, which protects active duty military personnel, was updated in 2003 and renamed the Servicemembers Civil Relief Act. It protects military personnel on active duty but is limited to protecting them from eviction if their monthly rent does not exceed $1,200. Since the person you described is an owner, the board may do the following: (i) suspend privileges, (ii) suspend voting rights, (iii) lien the unit to secure the association’s debt and then start appropriate collection actions.

Temporary Stay of Enforcement. However, service members or dependents may, at any time during their military service, or within 6 months thereafter, apply to a court for relief of any obligation or liability incurred by the service member or dependent prior to active duty or in respect to any tax or assessment whether falling during or prior to the service member’s active military service. The court may grant stays of enforcement during which time no fine or penalty can accrue.

Payment Plan. If you use a foreclosure company that specializes in condos, they should be familiar with restrictions related to military personnel. I’m a huge supporter of the military, if you can work out a payment plan with him, you should try to do so. However, if he is unable or unwilling to meet his obligations, the board has a duty to protect the association’s interests.

RESERVE TRANSFERS

QUESTION: If the board approved the reserve study, does it need to approve each expenditure when the time comes to replace a given item in the study?

ANSWER: Yes, reserve expenditures need board approval and all transfers require the signatures of two directors. Approvals need to be recorded in the board’s minutes.

BARKING DOG

QUESTION: Our neighbor has barking dogs. We submitted a complaint to the president of the board several weeks ago and received no follow up nor has there been a change in the situation. Are there any regulations about how quickly the board must respond when a complaint is filed?

ANSWER: There is no statute on how soon a board must respond. However, your board has a duty to investigate in a timely manner and take appropriate action to resolve the barking nuisance. The response time should be reasonable and that will vary from situation to situation.

FEEDBACK

Litigious Owners. I believe the best way to reduce litigation is for the HOA to act in compliance with the law and their CC&Rs. Far too often, ignorant power-hungry control-freak directors facilitated by unqualified or unethical property managers break the law or do not act in a fiduciary manner. They fail to live up to their duties and responsibilities. Director’s failures, malfeasance or bad acts leave homeowners with few choices other than to seek relief in court. -Phil A.

RESPONSE: Sometimes litigation is the only way to force a bad board to behave properly. However, it is much better (and much less expensive) to resolve such matters through the election process whenever possible.

QUESTION: Our HOA has some very contentious members at our meetings. Recently, one member rushed another and had to be held back. Our attorney suggested we start video recording the meetings. Some of the contentious members claim it violates the law and we must get permission from every one attending the meeting. Do you have an opinion on this subject?

ANSWER: I agree with your attorney. Recording and especially broadcasting your meetings to the membership will expose hotheads and bullies (both in the audience and on the board), and will go a long way toward establishing civility and decorum. Because board meetings are public forums, the board does not need the permission of attendees to videotape them.

INSURANCE AND
LITIGIOUS OWNERS

QUESTION: Our association has been sued several times by one of the members. The legal fees have been substantial and the board is concerned they may lose their directors insurance. Do you know if there is a “high risk” insurance pool for homeowner associations?

ANSWER: Associations that lose their insurance because of repeated litigation from problem owners can still get insurance through “excess and surplus lines” carriers. However, coverage will be limited, deductibles high, and premiums significant. Carriers who write “hard to place” accounts will likely be non-admitted carriers. Moreover, they may exclude known problems, such as actions filed by recognized litigious owners. Your association could anticipate paying higher premiums for about three years until your loss history improves. Once you’ve had no claims for three years, your insurance broker should be able to move you back to a preferred market carrier.

Stopping Litigious Owners. Litigious owners seem to revel in their dysfunctional behavior even though it isolates them and drives up everyone’s dues. Insurance companies exacerbate the problem by settling lawsuits filed by problem owners, i.e., they pay the owner to go away even when the lawsuit has no merit. This only encourages more litigation from the problem owner. He/she crows about “winning” the lawsuit and then waits for an opportunity to file another one. Generally, the only way to stop a litigious owner is to take the owner’s unmeritorious action to trial and beat him/her. Once they are forced to reach into their own pocket to pay the association’s legal fees, they are less likely to jump into another lawsuit. Unfortunately, this strategy is hard to implement because (i) convincing an insurance carrier to stay the course is difficult, and (ii) there is no guarantee the association will win the case (even when it should).

Thank you to Timothy Cline, President Timothy Cline Insurance Agency and Jack Socher, President Socher Insurance Agency for their feedback on surplus lines carriers.

LATE CHARGES ON FINES

QUESTION: Can an association legally charge late fees on fines that are not paid timely? I am talking about disciplinary fines that a board levies following appropriate procedures?

ANSWER: No, late fees cannot be charged against fines. The Davis-Stirling Act allows associations to levy a late charge of 10% or ten dollars, whichever is greater (unless the CC&Rs specify a lesser amount), against delinquent assessments. Civil Code §1366(e).

SURPLUS FUNDS
TO RESERVES?

QUESTION: Regarding your article on surplus budget funds, if an association rolls the excess into next year’s budget, must they be applied to the operating budget or can they go into reserve budget?

ANSWER: Since most associations are underfunded in their reserves, it is usually a good idea to apply those excess funds to the reserves. There seem to be several paths to minimize the tax effect of these transfers. Donald Haney, a CPA who does taxes for homeowners associations, offered these comments:

There are no special requirements or actions required for those HOAs that file 1120H tax returns. The just must pay 30% tax on their “Non-Exempt Function Income” (mostly interest income). If an HOA wants to file federal form 1120 as a technique to obtain the 15% tax rate on their “Non Exempt Function” taxable income under $50,000, then the conventional wisdom is that every year it must comply with Internal Revenue Service (IRS) Revenue Ruling (RR) 70-604 and have their owners vote at the annual meeting to comply with the terms and conditions contained in the ruling. I have no quarrel with that path and respect those professionals who advise their clients to do so. However, I have successfully followed another path without an IRS challenge over the last 33 years.

Without going into all the IRS hierarchical rules, the Internal Revenue Code (IRC) trumps IRS Revenue Rulings. For the last 33 years we have been reporting any “Exempt Function” excess of income over expenses for an HOA in any year as a “Section 118 Contribution to Capital.” In other words, a transfer into the association’s Reserve account. By using this technique we have been able to obtain the desired 15% tax rate result without requiring owners to vote at the annual election. There are several nuances to this process and it should not be done without professional advice.

RECOMMENDATION. Tax rules are constantly changing so boards should consult a qualified CPA on how best to handle these kinds of issues. -Adrian

BOARD AUTHORITY FOR
CC&R RESTATEMENT

QUESTION: Do we as a board have the authority to update our CC&Rs and increase our budget to cover the cost? Do we need to take this to the owners for a vote or can we as the board decide to do so given that our CC&Rs are more than 15 years old?

ANSWER: Boards have authority on their own to update CC&Rs, subject to budgetary limitations (5% special assessment and 20% dues increase). However, amended and restated CC&Rs, once drafted, must be approved by the membership.

FEEDBACK

Ranting Boards. In our association the BOARD yells at owners and bad mouths them. Please stop defending boards so much. Some of them are power-mad maniacs. -Trina M.

RESPONSE: When I say that ranting, defamation and threats are never okay, it cuts both ways. It’s never okay for owners and it’s never okay for board members. -Adrian

QUESTION: Most of the owners in our 12-unit association stopped paying their dues. The board is not holding meetings and the management company terminated the account. The insurance has not be paid, the landscape, trash, etc. are not serviced as the vendors haven’t been paid. At this point I think the intent is for all the owners to stop paying dues. Do you know what happens next?

ANSWER: What you describe is quite serious. Without insurance, all owners are personally exposed if someone is injured in your common areas. Each member could be sued and there will be no insurance to defend them or to pay any judgment. Each owner would need to pay out of pocket for an attorney and each could be liable for the entire judgment (joint and several liability). Your association has probably had its corporate status suspended, which means it cannot defend itself against lawsuits. Deferred maintenance will accumulate, leading to water damage and mold in the common areas (more potential litigation). In addition to owners being vulnerable to litigation, directors from the last board of record could be sued for breach of their fiduciary duties. Finally, the market values of your units will plummet to the point of being unsalable. Sellers must disclose to potential buyers the true state of your association’s affairs, and who in their right mind would buy into your association?

Chapter 7 Bankruptcy. A Chapter 7 bankruptcy by your association would likely not be granted. Under this particular filing, a company goes out of business and a trustee is appointed to sell the company’s assets to pay off debts. I don’t see how that is possible for a homeowners association. Associations have no assets of any significance to sell, and the common areas cannot be sold. Moreover, an association cannot realistically go out of business–someone has to maintain the common areas and associations are created specifically for that purpose. Accordingly, I don’t believe a Chapter 7 is possible.

Chapter 11 Bankruptcy. A Chapter 11 bankruptcy (reorganization) is possible if an association has debt and needs time to repay it. The federal bankruptcy court fashions a repayment plan which would likely include a special assessment against all owners to raise funds to pay those debts. It resolves debt issues but not your lack of management.

Court Appointed Custodian. Another option is for one or more members of the association to petition the state court to appoint a third party (a receiver or custodian) to manage the association as provided for in Code of Civil Procedure 564(b)(9). The receiver would have the power to run the association, including the power to assess the membership for all costs needed to pay for operations. The downside is that there are no restrictions on the size or frequency of assessments imposed by the receiver. The membership would have no say in what services were provided, what was repaired or when, or how much is paid for operations and repairs. All of that would be in the hands of the receiver. Moreover, the receiver would likely special assess the membership to pay for his/her services.

RECOMMENDATION: You should immediately seek legal counsel to determine your best course of action. A court-appointed receiver may be the quickest way to limit your exposure, especially since the association has no insurance. If the membership were smart, they would promptly restart association operations.

DELINQUENCIES

QUESTION: I was recently elected to an HOA board and found out that the board just wrote off $40,000 in bad debt. The association is financially in poor condition and not stable, with hardly any reserves. According to the financial statement I saw this past week, another $55,000 is now owed by other homeowners.

ANSWER: If the board is sitting on its hands and doing nothing to collect delinquent assessments, they are in breach of their fiduciary duties. I know it is uncomfortable for boards to initiate collection actions against their neighbors, many of whom are financially stressed through no fault of their own. However, failure to take action puts a greater financial burden on everyone else. The board needs to get dues-paying owners into those units as soon as possible.

NO SUPER-MAJORITY FOR
SPECIAL ASSESSMENTS

QUESTION: If our CC&Rs from 1963 say a 2/3 vote is needed for a special assessment, does the HOA follow the CC&Rs or can they go by the current law which requires a quorum of more than 50%?

ANSWER: The quorum for special assessments is set by statute. Regardless of anything to the contrary in your CC&Rs, special assessments are approved by a majority of the members casting votes once a quorum has been established. The Davis-Stirling Act defines a quorum to mean more than 50% of the owners. Civil Code 1366(b). As a result, the 2/3 provision in your CC&Rs is no longer valid.

FEEDBACK

Satellite Dishes. The installation of satellite dishes has proved to be a boost to my waterproofing business; installers just come out and slam them in willy nilly, causing leaks and lots of damage.

Dishes drilled into decks void warranties on the deck waterproofing. Mounting holes drilled through stucco damage or destroy the water resistant barrier inside the wall. Water penetrates the wall and deck, traveling into the framing and substrate where dry-rot and termites often result.

Cable wires are often attached to the stucco with nails driven through the top of the wall, allowing water to funnel into the building cavity. Cables are supposed to be installed so the wire forms a “J” allowing water to run off the bottom of the J, instead of going into the wall.

Boards need to write rules and enforce them when it comes to satellite dishes and water intrusion! -Bill Leys, The Deck Expert

Attorneys at Board Meetings. Excellent depiction of problem owners in “Attorneys at Board Meetings”, but the second half of the question went unanswered: What is an association supposed to do when everyone in the association has either been terrorized, bullied, defamed or otherwise dissuaded from participating on the board? In some associations it gets so bad that owners sell their units rather than deal the problems, terrorism, bullying, defamation, name calling, etc. What is an association to do? -Jim A.

RESPONSE: Recruiting volunteers is a growing problem. For more detail, see: “Losing Entire Boards.”

Ranting Owners. I take serious exception your January 31st newsletter regarding the ability of one person, whether a fellow director or a member of the audience, to generate chaos and drive up legal expenses. “Their ranting, defamatory communications, and threats can force good directors off boards and create a large spike in legal expenses…” Is the general manager and the board of directors always right and the complaining homeowner always wrong?? Are you suggesting that a homeowner never has legitimate reason for complaint? -V.F.

RESPONSE: Complaining is okay. Ranting, defamation and threats are never okay. -Adrian