Common Legal Questions About Reserves (No Math Required) By By Laurie S. Poole, Esq., CCAL

Common Legal Questions About Reserves (No Math Required)

By Laurie S. Poole, Esq., CCAL

Community association attorneys are often asked questions about reserves. So long as those questions don’t require mathematics (we went to law school for a reason!), reserve questions are always welcome since there are significant legal requirements governing the board’s treatment of reserves. The following are some of the common legal questions regarding reserves.

How Much Are We Required to Have in Reserves? Many boards ask this question, believing there is a legal requirement for the amount needed to fund reserves. However, the Davis-Stirling Common Interest Development Act does not have any statute that specifically requires associations to fund their reserves. Instead, this duty is implied because boards have a duty to impose regular and special assessments sufficient to perform their obligations under the governing documents. (Civ. Code §5600(a).) Boards also are required to exercise prudent fiscal management in maintaining the integrity of the reserve account.” (Civ. Code §5515.)

In Raven’s Cove Townhomes, Inc. v. Knuppe Development Co. (1981) 114 Cal. App. 3d 783, the court determined that the failure of the developer-controlled board to fund the reserves was a breach of fiduciary duty. Upon their election to the board of a common interest development, directors become fiduciaries with powers to act on behalf of the association. As fiduciaries, directors are held to a higher standard of conduct and have two primary duties: (i) duty of care, and (ii) duty of loyalty. Therefore, even though there is no mandate by the legislature to fund reserves, the prudent course is to fund reserves in accordance with the association's reserve funding plan. To lessen risks, boards should:

• Review and understand the reserve study, follow the reserve funding recommendations – leaning on the fiscally conservative and risk-averse side where possible.

• Rely on advice of your reserve analyst and legal counsel.

"BOARDS 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."

If It’s Not in the Reserve Study, Can We Use Reserve Funds? Boards 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. (Civ. Code §5510(b).) If an association is going to install a new element that doesn’t currently exist (e.g., a “capital improvement”), reserve monies cannot be spent on that element since it is not an item that the association already has the responsibility to repair and replace. However, once the element has been added to the association, the reserve analyst should include that item into the reserves so that future repair and replacement can then be funded out of reserves. The limitation on spending money from the reserves does not prohibit a board from “borrowing” from the reserve account, as authorized by law.

Can we Borrow from Reserves? Boards are allowed to temporarily transfer moneys from the reserve fund to the operating account to meet “shortterm cashflow requirements or other expenses.” (Civ. Code §5515.) Prior to borrowing money from reserves, boards are required to give notice of their intent to borrow by listing it as an item in the meeting agenda. The meeting notice must include the reason the reserve transfer is needed, some of the options for repayment, and whether a special assessment may be considered. If the board authorizes the transfer, it must issue a written finding recorded in the minutes explaining the reasons for the transfer, and describing when and how the money will be repaid to the reserves. Remember that the signatures of two directors are required for reserve withdrawals and the transfer may also require approval of the board. (Civ. Code §5502.)

How Long Do We Have to Pay Borrowed Reserve Funds Back? The transferred funds must be restored to the reserve account within one year of the initial transfer. (Civ. Code §5515(d).) However, the board may temporarily delay restoring the money to the reserve fund if the board makes a finding (supported by documentation) that a temporary delay would be in the best interests of the association. The same meeting notice requirements that apply to the initial borrowing need to be followed when a board determines to delay repayment.

Can We Use Reserve Funds Designated for One Line Item for Other Line Items? The reserve fund is a pool of money and funds can shift between line items in a reserve account as-needed to meet reserve funding needs. It is normal to make adjustments from year to year to reallocate funds to cover items that fail prematurely or cost less than was anticipated.

Laurie Poole, Esq. is a Partner at ADAMS | STIRLING PLC. She can be reached at (800) 464-2817 or Lpoole@AdamsStirling.com.