How Boards Can Survive Unanticipated Court Judgements

By Michael Knighten, Esq.

A homeowners association is obligated to prepare an annual budget to fund anticipated expenses for each fiscal year. The annual budget must take into consideration estimated revenue and expenses on an accrual basis. During the course of a year, there may be additional expenses that were not anticipated. What happens when there is an unanticipated expense such as a large construction project necessitated by life and safety issues or a judgment against a homeowners association? This article will discuss how a homeowners association can pay for an unanticipated judgment.

Recently, a Riverside County Court entered a judgment against a local homeowners association. After the judgment was entered, the Court entered an attorneys’ fees award against the homeowners association in the amount of $873,000. To make the issue more pressing, California judgments gain interest at 10% per year, so each year, there will be over $80,000 in interest added to the judgment. What can a homeowners association do to pay the judgment if it does not have the money in the operating account to make the payment? Subject to any restrictions in the governing documents, there are options. For the purposes of this article, we will assume the homeowners association has a $1,000,000 annual budget and 300 homeowners, which would make the regular monthly assessments about $278 per member.

ASSESSMENTS

A homeowners association generally has the right to levy regular and special assessments. After an assessment is levied, the next step is collecting the assessment. Typically, homeowners have at least thirty (30) days to pay the assessment, then the homeowners association has to attempt to collect the assessment. For owners on fixed incomes, assessment increases might be impossible to pay all at once. To the extent they cannot pay, the homeowners association would have to utilize collection techniques to obtain the assessments.

A homeowners association can raise regular assessments up to 20% of the assessment from the preceding fiscal year without membership approval, which would be about $55 per month. This means the association will receive about $198,000 per year. While there is no requirement that regular assessments be raised only at the beginning of the fiscal year, many times raising regular assessments in the middle of the year can cause homeowner confusion. Additionally, by raising regular assessments in the middle of the fiscal year, the homeowners association would not be able to raise assessments for the next fiscal year if it already increased regular assessments the maximum amount.

A special assessment is the “bad word” for a homeowners association. Typically, the maximum amount a homeowners association can specially assess members in a fiscal year is 5% of budgeted gross expenses for that fiscal year. In our case, that would be about $166 per member, which would give the association $50,000. This amount would not even pay the interest incurred during a year.

However, there is an exception for an “extraordinary expense” required by an order of a court. In a similar scenario to the Riverside County Court case, a Los Angeles Court appointed a receiver to issue and collect a special assessment because the homeowners association refused to impose an assessment. The receiver cost the homeowners association more money and the judgment continued to incur interest at 10%. This could have been avoided if the board of directors levied the special assessment itself.

BANK LOANS

A nontraditional way to pay for a common expense is to obtain a bank loan. There are various lenders that specialize in loans to homeowners associations, and many charge reasonable interest rates. Before deciding on obtaining a loan, the board of directors should consult with their legal counsel to determine whether the governing documents allow the board of directors to obtain a loan or whether membership approval is necessary. Some governing documents require membership approval before a loan can be obtained, which would take months to accomplish. The advantage of a loan is that it allows for the entire judgment to be paid at once. However, there are some disadvantages such as interest amounts, one-sided loan terms and risks of default on the loan in the event that some homeowners do not make their payments.

CONCLUSION

An unexpected expense can cause issues for a homeowners association, especially if the board of directors is slow to seek guidance from management and counsel regarding the options to pay the expense. In most cases, immediate action can save the homeowners association money and other problems. By seeking guidance, the board of directors can identify the most effective way to raise the necessary capital, even if that means using numerous options to pay the unexpected expense.

Michael Knighten is a partner at Knighten & Parlow PC, located in Palm Desert. Michael has been practicing law in the Coachella Valley since 2005 and focuses his legal practice on representing community associations. He can be reached at (760) 424-2222 or Michael@kplawcorp.com.