Can You Legally Borrow from Reserves?

By Karyn A. Larko, Esq.

When faced with unexpected expenses that cannot be deferred, boards will often look toward their association’s reserves as the solution. While the use of reserve funds may be the best solution in certain circumstances, it is important that boards understand the restrictions and requirements for using reserves so they do not inadvertently run afoul of California law. Knowing the following will help you guide your boards in this regard.

In accordance with California Civil Code (“CC”) §5510(b), a board may only use funds designated for reserves for:

• Maintaining, repairing, restoring and replacing major components the association is obligated to maintain, repair, restore or replace, for which the reserve fund was established;

• Litigation pertaining to the maintenance, repair, restoration and replacement of these components.

The CC&Rs for an association generally identify, at least broadly, the components for which the association is responsible. To the extent the CC&Rs do not address this issue, CC §4775(a) provides for a default allocation of responsibility. Further, CC §4775(a) states that unless the CC&Rs provide otherwise, an association is responsible for maintaining, repairing and replacing the common area, and repairing and replacing exclusive use common area.

Having well-funded reserves is important. A robust reserve account enables an association to fulfill its maintenance, repair and replacement responsibilities, thereby helping to, among other things, preserve property values and the appearance of the community. A robust reserve account also reduces the likelihood of the need to impose a special assessment or borrow to fulfill these obligations.

There is another benefit to having well-funded reserves – access to a quick source of funds in the event of an unanticipated expense or short-term cashflow deficiency.

Borrowing from Reserves

Although CC §5510(b) limits the purposes reserve funds can be used for, CC §5515 allows boards to temporarily borrow from reserves for other purposes, provided:

• The board votes to borrow from reserves in a duly noticed open session board meeting. The agenda for the meeting must state that the board intends to consider a transfer from reserves, as well as the reason(s) the transfer is needed, some of the options for repaying reserves and whether a special assessment will be considered.

• If the board approves the transfer, the minutes of the meeting must include the board’s reason(s) for needing the transfer, and when and how the reserve account will be repaid.

CC §5515 requires that funds borrowed from reserves be repaid within one year of the date of the transfer or the date of the initial transfer if more than one transfer is made.

It is possible to extend the repayment period beyond one year if the board determines it is in the best interests of the association to do so, provided the board follows the same procedure required to initially make the transfer. The CC does not define the term “temporary.” However, it is clear that an extension of more than a year or multiple extensions is not contemplated by the law. Moreover, CC §5515 mandates that boards exercise “prudent fiscal management in maintaining the integrity of the reserve account”, and requires them to levy, if necessary, a special assessment to fully repay reserves. Extending repayment by more than a year would likely not constitute prudent fiscal management in maintaining the integrity of the reserves.

Why Borrow?

When faced with an unexpected expense, especially one that cannot be delayed, and insufficient operating income to cover it, borrowing from reserves is the quickest way to obtain the needed funds.

Obtaining funds through an increase in regular assessments or the imposition of a special assessment takes at least 30 days because CC §5615 mandates that members be given at least 30 days prior notice of assessment increases or special assessment. If a member vote is required to impose the increase or special assessment, the voting process will take at least another 30 days. Further, there is the possibility the members will not approve the measure.

Although a member vote is not required to impose an emergency assessment, it will take at least 30 days to obtain the funds since CC §5615 does not exempt these assessments from the 30-day notice requirement. Further, it is only possible to impose an emergency assessment if the funds are needed to pay an extraordinary expense that is:

• Required by court order;

• Necessary to perform maintenance or repairs for which the association is responsible to abate a threat to personal safety; or

• Necessary to perform maintenance or repairs for which the association is responsible that could not reasonably have been foreseen at the time the board prepared and distributed the most recent budget.

Borrowing is also not a quick process. It takes time to secure a lender and complete the loan process. Oftentimes, this process is made longer by the need for a member vote on the loan, the collateral and/or the assessment needed to repay the loan. Sometimes the reason the funds are needed will disqualify the association for a loan.

Repaying Reserves

The same options are available for repaying reserves as for covering unanticipated expenses, mainly an increase in regular assessments, a special assessment, a loan or a combination of the foregoing. Additionally, depending on the reason the funds were needed, an emergency assessment may be possible.

Additional Practice Tips

The signature of two directors or one director and one non-director officer is always required to withdraw money from a reserve account.

When a board uses reserves to fund litigation, there are notice and reporting requirements. Review CC §5515 to ensure that the notices include all required information.

A special assessment to repay reserves that, individually or in aggregate with other special assessments imposed the same fiscal year, will exceed 5% of the association’s budgeted gross expenses for that fiscal year requires a member vote.

Karyn A. Larko, Esq., is an attorney with Epsten, APC who specializes in community association counsel and has 15 years of experience in the industry. She’s based out of San Diego.