8 minute read
How to Make It Safely Through the Disclosure Minefield
BY WILLIAM M. SCHERER, ESQ. & LOUIS J. SARMIENTO, JR., ESQ.
Tread lightly. Dealing with annual disclosures to members, and the related disclosures in the purchase and sale of a lot or unit in a common interest development, can be like walking through a minefield. Both must be done very carefully. Community associations are required to make very specific disclosures to their members throughout the calendar year, and to make specified information available to sellers, which is then passed on to prospective purchasers. To make it safely through, it is helpful to know the history of how and why this minefield was created in the first place.
A Brief History
The mandatory disclosure obligations predate the adoption of the Davis-Stirling Act (DSA) in 1985. In 1983, an urgency amendment to Civil Code §1360 was sponsored by the California Association of Realtors® (CAR). CAR was reacting to the Raven’s Cove case, which held that directors who were employees of the developer were fiduciaries and, among other things, obligated to fund and maintain proper reserves when the board was controlled by the developer. In support of the bill, CAR argued that most associations had “ignored
Continued on page 10
the responsibility to maintain adequate monetary reserves” and that it was therefore important to “establish uniform budgeting disclosure procedures for all homeowners associations.” The bill, as originally drafted, was opposed by none other than the California Department of Real Estate (DRE). Then DRE Commissioner, James Edmonds, Jr. wrote, prophetically, that:
The bill would require every common interest subdivision association, whether it be a condominium, stock cooperative, community apartment project, or planned development, whatever may be its size and whatever may be the extent of its common facilities to make identical reports at specific times. Every homeowners’ association bears a like and onerous burden of reporting.
Today, 37 years after the disclosure obligations were first put into place, many believe that the complex one size fits all system of disclosures has replaced one problem with another. Compliance is not easy, and community managers spend a substantial amount of time simply trying to keep up with the requirements. And too often associations, managers, realtors, sellers, and buyers are frustrated, confused – or sued – over a failure to comply with the dizzying array of disclosure obligations.
We recommend that boards think of disclosures as a two step process. Step one is complying with the annual disclosures to the members. Step two is complying
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Member FDIC with the disclosure obligations in a purchase and sale transaction. Both steps are important, and both carry the risk of putting your foot down in the wrong place. However, if an association has not complied with the first step, it has little hope of complying with the second step of the disclosure process.
Step One – Annual Disclosures
Although often overlooked, one of the most important duties that a board of directors has each year is the duty to review, approve, and then disclose to its members information about the association. See page 13 for a Disclosure Checklist that references the requirements and the timing of the mandatory disclosures, as well as other as-needed disclosures.
In 1985 one of the most important disclosures was the “Pro Forma Operating Budget.” Today, that has expanded and is known as the “Annual Budget Report.” (Civil Code Section 5300, et seq). It is known as the Annual Budget Package because it is more package than report – a collection of documents and statements that tell a story about the association: its financial health, the condition of its buildings, and in some respects, whether it is a functional or dysfunctional community.
One of the most overlooked requirements in the Annual Budget Report is the requirement found at Section 5300(b) (5), which requires that the association tell members:
“…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 therefore. If so, the statement shall also set out the estimated amount, commencement date, and duration of the assessment.
This bears repeating. The board must make a statement as to whether it “anticipates” the need to levy a special assessment in the future to make repairs or provide for adequate reserves. On this subject, reasonable minds may differ. For most older associations, the statement should often be something along the lines of “maybe, it depends.” As shown on the accompanying disclosure chart, step one also involves providing members with year-end financial statements, its collection policy, insurance information, and even notices about the right to receive the disclosures.
Who do the volunteer directors look to for guidance in complying with the requirements of annual member disclosures? Their community managers, of course. And while the obligation to provide this service is not only more than likely in the management contract, and required in the exercise of a manager’s standard of care, in the end it is an association (i.e., a board of directors) responsibility – so all involved must pay attention.
Step Two – Purchase and Sale Disclosures
The Step One information finds its way to a prospective buyer through Step Two, found at Civil Code Section 4525, which requires a seller to “as soon as is practicable” provide specified documents and information to the buyer, including: (1) Governing Documents; (2) a statement regarding age restrictions; (3) the Annual Budget Report, aka Package; (4) a statement regarding assessment levels and past due assessments; Continued on page 12
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How to Make It Safely Through Continued from page 11 (5) any notices to the Owner regarding unresolved violations; (6) a Section 6100 preliminary list of defects (if any); (7) post-litigation defect correction summary (if any) per §6100; (8) changes in assessments approved but not yet due; (9) a summary of any prohibition on rentals; and (10) upon request, the past 12 months of minutes.
The Step Two disclosures have to be delivered to the seller within 10 days of the request, and while fees can be charged, estimates must be provided, and a specified form must be used. A willful failure to comply with Step Two comes with a maximum
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$500 civil penalty, but the real exposure is in a lawsuit for nondisclosure, where a claimant’s damages may include all “actual damages occasioned” by a failure to disclose, and attorney’s fees.
For any association facing the challenge of underfunded reserves, budget shortfalls, and failing buildings, it is best not to address each purchase and sale on an ad hoc basis. Rather, consider implementing a standard process, have it approved by the board and the association’s legal counsel, and then make sure it is followed. Look for our recommendation on that process, and a draft resolution on disclosures, in the next issue of the Echo Journal.
Summary
The board should take an active role in disclosing important information about the association every year and ensuring that prospective purchasers know the association’s story before they become members. This is especially important in aging associations anticipating extraordinary repairs and special assessments. People can deal with bad news, but they really, really hate surprises. In the next issue, a recommended approach to disclosures in these situations will be discussed.
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David F. Feingold, Esq. (left) and Matthew A. Haulk, Esq. (right) practice community association law in the San Francisco Bay Area and are partners in the Marin County law firm of Ragghianti Freitas LLP.
