One of the things I frequently hear from homeowners association and condominium board members is how proud they are that they have managed to keep assessments low, sometimes without an increase for many years. While that may sound like an accomplishment, it can actually be a warning sign. Keeping assessments artificially low, particularly at the expense of properly funding reserves, may be one of the biggest mistakes a Board can make. It may also create legal problems for the Association and potentially its Board members.
The reality is that buildings age, roofs deteriorate, roads need resurfacing, and equipment eventually fails. None of this should come as a surprise. The question is whether the Board has adequately planned for these expenses.
What Does North Carolina Law Require?
Unlike some states, North Carolina does not have a general statutory requirement that every homeowners association or condominium association obtain a reserve study or maintain reserves at a particular funding level. However, that does not mean Boards can simply ignore future maintenance obligations.
As with most community association legal questions, the starting point is the governing documents. Declarations typically establish what the Association is responsible for maintaining, repairing, and replacing. Some also contain specific requirements regarding reserves. Boards need to understand these obligations and make sure they are complying with their governing documents.
Equally important are the fiduciary duties imposed on directors of nonprofit corporations under North Carolina law.
Specifically, N.C.G.S. § 55A-8-30 requires directors to discharge their duties:
1. In good faith;
2. With the care an ordinarily prudent person in a like position would exercise under similar circumstances; and
3. In a manner the director reasonably believes to be in the best interests of the corporation.
These requirements are the basis for what is commonly referred to as the business judgment rule. Generally speaking, the law provides protections to Board members who make informed decisions in good faith, exercise appropriate care, and act in what they reasonably believe to be the best interests of the Association.
Importantly, Board members do not have to make the right decision every time. However, they do need to exercise appropriate care in reaching that decision.
Reserve Studies and the Duty to Make Informed Decisions
For most community associations, one of the Board’s primary responsibilities is maintaining the common elements and other property the Association is obligated to maintain. But how can a Board fulfill that responsibility if it does not know what repairs or replacements may be necessary in the future or how much those projects are likely to cost?
This is where reserve studies become so important. A reserve study helps identify major components the Association is responsible for maintaining, estimates their remaining useful lives and replacement costs, and recommends an appropriate funding plan.
While North Carolina law may not specifically require a reserve study, I would argue that obtaining one is an important part of fulfilling the Board’s fiduciary duties. Remember, most community associations are multimillion-dollar nonprofit corporations being run by volunteer Board members. We cannot expect these volunteers to be experts in construction, engineering, finance, and law. However, we can expect them to rely on professionals who have that expertise.
A Board that obtains a reserve study, considers professional recommendations, and makes informed decisions regarding future funding is in a much better position to defend its actions than a Board that simply ignores anticipated expenses because it does not want to increase assessments.
The Trap of Artificially Low Assessments
One of my biggest pet peeves in the community association industry is the idea that keeping assessments as low as possible is somehow the measure of a successful Board. It is not. The Board’s responsibility is to act in the best interests of the Association, not necessarily to maintain the lowest possible monthly assessment.
Consider an Association facing a $500,000 paving project in ten years. By systematically accumulating reserves, the Association can spread that expense over time among the owners who are benefiting from the roads. Alternatively, the Board could keep assessments low, contribute little or nothing toward the project, and leave a future Board to figure out how to pay for it.
The second approach has not saved the homeowners money. It has simply postponed the expense. Worse, it has shifted the financial burden to future owners who may not have even lived in the community while the roads were deteriorating.
In my opinion, that is not fair and is not what community association living is supposed to be about. Part of living in a community association is sharing the costs of maintaining the community.
Of course, special assessments have their place. However, depending on the governing documents, they may require membership approval, may be limited in purpose, or may otherwise be difficult to implement. There is no guarantee that a special assessment will be available when the Association needs it.
Borrowing may also be an option, but loans come with interest costs and repayment obligations. Neither special assessments nor borrowing should be viewed as a substitute for appropriate long-term planning.
Underfunding Reserves Can Have Other Consequences
Inadequate reserves can create problems beyond simply not having enough money to pay for necessary repairs. Insurance companies are increasingly concerned about the condition of Association property and the risks associated with deferred maintenance. Associations that fail to properly maintain their property may face increased premiums, higher deductibles, coverage restrictions, or difficulty obtaining insurance altogether.
Inadequate reserves and deferred maintenance may also make properties less attractive to potential purchasers and negatively affect property values.
Perhaps most concerning, ignoring known maintenance problems can create safety issues and potential liability. A Board that knows significant maintenance is necessary but chooses to ignore it simply to avoid increasing assessments may have a difficult time arguing that it has fulfilled its fiduciary duties.
The Bottom Line
Board members are entrusted with protecting the Association’s property, finances, and long-term interests. That responsibility extends well beyond the next annual budget or election.
Keeping assessments artificially low may be popular with homeowners, but popularity is not the legal standard by which Board members’ decisions are judged. Good governance requires planning for foreseeable expenses, making informed decisions, and being willing to fund the Association’s actual needs.
Rather than congratulating themselves on keeping assessments unchanged for years, Boards should be asking whether those assessments are sufficient to meet the Association’s obligations, both today and in the future.
It is a much easier conversation to have with homeowners about reasonable assessment increases today than to explain years from now why the Association has no money to pay for a major expense that everyone knew was coming.
By Adam J. Marshall | Law Firm Carolinas
Our attorneys at Law Firm Carolinas are always willing and able to discuss assessments. Should your community association need assistance, one of our community association attorneys would be happy to help.