Loans can be an effective financial tool for community associations. Whether the goal is replacing roofs, renovating pools and other amenities, addressing deferred maintenance, or responding to an unexpected emergency, borrowing may allow an association to complete necessary projects without imposing a large one-time financial burden on owners.
Like any debt, however, a loan is a long-term financial commitment that should be approached carefully. Before signing loan documents, boards should ensure they have the legal authority to borrow, understand the obligations they are assuming, and communicate openly with the membership. Below are several important considerations for North Carolina community associations contemplating a loan. Remember- each community’s documents are different, so always seek legal advice before pursuing financing.
Confirm That the Association Has Authority to Borrow
Not every association has the right to borrow money. Both the North Carolina Planned Community Act and the North Carolina Condominium Act address the right to encumber property and grant security interests. However, the relevant provisions of the Acts are not retroactive. More general authority may exist under the Nonprofit Corporation Act or an association’s covenants or bylaws, but don’t’ assume this is the case. Further, many associations’ documents contain limits on when and how the entity may borrow. Boards need to understand fully their legal rights to borrow before approaching a lender or taking on any application charges. Often a membership vote will be needed, and usually this needs to be obtained before singing a commitment letter with a lender.
Understand What the Association Is Pledging as Collateral
Lenders will require collateral before extending credit to an association. In most, if not all community association loans, the lender requires an assignment of the association’s right to collect assessments as collateral. This assignment provides the lender with security by allowing it, under certain circumstances, to collect assessments directly to satisfy the loan obligation.
The right to collect assessments is generally considered a personal property right. Some governing documents require membership approval before the association may pledge or transfer personal property as collateral. Accordingly, the declaration, bylaws, and any other applicable governing documents should be carefully reviewed to determine whether owner approval is required before loan documents are executed. If a vote for loan approval or an assessment is needed as part of the loan process, the association can ask for approval to grant the security in that same vote.
Make Sure the Loan Is for a Proper Purpose
Having the authority to borrow does not necessarily mean the association may borrow for every purpose.
Some governing documents narrowly define the purposes for which borrowed funds or special assessments may be used. For example, older townhouse declarations sometimes authorize borrowing or special assessments only for improvements to the common area or common elements.
That limitation can create problems if the association intends to finance projects involving owner-maintained property or limited common elements, such as roofs, gutters, or other building components. Before pursuing financing, the board should confirm that both the governing documents authorize borrowing for the specific project being contemplated.
Ensure There Is a Realistic Repayment Plan
Before taking on debt, the board (and its members) need to know how the loan can be repaid. If regular annual assessments will fund repayment, the board must verify that they can continue to collect enough in assessments to service debt, along with fulfilling other ongoing obligations. If repayment depends on a special assessment, that assessment may require membership approval. This is another time sensitive step, and membership approval may be needed very early in the borrowing process.
Communicate with the Membership Early
Whether membership approval is needed for all or part of the loan process, associations should not take on secret debt. Members want to know how their funds are being used and tend not to appreciate learning of loans after the fact, particularly where the amounts borrowed are substantial or payment will take place over an extended period. It is best practices to communicate early and often with members about why a loan is needed, how it will be repaid, and how a loan is preferable to a large special assessment or increased dues. Discussion of these topics during meetings is one good way of sharing information, but don’t assume owners are staying up to date on the minutes. An e-blast or memo to the membership is a good way to share information and proactively address anticipated questions. Typical communications on loan issues will cover:
- why the loan is needed;
- what projects will be funded;
- how the loan will be repaid;
- whether assessments will increase; and
- what benefits the community can expect.
Providing information early gives owners an opportunity to ask questions, understand the board’s reasoning, and build confidence in the decision-making process. In many cases, owners prefer a loan that spreads the cost of major capital projects over time rather than a substantial one-time special assessment.
Borrow Carefully—and Plan for the Long Term
A community association loan is much like a home mortgage: it creates a binding financial obligation that may remain in place for many years. The directors who approve the loan today may no longer be serving on the board when the final payment is made.
For that reason, boards should approach borrowing strategically. Confirm that the association has legal authority to borrow, obtain any required approvals, ensure there is a sound repayment plan, and communicate openly with the membership throughout the process.
When properly structured, a loan can provide the financial flexibility necessary to preserve property values, maintain community assets, and complete significant projects without placing an unreasonable immediate burden on homeowners. Careful planning at the outset helps position both the board and the community for long-term success.
If your board is considering a community association loan, Law Firm Carolinas’ community association attorneys can assist.
Harmony Taylor is a partner with Law Firm Carolinas who regularly represents homeowner and condominium associations on governance, compliance, and litigation matters. She advises boards on director and member meetings and represents associations in state courts and Fair Housing and other discrimination proceedings. Harmony is a Fellow of the College of Community Association Lawyers and an active leader within the Community Associations Institute, including service on the North Carolina Chapter’s Legislative Action Committee and the College’s Board of Governors.