Can a board legally borrow money from reserves to purchase something not reserved or budgeted? (FL, Florida HOA)

Our board came up with a clever and creative way to avoid a special assessment! What are your thoughts?

Our Florida HOA has always funded reserves for specific purposes and the underlying estimates for our reserves seem reasonable but no one has ever checked or verified them.

Our governing documents do not address how our reserves are supposed to be spent but Florida Statute 720 “Budget” state: (h) Reserve funds and any interest accruing thereon shall remain in the reserve account or accounts and shall be used only for authorized reserve expenditures unless their use for other purposes is approved in advance by a majority vote at a meeting at which a quorum is present.

Facts: Our board wants to spend $35,000 to purchase pretty lamp posts but does not want to impose a special assessment for reasons not disclosed. We have zero reserves set aside for this purpose. It is doubtul that members would approve the funding of this expenditure. The board wants to fund this purchase by “borrowing funds from existing reserves” by creating a loan and paying ourselves.

? Is this fake loan unethical and a violation of fiduciary responsibilities?
? What action can members take if a check is disbursed for this purpose that does not appear to comply with governing laws?
? Should we start with filing a police report followed by a legal course of action?
? Any suggestions?

Banks are starting to tighten lending standards. If you have unfunded reserves, you run the risk of banks looking at it and turning down loans for your development/condos. So unless your buyer can pay cash, and no loan, your house wont sell. This will drastically lower house prices because its a small pool of buyers. New homeowners could quickly find their home loans underwater.

If I may make an analogy: Let's say you want to purchase a brand new Corvette from ABC Cars for $30K to replace the one you acquired just two years before. You just want a different color because you are tired or the red one. So you convince the 401K administrator to give you a hardship loan from your retirement funds to pay funeral expenses of a family member. (401 K funds are our reserves, 401K funds are the members of our HOA). This is the scenario that is playing out this week.

Steve: No traditional lender is sought since our financial statements would never pass any underwiting muster tests. No review or audit has never occurred. This is a "fake" loan from reserves to justify being able to pay a third party to use funds that are designated for a different purpose.

I see the funding of this via a special assessment or from a third party loan. BUT NOT FROM SPECIFIC RESERVES . Am I missing something? Isn't this a misuse of reserves in most every sense of governing laws and business ethics?

Melissa: No security issues exist - These are existing lights we presently rent from the utility company. Board presented a plan to purchase them utility company with some sort of cost reduction cost over the next 10 years. We would not actually own them outright because they are utility conduits or something. My question pertains to use of reserves not designated for this purpose.

Petunka: FL law appears straightforward about reserves and how they are supposed to be used. If $100K is meant to replace roofs I interpret the law to impply that money is not spent to erect a Tiki Bar at the pool. Please advise what is "out of context" with my quote from FS 720 and kindly refer one that is correct in your mind.

Thanks.

Kim,

Borrowing from reserves is neither clever nor creative. It's actually a rather common method of avoiding a special assessment, and is permitted in many states and HOAs.

Some reserves are set aside for a long-term major expense, like replacing roofs or repaving roads. As long as what has been aside for such purposes is not needed immediately, it's quite normal to "borrow" that money and replace it over a period of a few short years by increasing the annual assessment by a smaller amount to cover the repayment of the loan. That's a lot easier on the homeowners. Of course, interest should be paid on the loan (to replace the interest that would have been paid had the money not been borrowed).

Of course, the association could also take out a loan from a bank, but the interest on that debt would likely be greater than the interest the association would have to pay by borrowing from itself.

Look at it this way. It's really not a lot different than borrowing from your retirement account to pay for some immediate expense. It's OK (and usually permitted without penalty) as long as you're not planning on retiring in the very near future.

'Petunka: FL law appears straightforward about reserves and how they are supposed to be used. If $100K is meant to replace roofs I interpret the law to impply that money is not spent to erect a Tiki Bar at the pool. Please advise what is "out of context" with my quote from FS 720 and kindly refer one that is correct in your mind.'

Kim,

Unfortunately, Florida is law is NOT straight forward and even attorneys’ opinions vary on this issue. There are basically two ways you can fund the reserves. One, is to follow your docs and the other is to adopt ‘full funding of reserves’ as stated in 720. ONLY under certain conditions, is the ‘full funding’ mandatory. You quoted the provision from 'full funding' of reserves. Are you sure your Association adopted that provision to begin with or, do you follow your By-laws? No way to mix those two.

I do not know what the BOD terms of borrowing money from reserves are, or if there is something 'illegal' about it. Obviously, the money will be returned perhaps by increasing your regular assessments over some period of time in order to avoid special assessment.

My question pertains to use of reserves not designated for this purpose.’

I may be wrong, but this is not a case of co-mingling money.

PS: By the way, pool expenses require special budget.

Doesn't sound like a loan at all. Are you increasing dues or cutting operating expenses to pay back the reserves? If not, its not a loan at all. Your just taking money from reserves to buy something. This leaves the reserves unfunded and unable to pay for future expenses without special assessments. Sounds like your board is putting off a special assessment today, only to issue a special assessment tomorrow. AKA...... kicking the can down the road.

Steve - that's my impression too. But I am unable to find FL law allowing the board to do this without a yes vote of a majority of its members.

We already condoned the practice of writing checks payable to "cash" to save a few bucks, repaid by members in the form of a special assessment. Let's sign a few more blank checks and close our eyes.

The next project could be to fund the purchase of 200 new golf clubs for all homeowners.

Steve, I originally misread your email at first. You make a great point that underfunding reserves could prevent new owners from borrowing money from a bank or other lender. But how would a lender know that an association maintains less than adequate reserves?

I found no Florida law requiring an association to admit or certify that reserves are adequately funded. And it is almost impossible to determine this based upon unaudited financial reports (Hmm - the need for audit/reviews is an entirely different issue). The only documents a lender obtains include an estoppel letter and some sort of certificate denoting approval - what else am I missing?

Our delinquencies are increasing so less people will be repaying the loan.

Our Florida HOA has always funded reserves for specific purposes and the underlying estimates for our reserves seem reasonable but no one has ever checked or verified them. (Kim)

Kim,

please would you clarify what ‘always’ means. Florida law -describing FULL funding of reservers - was signed only four years ago(July 2007) and it is NOT mandatory for all HOAs. It only applies to those Associations where the Developer started ‘reserves’ OR the owners voted for adopting this provision. Does either of these two conditions apply to you?

If not, you could be following your By-laws which could also require funding of reserves but may not require FULL funding of reserves as the law requires. That is the difference.

Yes, audits are different issue. Am sorry I even mentioned it.

PS: FHA, for instance, only requires 10% of the annual budget going into reserves. This is one of the easiest requirements..

Kim,

How did the Board propose to repay this "loan" from the reserves and over how many years?

Petunka: The file attached references treatment of reserves or assements per FS 720, or go to the complete document here: http://www.leg.state.fl.us/statutes/index.cfm?App_mode=Display_Statute&URL=0700-0799/0720/0720.html

Since Day 1 it is my understanding our association began funded reserves specfically. Date of incorporation 1990. I can't find a doc that proves this.

I do not understand how your question "aways... Full Funding". Do you reference a particular section of Florida's HOA laws?

The system is not allowing me to add documents - sorry.

Steve,

we all know that. So, what? You are not offering any solutions. It is not only about the mortgagees but also insurance companies, the stupid laws and I can go on.

Kim,

Am too tired to explain again and again, what the law says and when it applies. In the mean time you should read the statute to determine when it applies and what the difference between ‘full funding’ and ‘partial funding’ of reserves is.You are very intelligent and I have no doubt you will figure it out. After all you said it was ‘straightforward’.

Given the increase in delinquencies and 3 - 5 foreclosures in process....

IT IS ALL ABOUT THE MORTGAGES and ADEQUATE RESERVES!

Thank you Steve. Your advise has been the most valuable piece of information of the day. Something I can share with the board, another reason why they need to think with their heads and not the mouth that feeds them.

Take care, Kim

'I was seeking specific reference to laws I may have overlooked.'

And, I am trying to tell you MAY not understand the law. Nor have you answered my question if the law even applies to you. How convenient.

'Thanks for your responses and commments. My unanswered questions follow:

- What action can members take if a check is disbursed for this purpose without membership approval?

- Should we file a police report and then follow up with a legal course of action if necessary?'

Perhaps your attorney would be the best bet at this point, although I do not undermine the answers you can get here, if any.

Good luck to you and to your police report.

[Emphasis added]


Here's the problem I see with the section you cited, it doesn't answer the question of who is voting or who is the meeting called for.

The Budget section discuss what the Association must do. Therefore, if the membership doesn't vote on the budget, it could be concluded that the meeting could be a meeting of the Board and the issue would only require a majority vote of the Board and not of the membership.

I will be the first one to say that I do not know FL laws and I may have missed something in the thread. Therefore, my interpretation could be flawed. I would recommend that a legal opinion is gotten as to who, per FL 720.303 Item 6, section (h), has the authority to make this decision.

In our HOA the board creates the budget, shares it with homeowners, allows discussion and then the board votes. The budget incorporates reserves based on a formula backed by estimates from vendors. I will try to attach the documenth highlighted which denotes the sections I thought were applicable.

Here are the two key paragraphs one must understand well.

Paragraph (b) says: UNLESS (d) is true the law does not apply and you revert to your governing documents. That simple.

'(b) In addition to annual operating expenses, the budget MAY include reserve accounts for capital expenditures and deferred maintenance for which the association is responsible. If reserve accounts are not established pursuant to paragraph (d), funding of such reserves is limited to the extent that the governing documents limit increases in assessments, including reserves. If the budget of the association includes reserve accounts established pursuant to paragraph (d), such reserves shall be determined, maintained, and waived in the manner provided in this subsection.'

And, paragraph (d) applies only:

1. IF the developer established reserves.
Q: Can you prove the developer established and maintained reserve funds when the Association was turned over to homeowners in 1990s?

2. IF the membership opts-in.
Q: Has the membership voted to adopt this provision for full funding?

I did ask both questions before and you did not answer. Please note, if the developer did not establish reserves AND the membership did not opt-in for dull funding your governing docs prevail. This is an example when Florida chapter does not always govern.

'(d) An association is deemed to have provided for reserve accounts IF reserve accounts have been initially established by the developer OR if the membership of the association affirmatively elects to provide for reserves. If reserve accounts are not initially provided by the developer, the membership of the association may elect to do so upon the affirmative approval of a majority of the total voting interests of the association. Such approval may be obtained by vote of the members at a duly called meeting of the membership or by the written consent of a majority of the total voting interests of the association. The approval action of the membership must state that reserve accounts shall be provided for in the budget and must designate the components for which the reserve accounts are to be established.'

PS: There is no requirement for full funding of reserves by FHA. Only 10% of the annual budget must be in reserves. Any mortgagee is more interested in a number of delinquencies AND % of leased units AND adequate insurance policies.
I know that this is not what you want to hear, but please do not try making it more difficult than it is already.