Developer Looking to Homeowner's Cover Net Loss before Transition

Started by BenjaminD • 11 replies • 2529 views

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BenjaminD (North Carolina)
Posts: 20

Posted:

We are a 9 year old community and with a down economy during that time we had very slow home sales. We have been running the same yearly expenses (approx. $138k/year) every year but just haven't had enough homeowner HOA dues (income) to cover our yearly expenses. The developer has been covering out net losses every year and this year will be the first time (fingers crossed) that we don't have a net loss. In that 9 years time though, the developer has spent $264,500 covering our losses.

We only have 40 lots remaining and are preparing for the HOA control to be turned over to us in the next 2-4 years. We are also mentally preparing for the fact the developer may ask us to pay back the debt. I'm wondering if this is common for homeowners to pay?

In conversations with the developer they mentioned possibly cutting the debt in half when I just hinted at what could be done. Since they were so quick to offer it got me wondering if its common for a builder/developer to have the homeowners pay it back at all? We currently have just short of $2,500 dollars in reserves right now on top of the fact that we know we have some rather large expenses coming up in the next few years.

Thanks in advance for any help!

NpS (Pennsylvania)
Posts: 4,216

Posted:

Do a reserve study. If you are 100% funded, you can pay him the overage (up to the amount that he says he is owed). If not, then he is leaving you with an underfunded reserve - So I don't see why you would pay him anything - unless of course there is something in your organizing docs that says you have to.

Sikubali jukumu. Read all posts at your own risk.

TimB4 (Tennessee)
Posts: 21,059

Posted:

Ben,

Typically a developer will artificially keep assessments low to attract buyers. Personally, I see this as a cost of doing business for the developer. The down side is that the Association typically receives no funds in a Reserve account.

I can't say if it's normal for a developer to ask for those funds back. If they did, I would counter for the assessments they would have paid on the lots they owned. However, the assessments would likely have been waived by the governing documents.

Expect an increase in assessments. There may also be a potential special assessment to fund the Reserves to the level it would have been if the Reserves were properly funded from the beginning. However, it's more typical for the Association to start the Reserves as of the day they gain control of the Association and defer maintenance or simply pay more to the Reserves then they would have had the fund been started earlier.

For more information on Declarant turnover see:
Developer/Homeowner Transition: A Guide To Success

Developer Transition in a Community Association

Best Practices - Transition from the Foundation for Community Association Research (pdf document)

Developertransition.com This website is intended to specifically address the issues facing townhome, condominium, and homeowner associations in North Carolina. [still has good general information as well]

Transistion Plan an HOA's formalized plan for transition.

Subject: HOA transition from developer control to homeowner control Thread in HOATalk that discusses having a Transition Study done by an engineering firm.

I've also attached the checklist that is typically provided by many on this site when there is a discussion about transitioning.

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BenjaminD (North Carolina)
Posts: 20

Posted:

Quote:

Posted By NpS on 04/06/2015 12:09 PM
Do a reserve study. If you are 100% funded, you can pay him the overage (up to the amount that he says he is owed). If not, then he is leaving you with an underfunded reserve - So I don't see why you would pay him anything - unless of course there is something in your organizing docs that says you have to.

Thanks for the reply and I apologize but I am bit novice here. What exactly do you mean when you say "are you 100% funded"?

We just had $42,500 in our reserves but $39k of it just went to resurfacing our pool. Our reserves are only contributed every time someone closes on a new home with a "HOA iniatiation fee". So it's clear that our monthly HOA fee is not enough and it seems that a reserve study should be done.

I will have to do some research to go about starting that process very soon. Thanks for you input!

TimB4 (Tennessee)
Posts: 21,059

Posted:

Ben,

For more information on Reserves, see the following thread in this forum:

Subject: Reserve Studies/Funds 101

There are links on that thread which include video seminars (via you tube) that go from the basics to advance information about Reserve Studies and what is considered 100% funded.

BenjaminD (North Carolina)
Posts: 20

Posted:

Quote:

Posted By TimB4 on 04/06/2015 3:24 PM
Ben,

Typically a developer will artificially keep assessments low to attract buyers. Personally, I see this as a cost of doing business for the developer. The down side is that the Association typically receives no funds in a Reserve account.

I can't say if it's normal for a developer to ask for those funds back. If they did, I would counter for the assessments they would have paid on the lots they owned. However, the assessments would likely have been waived by the governing documents.

Expect an increase in assessments. There may also be a potential special assessment to fund the Reserves to the level it would have been if the Reserves were properly funded from the beginning. However, it's more typical for the Association to start the Reserves as of the day they gain control of the Association and defer maintenance or simply pay more to the Reserves then they would have had the fund been started earlier.

For more information on Declarant turnover see:
Developer/Homeowner Transition: A Guide To Success

Developer Transition in a Community Association

Best Practices - Transition from the Foundation for Community Association Research (pdf document)

Developertransition.com This website is intended to specifically address the issues facing townhome, condominium, and homeowner associations in North Carolina. [still has good general information as well]

Transistion Plan an HOA's formalized plan for transition.

Subject: HOA transition from developer control to homeowner control Thread in HOATalk that discusses having a Transition Study done by an engineering firm.

I've also attached the checklist that is typically provided by many on this site when there is a discussion about transitioning.

Thanks so much for all of the info and I feel like we have a good idea of the things we need to do as we prepare for transition. The biggest unknown is this massive debt and whether or not we will have to pay it back. They are showing it as an accounts payable on our balance sheets so it feels like they are coming for it.

Between all the repairs we will need to make in the next few years with an aging playground, basketball courts, replacing a water slide, etc. I am not sure how we will fund any of the above and pay back the debt even with additional assessments. The additional assessments would have to be massive over the next few years.

I am trying to find someone that has had a similar debt (100k+) with a developer/builder and the actions the neighborhood took. Was this handled with negotiations by the homeowners or were lawyers involved? A few stories with different approaches would be good to read about but I can't find a single one. A needle in a haystack....

DouglasK1 (Florida)
Posts: 2,046

Posted:

Quote:

Posted By TimB4 on 04/06/2015 3:24 PM

Typically a developer will artificially keep assessments low to attract buyers. Personally, I see this as a cost of doing business for the developer. The down side is that the Association typically receives no funds in a Reserve account.

I agree with Tim. Until most lots are sold, HOA dues are not enough pay the expenses. The developer makes up the difference as one of their costs of doing business. I've never heard of a developer considering this a debt owed by the HOA after transition. Of course the only definitive answer would come from judge, assuming the developer bills you, you don't pay, and the developer sues.

Escaped former treasurer and director of a self managed association.

NpS (Pennsylvania)
Posts: 4,216

Posted:

Quote:

100% funded means that, based on the remaining useful lives of the components that will need to be replaced over the next 30 years or so, 100% of the money that should have been set aside already has in fact been set aside. A reserve study by an independent reserve specialist will give you this information.

As others have said, developers often keep fees low - which means that they underfund reserves. Which means that when it comes time to make these reserve expenditures for the components identified in the reserve study, you will have to catch up for what the developer didn't set aside.

My recommendation was to use the 100% funding as the only measure of whether you should pay him anything. Unless yours is a very unusual developer, he did not fund your reserves adequately, and that's on him. Why should he leave you holding the bag, and get paid extra for doing it?

Sikubali jukumu. Read all posts at your own risk.

BenjaminD (North Carolina)
Posts: 20

Posted:

Thanks for the feedback and I got a copy of our CC&R. It has a section in the document addressing deficits taken on by the declarant. Interesting enough its signed by the original builder, McCar Homes, but they went bankrupt in 2009. So I'm not sure if our current developer has to have their own or if this document transfers with the neighborhood owner.

Either way, the CC&R states:

"Section 8. Budget Deficits during Declarant Control Period: Declarant may advance funds to the association sufficient to satisfy the defecit, if any, in any fiscal year between the actual operating expenses of the Association (exclusive of any allocations for capitol reserves) and the annual and special assessments for such fiscal year. Such advances shall be evidenced by promissory notes from the Association in favor of the Declarant and shall be paid back to Declarant if and to the extent that sufficient funds are generated by assessments in future years until such time as Declarant no longer has the authority to appoint the directors and officers of the Association."

So it would see they do have the ability to hold us to the money owed. We will need to absolutely complete a reserve study to help with negotiations of not paying back the entire amount.

TimB4 (Tennessee)
Posts: 21,059

Posted:

Quote:

Posted By BenjaminD on 04/07/2015 9:02 AM

So it would see they do have the ability to hold us to the money owed.

yes and no.

Read that paragraph again.

Either way, the CC&R states:

"Section 8. Budget Deficits during Declarant Control Period: Declarant may advance funds to the association sufficient to satisfy the defecit, if any, in any fiscal year between the actual operating expenses of the Association (exclusive of any allocations for capitol reserves) and the annual and special assessments for such fiscal year. Such advances shall be evidenced by promissory notes from the Association in favor of the Declarant and shall be paid back to Declarant if and to the extent that sufficient funds are generated by assessments in future years until such time as Declarant no longer has the authority to appoint the directors and officers of the Association."

To me, the bolded section says that the funds need to be paid back only if the assessments are there and only if the debt can be paid back while the Declarant still controls the Association.

This is something you need to have an attorney look at. Not the attorney the Builder uses, but your own attorney.

As for your initial question, yes, it's typical for the new builder inherited the rights of the bankrupt builder.

RayC4 (Virginia)
Posts: 173

Posted:

Quote:

Posted By BenjaminD on 04/07/2015 9:02 AM
Such advances shall be evidenced by promissory notes from the Association in favor of the Declarant and shall be paid back to Declarant

Like others, I had not heard of this 'payback' concept. But I give the developer points for creativity. I'll bet an outside attorney (per Tim's suggestion) would conclude that it's improper.

The developer is one corporation, and the HOA is (presumably) another. States normally recognize the conflict of interest inherent in the developer/ HOA relationship prior to the transition to homeowner control, and many enact statutes that deal with it. The cardinal sin is any 'commingling' of funds between developer and HOA, and this certainly flirts with that. "Promissory notes from the Association in favor of the Declarant" strikes me as a two-fold conflict of interest while the Declarant 'wears both hats':

1) the whole promissory note methodology, and 2) the authorization of the expenses which underlie the deficit in the first place.

Moreover, you mentioned the transition is estimated as out "2-4 years." IMO the homeowners are quite vulnerable to this developer/declarant during this (prior) period arranging the budgets, financials, notes, etc, any way he wants. I'm thinking your assessments are going up at the same time you (the HOA) will magically be running surpluses for the next 2-4 years.

NpS (Pennsylvania)
Posts: 4,216

Posted:

Quote:

Posted By BenjaminD on 04/07/2015 9:02 AM
"Section 8. Budget Deficits during Declarant Control Period: Declarant may advance funds to the association sufficient to satisfy the defecit, if any, in any fiscal year between the actual operating expenses of the Association (exclusive of any allocations for capitol reserves) and the annual and special assessments for such fiscal year. Such advances shall be evidenced by promissory notes from the Association in favor of the Declarant and shall be paid back to Declarant if and to the extent that sufficient funds are generated by assessments in future years until such time as Declarant no longer has the authority to appoint the directors and officers of the Association."

Time to lawyer up. My attention is drawn to the "exclusive of any allocations for capital reserves" phrase. I think that this can be interpreted in many ways - even to the point of making this entire section of the contract unconscionable.

Should also check with your lawyer on what rights and obligations the new developer inherited after the bankruptcy.

Priority 1: Lawyer.
Priority 2: Reserve study.

Sikubali jukumu. Read all posts at your own risk.

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