Board Using Reserve Funds To Pay Legal Expenses?

Real life letter from a Virginia HOA Board to HOA Members as follows:

===Start Letter===

Dear HOA Members,

The 2017 Reserve Study recommended a balance of $300k in our Replacement Reserve Account at the end of 2020. This account is currently funded at $315k. The Declaration requires that funds in the Replacement Reserve Account be used only "for the maintenance, repair and replacement of Common Area Elements."

Over the past three years, the HOA has accrued legal expenses. As a result the HOA has an equity deficit of $130k. This means the approximate cash value of the HOA's equity is currently $185k. This is well under the $300k that the 2017 Reserve Study recommends. The law requires the HOA to fund its reserves at the recommended levels to defray future infrastructure costs without having any deficit. [infrastructure includes a lake, clubhouse and parking lot]. Consequently raising the HOA's equity funding, to eliminate this deficit, is necessary. Some members have suggested that the HOA impose a Special Assessment to refill the HOA's reserves. However, the equity deficit is due to legal expenses, and not infrastructure costs. Because the legal expenses caused the equity deficit, the law and covenants prohibit a Special Assessment.

To keep monthly assessments as low as possible, the Board is exploring the option of adjusting the Reserve balance from $300k to $185k. The purpose of such an adjustment would be to "reset" our reserve requirement and eliminate the deficit. If the Board chooses this option, members must bear in mind that this action will not eliminate the HOA's requirement to add funds when the time arrives to make repairs to common area elements. As repairs to common area elements are needed, the HOA may have to impose a Special Assessment.

Sincerely,

Board of Directors

======End Letter ====

Questions:

-- Does "equity deficit" here mean the HOA Board has paid the HOA attorney using money from the Reserve account?

-- What do readers here think " 'reset' our reserve requirement" really means?

-- Does the Board appear to be "borrowing" from the reserve account to pay the legal expenses? If so, is this lawful?

-- Other thoughts are welcome.

Let's start with the 300K amount. That amount is RECOMMENDED but not set in stone. It is what the HOA would be best funded at with it's reserve fund to pay for capital repairs. Which doesn't mean needing/having a special assessment to go back to the 300K. That would be needed if the project (Roof etc...) costs 300K. A raise in dues to contribute to catching to the 300K may be a better option.

Now the "reset" of HOA funds basically is setting the new RECOMMENDED amount to 185K what is on hand now. Which would eliminate the need to raise funds to re-fill the 300K RECOMMNEDED amount.

A good example of this is when I worked in testing equipment. EXAMPLE: The pass/fail was set at a 10 % plus or minus rate. Most of the product was testing at 20% plus or minus. So instead of failing most of the product they raised the failure rate to 20 % plus or minus. That meant more product went through and failure rate was raised. The HOA here is choosing to lower the "failure rate" to the 185K. Basically "resetting" the rate to something achievable without throwing the bath water.

Now should they have spent it on legal expenses? Depends. If it's for actual damages of a lawsuit the other party won, then yes. If someone won a 25K damages, then I can see using reserves. However, if it is paying legal expenses conducting business? Not so much. I would question strongly the need/use of such legal services. A HOA should not being running to a lawyer every little thing. Plus have a POC to talk to them. A retainer isn't necessary many times. I would find out why the legal expenses and what they are for.

It is very interesting to read how many Boards appear to get attorneys involved. They are expensive and should be avoided as much as possible. Our legal fees if we ever have any, will not be taken out of the Replacement Reserve. We would view those costs as part of the Operating Budget. If the Board has paid out attorney fees then that money should be assessed back to all of the owners. The Board represents the all of the owners, therefore everyone should help pay the costs. At the rate is being spent out of the Replacement Reserve there will not be much left for what the money is intended for.

I think this is debatable. The so-called reset (meaning sleight of hand by bona fide deep HOA state amateurs?) may be throwing out the baby and the bath water.

All good questions. I will share with the member who sent me her concerns.

Is there anything exact in Virginia statutes about borrowing from reserves? Or is it more that the statutes and usually, governing documents, are silent about borrowing from reserves to pay xyz non-reserve expenses?Yes. Though the words I used with my acquaintance were not as kind: This sounds like the directors wanting their egos validated via giving an owner a hard time via a lawsuit, at the expense of the membership.I will share your input with my acquaintance. Thank you for your thoughts.

The numbers being referred to come from the Balance Sheet.

Without seeing the balance sheet, I would say nothing has changed win regards to the reserves.

Here is a typical scenario. Operating cash is $300K beginning of 2018, income is $300K and expenses are $450K at end of 2018, causing a deficit of $150K During the year the Balance sheet under net loss would show thus number as it adds up.

Beginning of 2019, cash is now $150K, same income and same expense, with same operating loss.

What is bringing equity down is RETAINED EARNINGS. If reserves are actually being depleted, it would show in both the assets as well as equity.

I don't know if the board has used the reserves to pay the legal expenses, but this sounds like they want to - and that's a HORRIBLE idea.

"Reset the reserves" seems to mean let's use it like an emergency fund, which isn't what the reserves are for. The real term should be "borrow from reserves," but that would also mean pay it back, probably with interest, and the board doesn't want to do that, because that WILL mean an assessment increase, probably several over the next few years.

As for equity deficit, a Google search says this could be a decline in assets, increase of liabilities or both, and that can happen for many reasons. It's been a while since I've looked at a balance sheet, but I know there's something called owners equity (an organization's total assets minus total liabilities) and ideally, that should increase every year.

In this case, I'm wondering if someone's using a few technical terms to throw every off as to what the board is really trying to do an I g sounds a lot like - hey we have $315I in reserves, let's just use that and continue to keep assessments liw. And we all know what can happen if assessments are kept too low for too long. Some owners may still be around when the dog dookey hits the fan and they won't like another special assessment.

Usually special assessments are used to pay for major repairs to the common area, but I haven't see anything that limits them to infrastructure use only, so it seems to me if the money's needed for legal expenses they would just designate it for that and not mess with reserves. I know they don't want to raise assessments, but inflation usually makes that necessary anyway, so they may as well increase them and then take a hard look at the rest of the budget to see what can be reduced or cut until that debt is paid off.

Do you know what what's behind this legal expense? If it was used to go after delinquent homeowners, why haven't they been compelled to reimburse the association for legal fees and collection costs used to pursue the debt? Better yet, ask them to explain there terms in plain English. If they can't or start mumbling and using more nonsensical language, that's when you need to say hmmmm.

SheliaH,

-- I agree there are signs of subterfuge here. E.g. the Board thinks that Special Assessing members to fix the clubhouse roof sounds better than Special Assessing members to pay for a lawsuit. How to achieve this? Borrow from the Reserve account to pay the legal expenses. Then there's no choice but to special assess when the clubhouse roof fails.

-- I know the lawsuit had nothing to do with going after delinquent owners. I cannot share more without exposing my acquaintance to further retaliation from her HOA.

-- Thank you for sharing your impressions. They help.

To all:
Apologies if this thread is veering off to another session of 'let's get good and outraged' by another seemingly not-so-great HOA Board. I know it's not constructive. I wanted to see if others' take was the same as mine. My acquaintance was/is similarly interested.

MichaelS56, thank you for your input. It helps.

Respectfully, I would not say, "usually." I am not certain but I do not think the HOA in question is required to obtain a membership vote for a special assessment. Virginia statutes, for one, permit the Board to impose special assessment when the assessment will be used primarily "for the maintenance and upkeep of the common area and such other areas of association responsibility expressly provided for in the declaration, including capital expenditures." The latter might explain well why this VA HOA Board is doing what it is doing.

Not that anyone at this HOA is going to lift a finger to stop the hemorraghing of members' funds on this litigation.

Thank you for your input.

The board still needs to "translate" this into clear, factual statements.

What is the current amount of cash currently in the reserve account? $315,000 or something less?

A Special Assessment in our HOA requires 2/3rds OF ALL MEMBERS (owners) agreeing
to it.

So my take on this is Reserves have strict rules that say they can only be used for repairs and replacement of maintenance items.

The board I was first elected to back many years ago borrowed 150k from reserves and put in a new Parking lot. They setup a 3 year payback and once I got on the board and dug into this I found that this is illegal. In Ca. at the time borrowing from Reserves had to have a payback of 12 months or less.

It seems like the better idea and a way out of the problem they seem to have is to stop contributing to reserves for a period of time. Not knowing anything about this HOA who knows how much monthly or quarterly is budgeted for Reserves it is impossible to tell how long this could take but it would be an option. This way you are not borrowing but just are not contributing to Reserves. As others have mentioned the Study does not mandate your Reserve level it Suggests what they should be. Many HOAs have underfunded Reserves which is not ideal but happens.

The legal bills also appears to be not consultation but some kind of suit and a possible judgement. If that is the case the whole community should understand the problem and a special assessment could be the other way to right this ship.

I'd also like to ask members of this board why they think that their neighbors are as dumb as dirt.

Sounds like there must have been major expensive litigation, and litigation in which the HOA didn't do too well.

And all the HOA says is "the HOA has accrued legal expenses", as if that's a routine matter about which nothing more needs to be said.

Really? We're supposed to just accept that?

Without seeing the actual balance sheet, it is possible the reserves have a balance of $315K. What I think they might be trying to do is take whatever was used for legal expenses out of reserves, put it into operating and readjust the reserve numbers or as it was mentioned, "reset?.

In response to ChrisE8 and SheilaJ1, here's what I have from my acquaintance:

"As of December 2020, the current reserve amount is $185k. The Board will continue to incur legal fees for day to day. The legal fees due to litigation are probably only around $20k to $30k. I believe the Board runs each action and decision by the HOA attorney, and this has caused legal expenses of around $90k. The remaining deficit is due to pass under funding from 2016."

My acquaintance has written the Board in recent weeks asking for clarification. She says settlement talks regarding the litigation have begun. But no guarantees in her opinion.

JohnC46, thank you for the input.

It appears to me that this is the strategy the board is now using and perhaps has been using for a year or so. Thank you for the input MarkM19.

I was mistaken about the litigation. The litigation was not brought by the HOA. The litigation was about records requests, election abuses, and creating rules that had no basis in the covenants and were otherwise, not enacted properly.

I am going to step out because obviously, I do not have enough command of the facts. Maybe my acquaintance will join in.

This is insane.

The HOA attorney is billing $20k of legal fees per year for day-to-day legal work?

And the initial communication from the board was arguably a lie, if the reserve balance is $185k, not $315k.

Why did the board not disclose the facts of the litigation before?

I'd object to all of this and would try to get the board removed. I'd also want the lawyer removed if s/he signed off on the initial communication from the board, which is at best misleading.