Legal restrictions on use of reserves funds

Started by DavidG45 • 4 replies • 288 views

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DavidG45 (Delaware)
Posts: 994

Posted:

I am on the finance committee for a newer community that just took over control of the board last May. The developer had earlier established a reserves fund on our general ledger, and opened a checking account into which our reserves are deposited each month.

Without going too deep into the weeds on the details, there is some disagreement on the committee and on the board about how money in our reserves can legally be used. We will soon be going through transition, and there are a lot of unknowns about the expenses that will be involved. Some feel we should continue to aggressively fund reserves, some feel we should be more cautious, because if we are surprised by a large transition related expense we cannot use money from reserves to offset its costs.

I have looked through our governing documents, and they do not suggest any kind of restrictions. They merely say the board can, if it decides, create a reserves fund for "contingencies and replacements." I also cannot find anything in Delaware state law that places restrictions on the use of reserves funds. In fact, outside of condominiums (which we are not), I don't see much of anything in Delaware law that discusses HOA reserves.

I'm not expert on this, so I wonder if perhaps I am missing something. Are there generally legal restrictions on how reserves funds can be used?

DavidG45 (Delaware)
Posts: 994

Posted:

I should probably clarify that one specific issue is that we have significant surplus funds from 2022. State law does specify that surplus funds must be returned to homeowners or credited to offset future expenses.

My assertion is that we should move our surplus funds into reserves to satisfy state law. Others just want to leave it in our operating fund, fearing once it is in reserves we can't use it for unexpected expenses. My problem with this is that it would seem this is not in compliance with the law.

CathyA3 (Ohio)
Posts: 6,299

Posted:

Could you quote the exact wording of the state law that addresses use of surplus funds?

SheliaH (Indiana)
Posts: 6,964

Posted:

You could continue to fund reserves and establish some sort of contingency account that could pay for certain types of unexpected repairs. However, there may be tax implications and you'll need to establish rules on when that money is tapped and for what purpose. It shouldn't be seen as a slush fund to pay for whatever strikes the fancy of the board.

While you're at it, this would be a good time to establish rules on how reserves are to be used. Generally, they fund major repairs and replacement of the common areas, such as street repaying, so they shouldn't be seen as a slush fund either.

Did the developer have a reserve study done before turning the community over to the homeowners ? If so, start by reading that and your documents to see what's considered common area. You could also have the specialist come in and give all of you a crash course in best practices for managing reserves. A chat with the association attorney, accountant and master insurance company wouldn't hurt and you can use all that information to set up a policy.

Better yet, I might also push for certain things to be added to the documents, such as prohibiting borrowing from reserves (if that's necessary, specify how soon the money is to be repaid and with a specific interest rate), defining what a common element is (anything not meeting that criteria isn't eligible for funding), mandating reserve studies every five years or so, etc.

Amending the documents will require homeowner approval and while you don't have to put everything in the bylaws and CCRs, some fundamental things should be there, xuch as mandating reserve studies.

If it is not right do not do it; if it is not true do not say it. Marcus Aurelius

AugustinD
Posts: 1,027

Posted:

Quote:

Posted By DavidG45 on 10/23/2022 7:43 AM
Are there generally legal restrictions on how reserves funds can be used?

As it sounds like you are aware, there is no general rule. How reserve funds may be used is very much state and HOA/COA specific.

You are right to check the statutes, Bylaws and Declaration.

I happen to think Delaware does have some statutory restrictions on the use of reserves, as given in https://delcode.delaware.gov/title25/c081/index.html . Keyword search the latter for "repair and replacement reserve" to see what I mean.

General, examples of when reserve fund use may be restricted:
Anytime a statute or bylaw requires a vote of the owners on whether a Special Assessment is to be made and for a specific purpose.

Anytime a statute or bylaw requires that a Board impose a Special Assessment and that the Special Assessment has to be made for a specific purpose.

Aside: I am seeing the phrase used to describe the process for helping ensure turnover is proper is "transition audit."

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