Published on: October 8, 2019
By Edmund Allcock and Haley Byron
Life is full of transitions. In the life of a community association, the most important transition by far is the one that transfers control of the community ─ and responsibility for it ─ from the developer to the owners. A successful transition will set the community firmly on the path to self-governance and financial health. A less than successful transition can set the community back for months or even years in that journey.
Developers also benefit from a smooth transition. Owners who are well-prepared to manage the community and developers who have resolved financial and construction problems – two critical indicators of a smooth transition─ are less likely to be at odds (and possibly involved in litigation) after owners assume control. A community that is functioning well post-transition creates good publicity for the developer. Financial problems and litigation – two byproducts of a botched transition – have the opposite effect, creating massive headaches for the governing board and owners, and creating bad publicity that could make it difficult for the developer to sell future projects.
Unfortunately, owners do not always do the due diligence required to prepare themselves for self-governance; and developers’ short-term interest in selling units sometimes outweighs their long-term interest in taking the steps, and encouraging owners to take the steps, that will ensure a successful transition.
The transition actually has two phases ─before and after ─ and they are equally important. The goal for the first phase (before) is to prepare owners for the second (after).
Before the Transition
Developers can help lay the groundwork for a successful transition by familiarizing owners with the association’s operations, management and finances. State law and some governing documents specify the point at which developers must transfer control to owners ─ usually when a designated percentage of units have been sold. Some state laws also require developers to appoint one or more owners to the board, which is controlled by the developer before the transition. Even if that is not a requirement, we think it’s a good practice because it gives owners (through their representatives) a window through which to observe how the association is managed, and it provides a formal means through which owners’ concerns can be expressed.
Some developers appoint a “transition committee” to work with the developer and the developer-controlled board throughout the pre-transition period. This is another best practice we recommend. This committee has no governing authority, but it can serve as a liaison between the developer and owners, offering suggestions and relaying concerns to the developer, and conveying essential information about management issues and construction plans from the developer to the owners.
Owners don’t need the developer’s permission to create a transition committee; they can take this step on their own. Owners individually or collectively, as part of an informal advisory committee, are entitled to review the association’s records, including its financial records. They have a right to look over the developer’s shoulder and to question management decisions they don’t like or don’t understand. Some developers will cooperate willingly with owners; some will cooperate grudgingly; and some may not cooperate at all.
Owners who become concerned about what the developer is doing or not doing can hire an attorney, retain an engineer (to assess potential construction deficiencies) and take any other steps an elected owners’ board could take after the transition, including suing the developer, to protect the associations’ interests. The problem with this, and the reason it doesn’t occur very often: Until owners assume control of the association, they don’t control its finances, so they would have to cover personally any legal costs or other expenses they incur on the association’s behalf. The association may reimburse them after the transition, but only if the post-transition board agrees that the expenses were reasonable and that the owners’ efforts benefitted the community. The uncertainty of reimbursement and the time commitment required explain why few owners undertake these pre-transition oversight initiatives.
After the Transition
The developer’s last official action before relinquishing control to the owners will be to call a meeting at which owners elect the members of the board that will represent them. The board will have to hit the ground running – at warp speed or faster – because it will have to complete several tasks simultaneously, primary among them:
- Hiring a team of professionals. For most boards, this team will include an attorney, a manager, an engineer and an accountant.
- Commissioning a transition study.
- Collecting and reviewing essential association documents.
Transition Study. The board’s first priority must be to assess the physical condition of the community. A transition study conducted by a professional engineer will provide this assessment, which should be made as quickly as possible, because strict statutory time limits govern the association’s ability to sue the developer, if necessary, for any construction defects or deficiencies for which the developer is responsible. The study should describe in detail any structural problems or design deficiencies and estimate the costs for necessary repairs.
In addition to identifying structural problems, the transition study will verify that the development has been completed in accordance with the development plans. For example if the plans call for a swimming pool, a clubhouse and a playscape, you want to be sure those amenities are in place.
Reserve Study. The transition study isn’t the same as a reserve study (which the association also needs), which estimates the life expectancy of essential components and provides a base line for determining how much the association should contribute to a reserve fund that will finance repairs and replacements when they are needed.
Essential Records. Ideally, the owners’ advisory committee will have collected essential records and documents, or most of them, before the transition. If not, this should be another priority for the newly -elected board. The list of essential documents is essential – it includes virtually everything related to the association’s management, governance, and finances. The most important:
- The governing documents, including the declaration (with any amendments) of covenants, conditions, and restrictions (CC&Rs), the association’s by-laws, rules and regulations, and architectural guidelines.
- Minutes of all board meetings.
- Copies of all contracts to which the association is or has been a party.
- Copies of all insurance policies.
- Copies of all leases, if any.
- The names and contact information for all owners and a list of all lenders holding mortgages on owners’ properties.
- Construction plans and design specifications for the community.
- Certificates of occupancy and any other construction-related permits.
- Copies of deeds and plats for common areas.
- Copies of ads, brochures, and other promotional materials the developer used in marketing the community.
- Copies of all warranties still in effect.
- Financial records for the community, including:
- Audit reports
- Bank records
- Financial statements, including balance sheet information (income and expense reports, accounts payable and accounts receivable, records of common area assessments and delinquency reports, among others).
The attorney the board hires to represent the association should review the declaration and governing documents to make sure they comply with applicable laws, and should review pre-transition decisions made and policies established by the developer and the developer’s board to ensure that they, too, are consistent with the governing documents and applicable laws and regulations. The attorney will also identify any unreasonable or undesirable restrictions, such as “poison pill” provisions limiting the association’s ability to sue the developer for construction flaws or financial improprieties.
An accountant should review the financial records, to make sure the developer has managed the association’s finances appropriately. An attorney can also undertake this financial review, to verify, among other things, that the developer has:
- Collected all revenues owed to the association.
- Paid the association’s bills.
- Paid the developer’s share of common area expenses on units before they were sold.
- Not used association funds to pay expenses for which the developer should have been responsible.
Common area fees. Probably the single most important financial question for a newly elected condominium board: Has the developer set common area fees at a level sufficient to cover the association’s operating expenses and reserve fund contributions? The answer to this question is almost always ‘no.’ Developers usually set fees as low as possible to make the community as attractive as possible to prospective buyers. The lower the fees, the more affordable the monthly payments will seem to be. But the developer’s short-term interest in selling units undermines the association’s long-term interest in creating a strong financial foundation for the community. An artificially low fees will create a gap between the revenue the association collects and the funds required to manage the community responsibly.
Identifying this problem and correcting it early will avoid the debilitating effects of chronic funding shortfalls (deferred maintenance, massive fee increases and special assessments) and improve the community’s prospects for financial stability and long-term success.