Boards Must Ask the Right Questions to Ensure a Smooth Transition to Owner Control

Published on: July 1, 2010

Life is full of transitions, but the transition from developer to owner control of a community association undoubtedly ranks among the most challenging and (for novice board members) potentially overwhelming on that list.  More often than not, the developer delivers a huge box, or several huge boxes, crammed with official looking documents, miscellaneous papers and sometimes scraps of paper, invoices, reports and spare change (if you’re lucky) – arranged in no discernible order and identified poorly, if at all.  The board will have to figure out what’s in that box, what isn’t there that should be, and what it all means for the fledgling community.  That is no easy task, to say the least.

This annotated checklist won’t address all the issues board are likely to confront as they begin the transition process, but it will identify the essential information they need (and should demand from the developer), and provide a starting point for making sense of whatever comes tumbling out of the developer’s box.

The checklist is divided into three sections – governing documents, financial and management records and property information – highlighting in each section the documents and records boards should find, the questions they should ask, and the red flags they should recognize. 

GOVERNING DOCUMENTS

  • Master Deed or Declaration of Condominium
  • By-laws or Condominium Trust
  • Rules and regulations

Questions to ask: 

Do the documents contain any unreasonable or undesirable restrictions?  Watch particularly for “poison pill” provisions restricting the association’s ability to sue the developer.  If these provisions are included, are they enforceable?  Can they be amended or removed? 

Do the covenants or rules and regulations contain any provisions that violate the condominium statute or other local, state or federal laws?   One red flag:   Language providing that the developer does not have to pay condominium fees on unsold units, which would violate the Massachusetts Condominium Act.   

Do the documents give the developer continuing interests in, control over and/or the right to earn fee income from recreational amenities, parking garages, laundry rooms, or any other association facilities?  If so, does the developer have a responsibility to pay his or her fair share for the maintenance costs, or have those costs been imposed entirely on the association?

Do the documents give the developer the right to sit on the board until the last unit is sold?

Do the documents accurately reflect the interests and concerns of community residents?    For example, do they:

  • Prohibit or limit rentals?
  • Give the association the right of first refusal on the sale of residences in the community?
  • Prohibit owners from parking “trucks” on association property?
  • Prohibit owners from having pets or limit their ability to do so?
  • Bar home offices?

Do owners approve of these restrictions, if they exist?  Posing that question to owners directly will give them an early glimpse of what it means to live in a self-governing community.

FINANCIAL AND MANAGEMENT RECORDS

Not surprisingly, this is the longest list.  It includes:

  • Association budgets
  • Invoices
  • Bank records, including statements and bank ledgers
  • Financial statements, including:  Balance sheet information, income and expense reports, accounts payable and accounts receivable, delinquency reports records of association assessments and audit reports
  • Copies of all insurance policies
  • Information on any pending insurance claims and pending litigation in which the association is involved as a plaintiff or a defendant
  • Copies of all contracts
  • Warranties still in effect
  • Copies of leases
  • Names and contact information for all owners
  • A list of all lenders holding mortgages on owners’ properties
  • Minutes of board meetings
  • Copies of all ads and other sales material the developer has used in marketing the community

What to watch for

There is no short answer to this.  In the financial area, the board’s goal is to “follow the money,” to make sure that all association funds are accounted for and to verify that the developer has managed the funds appropriately, accounted for them properly and built a solid financial foundation for the community.  A post-transition audit by a CPA is essential and it should be conducted as soon as possible after the board assumes control.  Among the specific questions the audit should ask and answer: 

  • Did the developer collect all revenues owed to the association, especially revenues owed by the developer or his affiliates?
  • Is there a separate, segregated reserve fund or working capital fund that is being turned over to the Association.
  • Has the developer paid the association’s bills?
  • Did the developer pay his share of common area expenses on units developed before they were sold?  (It is important to ask this question, because the answer is frequently ‘no.’
  • Is there any evidence that the developer used association funds to pay expenses for which the developer should have been responsible? 
  • Are the developer’s income and expense projections reasonable?  Does the operating budget accurately reflect those assumptions? Does it include a regular allocation for the association’s reserves?  This is another way of asking whether the developer has set the common area fees high enough.  Many set them artificially low in order to attract buyers, leaving it to the board to deal with the inevitable budget crunch that will result.

These questions are crucial because they target the association’s financial strength – or lack thereof.  The audit in conjunction with a reserve/replacement study assessing the useful life of the buildings and their key components (which the board should also commission immediately after assuming control) will provide the information the board needs to develop a realistic budget and create a financial blueprint that will guide the community going forward. 

Management issues

The document checklist includes minutes of board meetings held under the developer’s control.  This is another essential review, often overlooked, which the association’s attorney should conduct.  Its purpose is to make sure the decisions the developer made and policies the developer established are consistent with applicable laws and regulations and reflect the policies and priorities of the new owner-selected board. 

The board should also ask a number of specific management-related questions, primary among them:

  • Should the association hire a professional management company?  (Unless the community is very small, the answer is almost certainly, yes).
  • If the developer hired a management company, should the board retain or replace it? 
  • Are the provisions of existing vendor contracts acceptable?  If not, can the terms be changed?
  • Should the board continue working with vendors hired by the developer or subject some or all of those contracts to a competitive bidding process?
  • Is the insurance coverage in place appropriate? An insurance agent who specializes in community association insurance should review the policies and help the board ensure that the community has the right types and amounts of coverage. 
  • If there are pending insurance claims, did the developer meet all required notice and documentation requirements. 
  • Are existing security measures adequate?  The board should consider having a professional security firm conduct a base-line review to identify any gaps.  At a minimum, the board should obtain current police reports to identify specific security concerns in the area. 

PROPERTY INFORMATION

  • Copies of deeds and Condominium Plans
  • Construction plans
  • Design specifications
  • All construction-related permits
  • Bonds with local permitting authorities
  • Certificates of occupancy

Boards assuming control of their associations in the current economic climate may face particularly difficult challenges, including the possibility that the development is incomplete.  Promised amenities (swimming pools, a clubhouse, landscaping) may not have been added, infrastructure improvements may not be in place, construction quality may be inferior and  the schedule for completing future phases of the development may be uncertain or in some cases may have lapsed. 

In the case of phased developments that are incomplete or in which construction is still under way, immediately after assuming control, the board should have a condominium lawyer review the association’s documents to identify any legal issues related to the phasing. Associations can potentially benefit from lapsed development rights or improperly created or executed development or phasing documents.  These issues, which can be worth several hundred thousand dollars to an association, are often discovered in conjunction with construction defects or other problems. 

Because the issues arising from improper phasing are highly technical and complex, it is important to have competent transition counsel review the documents as early in the transition process as possible, preferably before other problems have been identified.

A separate transition study by a professional engineering firm is equally important. The purpose of this study is to evaluate the condition of all buildings, building systems and common areas, identify construction and design flaws or any other problems the board should address, and estimate the costs for correcting those problems.  (The engineering firm conducting the transition study can undertake the reserve study at the same time.)

The transition study will create the factual foundation on which the board will base any negotiations with the developer to resolve construction-related complaints.  If those negotiations fail, the study may serve as the springboard to litigation and possibly provide evidence supporting the association’s case.  

Strict deadlines apply to construction defect suits, which must be filed within three years after the problem is discovered or reasonably should have been discovered, and within six years after construction (per phase or improvement) has been substantially completed, resulting in a rolling six year time frame – another reason for the board to put commissioning the transitions study at the top of its ‘to do’ list. 

In considering whether to sue the developer, the board should consider, among other issues, the litigation costs as weighed against the cost of the repairs, the likelihood of prevailing in court, and the prospects of collecting any damages awarded ¾ a function of whether the developer has any assets and how effectively he has put them beyond the reach of creditors. 

While construction defect concerns will loom large, if they exist, they are not the only property-related issues the board must address.  On a long list of questions boards should ask, these stand out:

  • Is the development complete?  Are any amenities or infrastructure components unfinished?
  • Are all permits for future construction in place and current?  Are there affordability requirements or other restrictions that apply?
  • Is this a phased development?  If so, what are the construction deadlines?  Has the developer missed any of those deadlines, violated the condominium statute, or made any other legal errors that would entitle the association to take over the development rights or extract concessions from the developer?
  • Is there a Master Condominium/sub-association structure in place?
  • Does the condominium structure include shared facilities, limited common areas, water rights (including docks), or leasehold interests (which would apply if the land on which the condominium is built is leased rather than owned)? 
  • Does the condominium include commercial facilities? 
  • Does it include major components – sewage treatment facilities, for example — for which the association is responsible?
  • Are there easements with adjoining properties or other property rights to which the condominium is subject?  If easements apply, are there separate budgets for easement holders and condominium owners? 

No one likes conflict and many transitions proceed smoothly.  But some do not and well-prepared boards need to anticipate that possibility.  Hopefully, this checklist will help boards identify potential problems and successfully negotiate unforeseen bumps in the transition road if they arise.