Smooth Transition from the Developer to Owners Puts New Communities on the Path toward Successful Self-governance

Published on: October 22, 2007

Behavioral scientists differ on whether it is the first three minutes, the first three months, or the first three years that are most important in the development of a child. But they agree that what happens or doesn’t happen during the formative years, however defined, plays a huge role in determining a child’s future well-being and success.

A common interest ownership community also goes through a formative period comparable to a child’s early years. And for a newly minted homeowner association, it is the transition from developer to owner control that plays the pivotal role, shaping the community’s future development and largely determining its chances for success. What happens before, during and after the transition will determine whether a fledgling association gets off on the right foot on the path to self-governance or stumbles out of the starting gate and then struggles, perhaps for years, to find its footing and regain its balance. The transition, in short, can make a new community or break it. The time for owners to begin thinking about the transition and preparing for it is long before it occurs. 

The foundation for a smooth transition actually should begin, although it doesn’t always, with the developer. The developer initially owns all the units and so appoints and controls the homeowner association’s first governing board. State law and the community’s governing documents will define the point at which the developer must turn over control to a board elected entirely by the owners. These requirements differ, but, developers typically must begin appointing owners to the board when a specified percentage of the units have been sold, adding more owners progressively as more units are sold, and completing the transition to an owner-elected board within a specified period after the association is created or after a designated percentage of the units have been sold.

Laying the Groundwork: The Transition Committee

Enlightened developers recognize that they have an interest in ensuring a successful transition and will do all they can to facilitate the process. A good first step is for the developer to appoint a transition committee to work with the developer and the developer-controlled board throughout the pre-transition period. This committee 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.

Establishing and maintaining open and constructive communications between owners and the developer during the pre-transition period can do much to ensure a smooth transition when that time comes. The transition committee can also provide an effective training ground for owners, many of whom are embarking on their first common interest ownership experience. Working with the developer, observing board meetings and learning about the decision-making process may provide the only advance training these owners and future board members receive before they assume responsibility for governing their community.

Some developers, as noted, will create transition committees well in advance and even provide some association funds to support them. But if the developer doesn’t establish a transition committee, owners can and should take that step on their own. Owners don’t need the developer’s permission or approval to create an advisory committee and begin preparing for the transition to come. This is a good time for owners to begin learning what it means to be responsible for the community in which they live.

Keeping Watch

As part of their transition preparations, the advisory committee should track the decisions of the developer and the developer-controlled board. They should attend board meetings, if possible, review the minutes of board meetings, monitor the pace and progress of ongoing construction, pay attention to association finances, and begin identifying potential management and construction-related concerns.

Even if the committee lacks the formal blessing of the developer, as owners, committee members 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. The developer still controls the association at this point, but owners have a vested and long term interest in the community’s future.

The committee should be able to gauge early on how much or how little cooperation owners can expect from the developer. If the relationship is positive, with good communication and give-and-take on both sides, the committee should arrange to meet periodically with the developer and begin creating a mutually agreeable “punch list” of construction issues and management problems for the developer to address before the transition.

One of the major concerns for a new homeowners association is the possibility that owners will discover serious construction defects that need to be resolved. If the developer is less than cooperative during the pre-transition period – if he resists requests to correct even minor problems — it is probably reasonable to assume that he will not become more cooperative after relinquishing control. Advisory committees confronting this situation may want to consider hiring an attorney to represent them before the transition. This is especially true if there are reasons to suspect that the developer is mismanaging association funds, or if it appears likely that owners will want to pursue a construction defect claim. The developer at this point still controls the association’s finances and is unlikely to allocate funds for an attorney who may eventually represent the owners in a suit against him. So owners would have to pay any pre-transition legal costs out-of-pocket, but depending on the situation, that may be money well spent.

Collecting Essential Documents

Whether the transition committee is an “official” body created and supported by the developer or an ad hoc group the owners establish on their own, one of its most important tasks will be to identify and (if possible) begin collecting the documents and information the owner-elected board will need when it assumes responsibility for governing the association. In essence, the board will want virtually every scrap of paper related to the association’s construction management, governance, and finances. The most important items on this extensive list will include:

  • 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:
    • Budgets
    • 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).

If the transition committee has collected all of that information, or most of it, the new board can hit the ground running immediately after the election, losing no time in grasping the wheel of the community it now must steer.

After the Transition

The developer’s last official action before relinquishing control to the owners will be to call a meeting at which owners must elect the members of the board that will represent them. In addition to electing new officers and getting organized, among the new board’s first official acts should be to hire the professionals they will need to advise them in the days immediately following the transition. Specifically, they will want to retain an attorney, a management company, an engineer, and an accountant.

The Attorney

If the transition or advisory committee retained an attorney before the transition and is satisfied with the attorney’s work, the board may want to continue that relationship. The difference now is that the attorney’s fee can be paid from association funds rather than from the owners’ pockets. If the transition committee has not actually hired an attorney, it should have done enough preliminary research to enable the board to make the selection quickly.

The attorney 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 is looking for anything the developer may have overlooked, done incorrectly, or failed to do that could create problems or potential liability for the association. The attorney should also review the by-laws and rules and regulations to make sure they cover effectively all the major issues the association will want to address. Ideally, the transition committee will have undertaken an initial review of the governing documents. Board members who have not already done so should immediately familiarize themselves with these documents. One of the most important first steps for the new board should be assessing whether the boilerplate rules and regulations the developer put in place represent a good match for the community. The board should solicit feedback on this question from owners (a good chance to them involve din the decision-making process early on), and then work with the attorney to revise or eliminate any undesirable rules and adopt new ones.   

The Association Manager

If the association decides to hire a professional association manager or a management company – a good idea for all but the smallest communities – the board should make that selection as soon as possible after the transition. The expertise an experienced manager provides can be invaluable in the early days when the new board is learning the association governance ropes and taking over the operations of the association.  Associations will often choose to retain the management company hired by the developer.  The company’s knowledge of the community may be an advantage, helping with both continuity and the education of board members. However, if the developer’s management company hired stays on, it is important that the board renegotiate the management contract to clearly define the manager’s role, to ensure that the manager understands the association’s expectations, and to ensure that the association receives the services it needs. It is also important for the board and the manager to discuss the manager’s relationship with the developer; the board should ask specifically what the manger’s position would be if the association were to become involved in litigation with the developer.

The Engineer

Immediately after the transition, the board will want to hire a professional engineer to conduct a thorough transition study, to evaluate the condition of all buildings, building systems, and common areas, and to identify any problems or potential problems the developer should address. This study should include a detailed description of any structural problems (including construction and design flaws), an estimate of the costs for repairing or replacing defective components, and a suggested schedule for undertaking and completing that work. (In conjunction with the transition study, the engineer should also prepare the reserve replacement study the board will need for budgeting and future planning purposes.)

 The transition report will create the factual foundation the board may need to negotiate with the developer and, if the negotiations are not successful, to initiate legal action if necessary to force the developer to correct or pay to correct any problems for which the developer is responsible.

There is no reason to assume that the board will have to sue the developer to remedy construction problems or for any other reason. The transition study may determine that everything is fine or the developer may willingly correct any problems the study does identify. But if there are structural problems, you want to identify them early in the process, partly because the passage of time will almost certainly make the developer less responsive, but also because construction defect suits are subject to strict time limits. Delays in discovering problems could prevent the association from pursuing legal action or reduce the prospects of recovering damages from the developer even if the association sues successfully and wins an award.

The Accountant

While the attorney reviews the legal issues and the engineer focuses on structural concerns, the board will want a certified public accountant (CPA) to assess the association’s financial condition by conducting a post-transition audit. The audit’s purpose generally is to verify that the developer managed the association’s funds appropriately, accounted for them properly, and created a solid financial foundation for the new community. On the income and expense side, the accountant will want to determine whether the developer has collected all revenues owed to the association, paid his/her share of the common expenses on units the developer owned before they were sold, paid outstanding bills and properly allocated expenses. The association wants to be sure the developer did not classify as association expenses and pay with association funds costs for which the developer should have should have been responsible.

On the budget side, the audit should evaluate the developer’s expense and income projections to determine if both are reasonable.  The accountant should tell the board in particular if the common area fees are realistic.  Developers sometimes set the fees at an artificially low level while marketing a new community to increase the appeal to prospective buyers.  If an audit determines that to be the case in your community, the board will want to identify the problem and make any necessary adjustments, increasing the fees if necessary.  The longer the board leaves artificially low fees in place, the more financial problems the community will face, and the more painful the inevitable correction process will be for owners.  The transition audit report combined with the reserve replacement study the engineering firm produces will give the board the information it needs to develop a realistic budget and to determine how much the association should contribute annually to its reserve fund.  In terms of the long-term financial health of the community, few decisions the board makes will be more important than these.