Author: Karyn Larko – Epsten, APC

Mum’s the Word When Disclosure Leads to Breach of Fiduciary Duty

It is common knowledge that a director has a fiduciary duty to his or her association and its members. To be a fiduciary means that the director has accepted the highest duty imposed by law. This duty obligates the director to act:

1. In good faith;
2. In a manner such director believes to be in the best interests of the Association; and
3. With such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.

This duty also obligates the director to place the interests of the association and its members as a whole over the director’s personal interests in the event these interests conflict. This duty is referred to as the duty of loyalty or duty of undivided loyalty.

What may be less known is that one of the most common breaches of fiduciary duty is the disclosure by a director of information that should be kept confidential.

The disclosure of information that should be kept confidential can give rise to both a breach of a director’s duty of care and duty of loyalty. In accordance with Civil Code section 4935, certain matters are discussed out of earshot of the members in executive session board meetings (i.e., discussions pertaining to personnel issues, the formation of contracts with third parties, litigation and potential litigation, disciplinary actions against members and member assessment issues). Each of these issues requires the discussion of matters that if made public (i.e., disclosed to any persons other than current board members and management, including other owners) could needlessly and unnecessarily embarrass an owner or employee, compromise the association’s legal position in a dispute, result in the waste of association funds, lead to a claim that an owner’s privacy rights have been breached, or otherwise result in an unfavorable position for the association. All of these results could lead to litigation and ultimately, to liability for the association.

Another act that is contrary to the interests of an association and damaging is the disclosure of association attorney-client privileged communications (i.e., legal advice) to third parties. Communications between an association’s legal counsel and the board or management staff are subject to the attorney-client privilege. This means these communications are protected communications that can be kept confidential from any disclosure, including disclosure during litigation. In the litigation context, this protection is extremely important as it allows frank and open communication between the board and/or management staff and the association’s legal counsel as to what occurred and the strengths and weaknesses of the association’s position with regard to the claim or claims being made. This protection also enables the association’s legal counsel and board to properly evaluate what course of action the association should take.

When communications between an association’s legal counsel and board or management are revealed to others, including owners who are not on the board and family members, this disclosure can result in a waiver of the association’s attorney-client privilege. This means that the association may be required to disclose all of the communications between the association’s legal counsel and the board or management, including without limitation, communications regarding the strengths and weaknesses of the association’s position and its legal strategy. The disclosure of this information would, inevitably, be extremely prejudicial to the association’s interests.

A final act that is contrary to the interests of an association is the disclosure to persons other than board members of other sensitive information or documents that could expose the association to potential liability. Examples of such information and documentation include the release of social security numbers, owner bank account numbers or other financial information, owner or resident health records, owner disciplinary records, plans and specifications for owner alterations (including security systems), vendor bids and proposals and confidential settlement agreements. It should be noted that this list is by no means all encompassing.

The Significance of Disclosing Information that Should be kept Confidential

As stated above, the disclosure of information that should be kept confidential can lead to liability for the association. It can also lead, in some cases, to personal liability for the director who discloses the information. We say this because while California law generally protects volunteer directors from liability for their acts when those acts fall within the scope of their duties as a director, subject to certain requirements being met, this protection does not extend to instances where directors have breached their fiduciary duty to the association and its members. Likewise, while the governing documents for many associations contain clauses protecting directors from liability, California law (i.e., Corporations Code section 204(a)(10)) expressly invalidates these clauses to the extent they attempt to protect directors from personal liability for breaching their fiduciary duty.

Finally, it is important to know that most directors and officers policies contain an exclusion whereby there is no coverage for a director who has breached his or her fiduciary duty. Further, some carriers will issue a reservation of rights letter when asked to defend a breach of fiduciary duty claim. This means that if the director is ultimately found by a judge or jury to have breached his or her fiduciary duty, the carrier is entitled to recover its defense costs from the applicable director.

PRACTICE TIPS:

When in doubt, do not share information with persons outside of the board and management without first checking with your association’s legal counsel on the advisability of doing so.
If participating in a telephonic or video executive session board meeting, do so in private. Do not allow family members or other persons to listen in on executive session meeting discussions.
Do not use phrases like “according to our attorney” or “on the recommendation of our attorney” when communicating with persons outside of the board and management as the use of such phrases could be deemed a waiver of the association’s attorney-client privilege.

Strapped for Cash?

A Short Tutorial on Borrowing from Reserves

By Karyn A. Larko

Even a well-run association can find itself short on cash occasionally due to unexpected operating expenses or an unexpected shortfall in assessment income. Should this occur, a healthy reserve account can provide the solution – or at least the first step in the solution.

California Civil Code (“Civil Code”) section 5510(b) only permits a board to spend funds designated for reserves for maintaining, repairing, restoring and replacing major components the association is obligated to maintain, repair, restore or replace, for which the reserve fund was established; or litigation pertaining to the maintenance, repair, restoration and replacement of these components. However, Civil Code section 5515 allows reserve funds to be temporarily used for other purposes provided they are timely repaid.

The Benefits to Borrowing from Reserves

Because reserve funds can generally be quickly accessed, they can be used to meet the association’s cash shortfall until the Board can implement a financial plan to pay for the expense, such as increasing regular assessments, levying a special assessment, identifying budgeted expenses that can be deferred, reduced or eliminated, or obtaining a loan.

The Requirements for Borrowing from Reserves

Civil Code section 5515 imposes the following requirements when borrowing from reserves:

The board must vote to borrow from reserves at a duly noticed open session board meeting. Further, the board must vote on a financial plan to replace these funds within one year.
The fact that the board intends to consider a transfer from reserves must be included on the agenda for this meeting. The agenda must also state the reason or reasons the transfer is needed, whether the board will consider the imposition of a special assessment to repay reserves, and some of the other repayment options to be considered.
The minutes for the board meeting must include the board’s vote to approve the temporary transfer of funds from the reserve account, the reason or reasons the transfer was necessary, and when and how the reserve account will be repaid.
The funds borrowed from reserves must be repaid within one (1) year of the date of the transfer. If more than one transfer is needed, the funds must be repaid within one (1) year of the initial transfer.

Notwithstanding the one (1) year repayment requirement imposed by the Civil Code, it is possible to extend the repayment period if the board determines it is in the best interests of the association to do so. However, the same requirements for borrowing the funds apply. In other words, the board must vote at a duly noticed open session board meeting to extend the repayment period and on the new plan for repayment. The agenda for this meeting must clearly indicate that the Board will be considering a repayment extension and a new (or revised) plan for repayment, including a statement on whether a special assessment will be considered. The meeting minutes must reflect the board’s vote to extend the repayment period, the reasons the extension is necessary, and when and how the funds will now be repaid.

PRACTICE TIPS:

Borrowing from reserves is not an alternative to careful and considered budgeting. Nor is it an alternative to imposing the assessments needed to cover the association’s anticipated operating expenses. This tool should be used judiciously and infrequently in order to maintain the integrity of the reserve account.

A board cannot borrow what the association doesn’t have. A well-funded reserve account is important not just for fulfilling the association’s maintenance, repair and replacement responsibilities, but also for avoiding potential financial crisis in the event of an expected cash shortfall.

When meeting to vote on whether to borrow from reserves, don’t limit your options. Identify and duly consider all the ways the reserve funds can potentially be repaid. It may be the best option to combine methods of repayment.

The ability to extend the repayment period is not a license to use reserve funds to permanently fund purposes other than those authorized by the Civil Code. Any extension in the repayment period should not exceed a year at the most.

Please reach out to us if you would like further guidance on the board’s responsibilities when it comes to funding and borrowing from reserves, or assistance in implementing repayment plan.

Formation and Use of Executive Committees

By Karyn A. Larko, Esq.

A committee is a group of persons appointed by an association’s board of directors to perform a specific task or tasks.

The scope of authority of a committee is largely dependent on its composition. A committee composed solely or partially of persons other than board members is generally tasked with advising the board on specific matters or exercising powers granted to that committee by the governing documents (e.g., some architectural review committees (“ARCs”).

Conversely, executive committees (“ECs”) are composed of two or more current directors and only current directors in accordance with California Corporations Code § 7212. ECs are given decision-making power that would otherwise be exercised by the board. An example of an EC is a litigation committee comprised solely of directors, established to communicate with the association’s legal counsel and make decisions pertaining to a lawsuit. Another example is an ARC comprised solely of directors tasked with exercising the board’s authority under the governing documents to approve or reject architectural applications.

Forming an EC

An EC should be formed when a board needs to delegate tasks for which it is responsible. This need may arise when a board is dealing with a complex, time-consuming matter that is ongoing and necessitates attention between board meetings. This need also exists when a dispute exists between a director and the association. In the latter example, the interested director (i.e., the director whose interests are contrary to the association’s interests) should not serve on the EC due to their conflicting interests.

California Civil Code § 5350 requires directors to recuse themselves from voting on certain matters. In some instances, it may also be prudent to form an EC to address these matters.

ECs should not be formed to exclude a director from generally participating in board discussions and votes. However, if a director is jeopardizing the interests of the association by, for example, revealing confidential or privileged information to others, it may be appropriate to form an EC to exclude that director from meetings whereat the Board discusses matters that, if made public, might expose the association to liability or disadvantage the association in a dispute. Your boards should consult with their association’s legal counsel before forming an EC for this purpose as taking this action can also create legal issues for the association.

Why Form an EC?

There are benefits to having ECs. An EC comprised of directors willing and able to volunteer more time to the association can address complex, time-consuming matters more quickly than the entire Board. Additionally, since an EC has fewer members, scheduling meetings and coming to a collective decision on matters is often easier. Finally, if less than a quorum of directors serves on an EC, the EC meetings are not subject to the Open Meetings Act (i.e., the meetings are not subject to the same notice and agenda requirements as board meetings).

In the event of a dispute involving a director, especially a dispute that could lead to litigation, there are important additional benefits to establishing an EC of disinterested directors (i.e., directors not adverse to the association in the matter) to handle the dispute. By establishing the EC, the board can prevent the interested director from obtaining privileged or confidential communications and documents related to the matter (e.g. correspondence between the EC and the association’s legal counsel, expert findings), thereby better protecting the association’s attorney-client privilege and its interests. The board can also avoid the appearance of impropriety and better protect the association and directors individually against potential liability.

In order to preserve the association’s attorney-client privilege, however, all EC meetings pertaining to the director dispute must be held in executive session and all legal guidance, EC discussions, meeting minutes and other documents and information related to the dispute cannot be disclosed to persons outside of the EC, including other directors.

Forming an EC

Have your boards review their governing documents prior to establishing an EC. The governing documents may already establish the EC, grant the board committee-making authority or, conversely, limit the board’s committee-making authority, as well as impose requirements on how ECs are formed or who may serve on them.

Unless otherwise provided for in the governing documents, ECs may be formed by a resolution or charter adopted by a quorum of the board pursuant to Corporations Code § 7212. A resolution is an official expression of the opinion or will of the board that includes the reasons for that opinion or will. A charter is a founding document that is typically more detailed than a resolution and outlines the EC’s responsibilities and authority.

When forming an EC, your boards should consider: 1) whether any directors have conflicts of interest that disqualify them from appointment or perceived conflicts that make appointment unwise; 2) whether certain directors have knowledge and experience that would benefit the EC; 3) the time commitment needed to serve on the EC; 4) whether the governing documents dictate which directors serve on the EC (e.g. based on the offices they hold); 5) whether California law dictates the composition of the EC (e.g. Civil Code § 5501 requires the treasurer to serve on an EC that reviews the association’s financials); and 6) the willingness of directors to serve on the EC.

The board should also keep in mind that if the EC is composed of a majority of the board, the same notice and agenda requirements for board meetings will apply to EC meetings. Having said this, the authority of an EC composed of a quorum of the Board is less likely to be challenged. Thus, ECs established to handle controversial matters should generally include a quorum of the board.

Multiple Choice Questions (correct answers in bold)

An executive committee may be composed of two or more:

a) current and former directors.

b) current directors and general members.

c) current directors and non-member experts on the matter.

d) current directors only.

Which of the following is not an appropriate reason for a board to form an executive committee?

a) a complex, time-consuming matter has arisen for the association

b) a majority of directors do not like the personality of another director

c) a dispute exists between a director and the association

d) the governing documents have granted the Board the authority to do so

Which of the following statements pertaining to executive committees is accurate?

a) An executive committee must be formed by a quorum of the board, and all executive committee meetings must be properly noticed pursuant to the Open Meetings Act.

b) An executive committee may be formed by a quorum of the board, in which case the executive committee meetings must be properly noticed pursuant to the Open Meetings Act.

c) An executive committee may be formed by a quorum of the board, but, in either case, notice of executive committee meetings should not be provided to the membership.

d) An executive committee may not be formed by a quorum of the board, and notice of executive committee meetings should not be provided to the membership.

*This article was originally published in The Law Journal Winter, 2022 and was adapted from the original article, Formation and Use of Executive Committees, as authored by Karyn A. Larko, Esq.

Refresher on the Architectural Approval Process

By Lindsay J. Anderson, Esq. and Karyn A. Larko, Esq.

Most CC&Rs require owners of the separate interests to obtain association approval prior to making structural alterations or alterations to the exterior of their separate interests or common area.

In some instances, the language is vague, imposing the obligation on owners, but providing few details. In other instances, the CC&Rs set forth in detail the process owners (and the association) must follow.

Directors should be encouraged to review their association’s CC&Rs so they are well-versed on the architectural approval process (“Process”) they must follow. Likewise, if the CC&Rs provide for an architectural review committee (“ARC”), ARC members should be encouraged to review the Process.

Having said this, “knowing” the Process is not enough. The board and ARC, if any, must also comply with the Process. Failure to do so can lead to the inadvertent approval of alterations that are not acceptable to the board or ARC.

Many CC&Rs state that if an application is not approved or denied within a specified time period, the application is automatically approved or association approval is no longer required.

The inadvertent approval of alterations can result in alterations that are detrimental to the appearance of the community and property values, or that undermine the structural integrity of a building. Inadvertent approval of alterations can also lead to potential liability for the association and, in some instances, individual board or ARC members.

On a related note, be sure your boards and ARCs know the time periods imposed by California law for reviewing solar energy systems and electric vehicle charging station applications. California Civil Code (“CC”) §714(e) (2)(B) provides that unless a solar energy system application is denied in writing within 45 days of submission, it is deemed approved.

CC §4745(e) provides that if an electric vehicle charging station is not denied in writing within 60 days of submission, it is deemed approved. The Civil Code controls in the event the governing documents grant a longer review period.

Federal law also imposes a deadline for reviewing applications for qualifying satellite dishes and antennas. If your clients require approval for the installation of these devices, encourage your boards to consult with their association’s legal counsel on this matter

REVIEWING APPLICATIONS

The CC&Rs generally identify the factors the board or ARC is to consider when evaluating applications, such as conformity of the alterations with the governing documents, the quality of the proposed workmanship, the design and harmony of the alterations with existing structures, the location of the alterations in relation to surrounding structures, topography, and finish grade elevation.

It is important that boards and ARCs understand the scope of their authority and duty when evaluating applications, and perform their evaluation in keeping with this scope.

If an application contains a disability related request for a reasonable accommodation, the board or ARC should consult with the association’s legal counsel on how best to evaluate the application.

APPROVING/DENYING APPLICATIONS

Boards and ARCs must act reasonably and not in a capricious or arbitrary manner when deciding applications. This does not mean that if they have previously approved an alteration, they must approve all future applications for the same or similar alterations.

Nor does it mean that if they have previously denied an alteration, they must do so in the future. However, they should have objective reasons for treating the applications differently and these reasons should be noted in the meeting minutes.

For example, the location of a proposed alteration in relation to other structures might be a basis for denying a request that was previously approved elsewhere in the community.

CC §4765(a)(4) mandates that applications be approved or denied in writing, and that if an application is denied, the notice of denial must include the reason(s) for the denial and a description of any procedure the owner must follow to appeal the denial.

Your boards and ARCs may impose reasonable conditions when approving applications, subject to any limitations imposed by the governing documents. If any conditions are imposed, these conditions should be clearly set forth in the notice of approval.

APPEALS

If applications are denied by an ARC, other committee, or subcommittee of less than the whole board, CC §4765(a)(5) grants owners the right to appeal the denial of their application to the board. Section 4765(a)(5) does not extend this same right of appeal to other owners who may object to the approval of a neighbor’s application.

Some governing documents provide an appeal process regardless of the composition of the body reviewing applications. In such instances, this process must be followed even if the right to appeal is not imposed by the CC.

If owners are entitled to appeal, the board must promptly consider their appeal at a duly noticed open session board meeting, subject to any additional requirements imposed by the governing documents.

ARCHITECTURAL GUIDELINES

CC §4765(a)(1) requires associations to have a fair, reasonable, and expeditious procedure for deciding applications, including the maximum time for responding to applications and appeal requests. This procedure must be set forth in the governing documents, which include CC&Rs and rules or guidelines.

Therefore, if any of your clients have CC&Rs that do not include a detailed description of the architectural review process or have concerns about the current process, they should consult with legal counsel.

If authorized by the governing documents, your boards should adopt architectural guidelines that set forth any standard restrictions on commonly requested alterations. By doing so, they reduce the potential for inconsistent application decisions and claims of wrongdoing.

ANNUAL DISCLOSURE

CC §4765(c) requires associations to notify their members annually of any requirements for association approval of physical changes to property. This notice must describe the types of changes that require association approval and include a copy of the association’s process.

*This article was originally published in The CACM Law Journal, Fall 2022 edition and was adapted from the original article, Refresher on the Architectural Approval Process) as authored by Lindsay J. Anderson, Esq. & Karyn A. Larko, Esq.

Key Tips for Levying Special Assessments

By Karyn A. Larko, Esq.

There are times when levying a special assessment is necessary or prudent to obtain needed funds. However, if not well planned and properly implemented, a special assessment can turn into a nightmare for the Board, and for you.

Here are some key tips to help avoid such a nightmare.

Ascertain Whether a Member Vote is Required

California Civil Code (“Code”) § 5605 controls when a member vote is needed to levy a special assessment. No matter what an association’s governing documents state, a member vote is not required to levy a special assessment if that special assessment individually, or when combined with any other special assessments levied the same fiscal year will not exceed 5% of the association’s budgeted gross expenses for that fiscal year. Conversely, a member vote is always required if the special assessment individually, or when combined with any other special assessments levied the same fiscal year will exceed 5% of the association’s budgeted gross expenses.

The Civil Code Sets the Member Approval Requirement

If member approval is required, Code § 5605 also dictates the votes needed to approve the special assessment, as well as quorum. The affirmative vote of a majority of a quorum is required to pass a special assessment. A quorum is more than 50% of the members.

Comply with the Civil Code When Conducting the Vote

A member vote to approve a special assessment must be conducted using the double-envelope secret ballot voting process set forth in Code § 5100 et seq. In short, this means providing all members with a ballot, two balloting envelopes and the association’s election rules at least 30 days before the voting deadline. (The election rules can be omitted if they are posted on the association’s website and the ballot contains the language mandated by Code § 5105.) It also means having one or three qualified inspectors of elections open and count the ballots at a duly noticed meeting whereat the members can observe this process, and providing members with notice of the vote results within 15 days.

Notify the Members

Regardless of whether a member vote is needed, members must be given written notice of a special assessment no less than 30 days and no more than 60 days before that special assessment becomes due in accordance with Code § 5615. If a member vote is required, this notice can be combined with the notice of the outcome of the vote that must be provided to members so long as: 1) this notice is provided via “individual delivery” and 2) the special assessment will become due between 30 and 60 days after this notice is given.

Payment is Important

It goes without saying that when planning a special assessment, it is critical to consider when the funds will be needed. However, there are other factors that should also be considered.

If members will be voting on whether to approve the special assessment, giving members more than one payment option (e.g. the option of paying in one lump sum or in installments over time) may increase the likelihood of members voting in favor of the special assessment.

On the flip side, if members will be given the option of paying over time, it is possible that more members will decide to pay over time than expected. If some or all of the special assessment monies are needed quickly, this situation could result in a serious cashflow problem for the association.

If a special assessment is to be paid over time (e.g. monthly installments), it is important to secure the debt in case any members file bankruptcy or sell. The longer the payment period, the greater the likelihood of collection issues. However, securing the debt means going through the pre-lien and lien process, which can be costly for the members who are subject to this process. Thus, levying a special assessment that will or can be paid over time may only be a perceived benefit to members if the assessment amount will be significantly greater than the pre-lien and lien costs.

It is a good idea to have members who cannot pay a special assessment when due enter into a payment plan whereby they agree to pay the assessment within a longer period of time that is acceptable to the Board. Doing so will help the Board predict the association’s cashflow and prevent any misunderstandings as to what payment allowances the Board is granting. It may also create good will with members who are struggling financially. However, a payment plan should generally be used in addition to, and not in lieu of a lien, because a payment plan will not secure the debt. A lien will.

In the event a member fails to pay the special assessment and that debt is not secured, the association’s only recourse for collecting the debt is to file a lawsuit against the member. The association cannot collect the debt via foreclosure unless the debtor still owns the separate interest and a lien is filed.

When in Doubt, Encourage the Board to Consult with Legal Counsel

While it may be tempting to save a little money by not consulting with the association’s legal counsel for guidance when levying a special assessment, making a special assessment misstep could cost the association a lot more in time and money. For example, a mistake could result in a missed opportunity for the association, create a serious cashflow problem, necessitate a second member vote and/or place the association in the position of having to return to members any special assessment payments received. It could also leave the association vulnerable to liability for violating the Code and unable to collect from delinquent members.

*This article was originally published in the Summer 2022 Issue of The Law Journal by the California Association of Community Managers (CACM).

Records to Keep

By Karyn A. Larko, Esq.

There are few laws that say exactly what records a community association should keep and for how long. Some of these laws are clear and some are not. For this reason, much of this article is based on the author’s experience and opinions, with input from experts in other legal and financial disciplines. Please note, there are undoubtedly some categories of records not addressed in this article that may be as important as those addressed below.

Member Meeting, Board Meeting and Committee Meeting Minutes

An association’s minutes constitute the official record of its acts. Both incorporated and unincorporated associations must keep minutes and must allow members to inspect them (see Corp. Code § 8320 and § 8333; Civ. Code § 4950 (board meetings), § 5200 and § 5210). The original minutes should be kept forever, including minutes of membership meetings, regular board meetings and executive sessions (kept separately from regular board meeting minutes). The same applies to minutes of any committee that is empowered to exercise any board powers. If you don’t have originals, keep what you do have, signed or unsigned.

Ballots, Outer Balloting Envelopes and Proxies

The law provides direction on the retention of candidate registration lists, voter lists, ballots, proxies, sign-in sheets, signed voter envelopes and other election records. For Board elections and member votes to amend the governing documents, increase regular assessments, impose special assessments, and grant the exclusive use of common area, Civil Code sections 5105, 5125, 5200 and 5210 require that candidate registration lists, voter lists, ballots, signed voter envelopes, proxies and sign-in sheets be stored by the inspector(s) of elections or at a location designated by the inspector(s) for one year from the date the cause of action accrues. This can be a challenging date to identify. Depending on the nature of the claim, the date of the cause of action can be prior to the date the ballots are opened and counted, the day the ballots are opened and accounted, or a later date. Thereafter, these records must be held by the association until a total of three fiscal years have elapsed. (For example, if an association’s fiscal year is January through December and the election is held in June 2020, these records must be retained until January 2023.)

Remember to note the election results in the relevant meeting minutes (see Corp. Code § 8325).

Contracts

Civil Code sections 5200 and 5210, which became effective January 1, 2014, require associations to make executed contracts that are not privileged under law available to the owners (which is the same as saying they must “retain” these records) for the current and prior two fiscal years. Having said this, an association should not destroy these documents at the end of this period.

California has a 4-year statute of limitations for lawsuits arising out of contracts or other written documents (Code Civ. Proc. § 337). Therefore, even if you signed a contract more than four years ago, you should keep the document for at least 4 years after the contractual relationship ended. For example, if you have an automatically renewing management or landscape maintenance contract, you should keep that contract for at least 4 years from the date the contract was terminated.

To keep track of contracts, you should keep a file or notebook containing all active contracts and a separate file for contracts that have expired or have otherwise been terminated.

Records Related to Taxes

Civil Code sections 5200 and 5210 also require associations to make many tax related records available to owners for the current and prior two fiscal years. (The tax-related records subject to section 5200 include, without limitation, state and federal tax returns, invoices, statements, receipts, canceled checks, approved purchase orders, reimbursement requests and credit card statements.) However, an association should not destroy these records at the end of this period.

We are informed that the IRS generally has a 3-year rule and that the California Franchise Tax Board has a 4-year rule for conducting tax audits (absent fraud). However, if a claim of loss from worthless securities is made or a deduction is taken for a bad debt, the statute of limitations (i.e., the timeframe within which the IRS can challenge the claim or deduction) is 7 years. Furthermore, there is no limit on when these agencies can pursue a claim if a tax return wasn’t filed. We have had clients whose corporate status was suspended for allegedly not filing a tax return more than fifteen years before. If the IRS has no record of a tax return or the tax payments, it will be impossible to show that you filed or paid the taxes without the return and the canceled checks. Using this knowledge, it would be wise to keep all original financial documents for at least 4 years after filing the tax return (7 years if the return included a bad debt deduction or claim of loss) and to keep the tax returns and any tax payment checks forever.

If the Franchise Tax Board has no record that you filed or paid taxes and you do not have the records to prove otherwise, your corporation can be suspended. The state will not revive the corporation or allow you to terminate the existing corporation unless and until the Franchise Tax Board acknowledges that all returns have been filed and taxes paid.

A few publications from the IRS provide additional guidance on the retention of tax related records. Publication 17 (2014) “Your Federal Income Tax” and Publication 583, “Starting a Business and Keeping Records,” are both available on request or can be accessed and printed from the Internet at http://www.IRS.gov. Also, an article in Smart Money Magazine[1], citing an H&R Block tax specialist, gives suggestions for individuals. The specialist suggests keeping all tax-related items for seven years. It should be noted that the suggestions for what not to keep seem more applicable to individuals than businesses.

Since we are not tax attorneys, our best advice is that you obtain the advice of your association’s CPA or a tax attorney before discarding any tax related records.

Employee Related Records

For associations with employees, retaining payroll and employment records is more difficult to address. There are different statutes of limitations for state and federal wage claims, age and sex discrimination claims, and benefit claims, etc. Some run from the date of the first breach and others from the date of the last violation. Depending on the claim raised, you may need time cards, hourly rates and annual salary data paid to different employees, evaluations and other personnel file records, and employee manuals and amendments. You should probably retain the records on an employee for at least six years after the employee’s employment with the association ends. Certainly, you should retain all records for current employees for at least six years and you should retain all personnel file information including benefit information for at least six years after the employer/employee relationship is terminated.

Unfortunately, it is far more difficult to say how long you should keep these records to defend against claims that current employees might raise in the future.

When you discard employee records, be sure to shred them to prevent both identity theft and the access of personal and confidential information by unauthorized persons.

Association Records Subject to Owner Inspection Pursuant to California Law

Civil Code section 5200 specifically identifies a number of other association records that must be made available to owners for inspection (and therefore, must be retained) for the current and prior 2 fiscal years. Excluding minutes, contracts and tax related documents, which we addressed separately, these records include: (1) all governing documents; (2) documents required pursuant to Civil Code sections 4525, 5300, 5305, 5310 and 5565; (3) interim financial statements which include a balance sheet, income and expense statement, budget comparison or a general ledger; (4) written board approval of contracts or vendor bills; (5) reserve account records and records of payments made from reserve accounts; (6) the agendas for membership meetings, board meetings and meetings of committees established by the board pursuant to Corporations Code section 7212; (7) membership lists; and, (8) check registers.

The retention period required by Civil Code section 5200 is the minimum retention period. These records should be kept longer if another rule or category applies that mandates a longer retention period.

Legal Documents

Legal documents, especially those that are not recorded in the official records of the county the association is located in, including settlement and mediation agreements, releases and maintenance agreements should be retained indefinitely – or at least until the association’s legal counsel confirms that it is safe to destroy them.

Any time there is a dispute involving the association and either a claim is made or a lawsuit is threatened, all documents pertaining to that matter must be preserved until litigation has concluded or the matter has otherwise been fully resolved, and legal counsel has confirmed that is safe to destroy them. Additionally, all electronically saved communications, documents and video related to that dispute must be preserved, including without limitation, all emails, facsimiles, website and blog postings, voice-mail and text messages.

Other Association Records

There are records that an association is not required by law to retain, but we recommend doing so (at least for a substantial period of time) as a matter of good practice.

Annual audits or reviews are among the most important association financial records. These documents, which typically come in a small booklet, summarize an entire fiscal year. It seems reasonable to keep them indefinitely.

You should maintain an inventory list, at least for items having a significant value. This list should include a description of each item purchased, the purchase date, the amount paid and the check number. If you have a casualty loss, you will need to provide the association’s insurance carrier with a copy of the applicable purchase invoice(s) or canceled check(s). Accordingly, you should keep these documents for as long as you own the property.

If you have an uncollected judgment, it is good for an initial 10 year period and can be renewed for an additional 10 year period. Judgments and recorded abstracts of judgment can pop up years later, usually when a former owner wants to pay off the judgment to obtain new credit. While a copy of these documents may be available in court files or attorney records, they may have been archived or even destroyed. Even if they can be obtained, it may take some time to obtain them from storage. Therefore, it is wise to keep these records while the judgment is valid.

Liability claims and certain property casualty claims can arise years after the incident(s) leading to such claims occurred and the association may have changed carriers one or more times in in the interim. The association will need to find the applicable insurance carrier to obtain insurance defense. A file should be kept for each insurance carrier and its policy(ies). Each year’s declarations page, as well as any changes and endorsements that take effect during the life of the policy, should be added to the file.

Most associations keep a file for each owner’s property containing all correspondence and other records relating to that property or its owners. If an owner changes, routine correspondence can be archived and probably discarded following the general guidelines at the end of this article. However, for the reasons described below, you should probably retain indefinitely those documents relating to the property itself, such as architectural applications and recorded maintenance and indemnity agreements.

If architectural applications and approvals are discarded, it becomes impossible for the association to confirm which lot alterations had been approved. It also become impossible to confirm which improvements had been owner rather than developer constructed.

There is another benefit to retaining architectural decisions. Prior architectural decisions can provide guidance to architectural committees and boards by providing a record of what alterations did and did not work in the past and why. These records can also assist an association in the event an owner challenges its approval for denial of a proposed alteration. (Courts have allowed associations to change their minds based on the lessons of experience.)

Civil Code section 4765 requires architectural decisions to be in writing, and if a proposed change is disapproved, the written decision must explain why. Although you may keep the originals in separate files for each separate interest, you may find it more helpful to have at least a summary of each decision well-indexed in one or more files or notebooks. The summary should identify the improvements proposed and the reasons why they were or were not approved. This summary should also identify any regrets or complaints that followed an approval.

A general rule would be to say that, apart from the discussion above, most records can be discarded after five years, with the exception of employee benefit data/records, which must be kept for six years. However, even a five-year guideline cannot be applied categorically, and once a unique document is discarded, it is gone forever. If you are in doubt, you probably should err on the side of keeping the document, or at least get specific advice from someone with special expertise in the area that may be affected by the disposal before deciding whether to discard it.

Effective Record Retention

Records seem to disappear over the years. Thus, it is a good idea to consider using either a professional document storage company or a commercial self-storage unit just for your association’s records. You should also develop a numbering system for the boxes and keep an index of what is in each box so that you can readily find documents many years later.

Records that you plan to keep forever should probably be kept with like documents in date order to make locating them easier (e.g., tax returns). It also makes sense to keep all records in the association’s active files that are to be kept forever in a separate drawer or banker’s box marked “KEEP FOREVER” to reduce the risk of them being inadvertently discarded. If you do not separate out these records at the time of their creation or receipt, they will become commingled with other records that may later be inadvertently discarded. Waiting until you are ready to discard records to separate out those that should be kept will likely be significantly more difficult and time consuming than filing them separately in the first place.

If you have large quantities of documents that you think you should keep, but you don’t have the room, you may consider storing the records in computer form, either with software data files or scanned images. While this will take far less physical space than paper, it is important that you develop a plan on how you will access the documents in the future. Just as floppy disk drives have disappeared, making it difficult to pull data stored on such disks, it is important to realize that technology commonly used today may become obsolete or fail. Therefore, unless you are using the most common software and hardware available now to store your records, know that it may not be readable in 10 to 15 years. In fact, even using the most common software and hardware available now will not ensure that you will be able to access your electronically stored records a decade or so from now. Additionally, hackers, ransomware, malware and viruses have all become commonplace. As a result, the security and protection of electronically stored records is becoming increasingly challenging. Built in storage redundancy, frequent document backups, and the use of current virus and malware protection software can significantly reduce the risk of loss. However, these measures are not foolproof. For these reasons, keeping paper records may still be the safest option.

[1] April 2000 edition, page 88.

What’s All the Buzz About FHA?

By Karyn A. Larko, Esq.

You may be hearing rumors that the Federal Housing Administration has made changes to its requirements for insuring condominiums. The rumors are true and the new requirements will take effect on October 15, 2019.

Before addressing the substantive changes made by the FHA, however, it is important to mention that the certification period for FHA approved condominium projects has increased from two (2) years to three (3) years. This means that condominium associations who want to maintain their FHA certification will only have to re-apply every three (3) years going forward. While not as convenient as the “old days” when FHA certification did not expire, it does reduce the frequency with which associations must go through the re-certification process.

The first noteworthy change when it comes to FHA and condominium associations is the addition of spot or single-unit FHA approval. Under the current FHA guidelines, a project or phase of a project must be FHA certified in order for any unit within the project or that phase to be eligible for FHA. As of October 15th, it will be possible to obtain FHA certification on a condominium unit within a project that is not certified provided certain requirements are met, including the following:

The project is a completed project consisting of at least five (5) residential units.
The project is not comprised of manufactured housing.
The unit is not part of a project that is FHA certified or has one or more FHA certified phases.
For a project with at least twenty (20) units, the percentage of units within the project owned by the same party or related parties does not exceed 10%. For the purpose of this requirement, a related party is an individual related to another unit owner by blood, marriage or operation of law; a person serving as the unit owner’s officer, director or employ; or a direct parent, subsidiary or other related entity with which the unit owner shares a common officer or director. For a project with fewer than twenty (20) units, no owner may own more than one (1) unit and no related party may own a unit.
For a project with at least ten (10) units, no more than 10% of the units within the project are already FHA insured. For a project with fewer than ten (10) units, no more than two (2) units within the project are already FHA insured. (This requirement differs from FHA certified projects where the FHA will insure up to fifty percent (50%) of the units.)
The project is at least 50% owner occupied.
The project meets other standard requirements for FHA (e.g., no more than 15% of the units are delinquent in the payment of regular or special assessments by more than sixty (60) days, no more than 35% of the project is mixed use).
The borrower meets certain eligibility requirements.

The second noteworthy change is the expansion of the definition of site condominiums. Under the FHA guidelines, projects consisting solely of site condominiums do not require project-wide FHA certification or single unit approval. Currently, site condominiums are defined as single family totally detached dwellings encumbered by CC&Rs and a condominium form of ownership, where the units consist of the entire structure as well as the site and airspace, and the owners are solely responsible for the insurance and maintenance costs for their units. As of October 15th, site condominiums will include condominium projects (other than manufactured homes) consisting of horizontally attached dwellings (i.e., townhomes) where the units consist of the dwelling and land. The requirement that the owners be responsible for all insurance and maintenance costs pertaining to their units still exists, with the exception of landscaping.

Do We Only Need a Member Vote to Borrow Money if the Governing Documents Say So?

By Karyn A. Larko, Esq.

Borrowing is a common method for community associations to pay for major projects within their communities. However, Boards frequently find the lending process a lot longer and more stressful than they first imagined – primarily because they do not realize until they are ready to close on the loan that they need member approval, and maybe even mortgage holder approval, to obtain a loan.

It is not uncommon for a community association’s Bylaws or CC&Rs to include a provision expressly providing that the approval of a specified percentage of the membership is required to borrow money. However, the absence of such a provision in these documents does not necessarily mean that the Board has the authority to take this action on its own. In some cases, the Bylaws and CC&Rs are silent, but the Articles of Incorporation impose restrictions on borrowing. In other cases, the Articles, Bylaws or CC&Rs impose member and/or mortgage holder approval requirements on actions that are, or may be required to borrow money. Examples of these actions include restrictions on the Board’s ability to unilaterally encumber common area, or pledge or assign other association assets.

One provision that is contained in the Bylaws or CC&Rs for many associations that is commonly overlooked when ascertaining the Board’s ability to borrow money is the provision requiring member approval for contracts exceeding one year. Because a loan is a contract, a loan with a repayment term exceeding one year will generally be subject to this provision unless there is language in the governing documents that expressly exempts loans from this requirement. Remember also that any regular assessment increase or special assessment needed to repay the loan may also require a membership vote.

If your association requires assistance determining whether member or lender approval is required to borrow money, or assistance obtaining the required approval, please contact us.

Q&A. Must we have a published fine schedule if we notify owners in the hearing notice what fine the board intends to impose at the hearing?

A: Yes. California Civil Code section 5850 requires associations that want to use fines as a means of disciplinary action for violations of the governing documents to prepare and distribute a fine schedule. Additionally, section 5850 limits associations to imposing fines that comply with their published fine schedules. In other words, if an association’s fine schedule provides for a $100 fine for a given governing document violation, the association’s board cannot impose a $150 fine for that violation. The hearing notice should include the possible fine amount(s) but this doesn’t replace the need for a fine schedule.

On a related note, please remember that boards need to follow the rule adoption process mandated by Civil Code section 4360 when adopting a fine schedule. This means that the proposed fine schedule must be sent to all members for at least a 28-day comment period before being adopted at a duly noticed open session board meeting. The purpose and intended effect of the fine schedule must also be provided. Finally, notice of the board’s decision to adopt the fine schedule must be provided to the members within 15 days of the board meeting whereat the fine schedule was adopted. – Karyn A. Larko, Esq.

Rental Restrictions – A Potential Pitfall for Condominium Communities

By Karyn A. Larko, Esq.

It is common for associations to amend the rental provisions in their CC&Rs in an effort to address the issues associated with tenants. However, when an association is a condominium community, there is an important consideration that is frequently overlooked during this process – the FHA.

With few exceptions, FHA insured mortgages and reverse mortgages on units within a condominium community are only available if the community is FHA certified.

The FHA will only certify associations that meet all of the certification requirements, including those pertaining to rental restrictions. The rental restrictions the FHA allows are limited to the following:

A requirement that all leases must be in writing.
A requirement that that leases comply with the association’s governing documents.
A requirement that owners provide the association with a copy of their lease or sub-lease.
A requirement that owners provide the association with the names of all tenants and any family members of the tenants who will occupy their unit.
A prohibition on leasing for an initial term of not less than 30 days.
A maximum allowed length of lease.
A restriction on the number or percentage of units that may be concurrently rented within the community, provided this percentage does not exceed 50%.
Language allowing the Board to grant hardship exceptions to the rental cap.
A requirement that owners check the Registered Sex Offenders list prior to renting.
A requirement that rent be assigned to the association if a unit owner is delinquent in the payment of assessments.
A requirement that the Board review leases (but not that the Board approve leases).
A requirement that a specific form be used for leases.
Corporate leasing restrictions.

Complete prohibitions on renting, prohibitions on new owners renting their units, stated minimum lease periods greater than 30 days, requirements that leases and/or tenants be vetted and approved by the Board, and requirements that owners perform a background check on potential tenants (other than a check of the Registered Sex Offenders list) are a few examples of rental provisions that will disqualify an association for FHA certification.

Stated minimum lease periods of less than 30 days will also generally disqualify an association for FHA certification. However, it may be possible to overcome such a provision with a declaration signed by a Board member or manager attesting to the fact that, to the best of his/her knowledge, no units are being leased for a period of less than 30 days or for hotel or transient purposes.

For more information on FHA certification requirements, please see HR 3700: Requirements for Qualifying and Applying for FHA Certification.

Please contact me for assistance with FHA (or VA) certification. I am here to help.