A Short Tutorial on Borrowing from Reserves
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.