Homeowner Associations: Transition of Control from the Developer to the Homeowners
By James C. “Beau” Brincefield, Jr. and Lisa Wells
Importance Of The Transition Period
The most important year in the life of any homeowners’ association – whether condominium, co-op, planned unit development (PUD) or other type of common interest association – is usually the first year after the developer turns over control of the association to the homeowners.
Two factors combine to make this transition period also a time of great danger for the members of the association.
First, the initial homeowner elected board is likely to be relatively inexperienced in dealing with association management issues.
Secondly, the potential claims of the association may become uncollectable or time barred (by the expiration of statutes of limitations) if they are not asserted promptly after the homeowners assume control of the association. Should this happen, the homeowners, themselves, would ultimately have to bear the costs of correcting deficiencies that should have been the responsibility of the developer or others and the members of the first homeowner elected board might find themselves exposed to liability to the rest of the homeowners for such losses.
This article outlines the most important actions which a newly elected homeowner board should take to identify and preserve any claims the association may have.
Select Independent, Experienced Legal Counsel
As soon as possible after assuming control of the association, the board should retain its own independent legal counsel. It is essential that the attorney have experience in dealing with association claims in general and transition claims in particular. This necessarily requires knowledge and experience in identifying all of the potential claims that need to be investigated, identifying the potential parties against whom claims can be asserted, determining who has the right to assert any claims, and determining what statutes of limitations apply to each of the potential claims.
Collect All Relevant Documents
One of the first tasks that counsel will undertake will be to help the board identify and collect all relevant and important documents. Among the most important documents to locate are: current and complete sets of the governing documents of the association; marketing materials used by the developer; plans and specifications for the project; association contracts; and all financial and other association records and correspondence. Taken together, these documents reflect the most important rights and duties of the association.
Determine the Physical Condition Of The Property
Along with assuming control of the association, the first homeowner elected board also assumes responsibility for all physical components which comprise the common elements of the project. The board must make certain that these common elements have been turned over to the board in the condition in which they were promised by the developer.
The developer will usually have given the homeowners certain warranties as to the condition of the property. These warranties may be statutory and/or contractual and/or implied by law. They may be found in many different sources such as purchase contracts, public offering statements, other marketing materials, written warranty documents and representations of sales representatives, just to mention a few.
In order to assist the board in evaluating the physical condition of the property and determining whether the developer has delivered the property in the condition promised, counsel will usually recommend that the board retain an independent professional inspector to conduct a thorough survey of the property. Usually, this inspector will be an architect and/or engineer.
Counsel should talk with the inspector before the inspection to explain any legal terms or issues that may have a bearing on the inspection. For example, if the property to be inspected is a condominium, it would be extremely important for the inspector to understand the definition of the term “structural defect” as it is defined in the Condominium Act. (The definition of that term in the Condominium Act is substantially different from the way in which it is normally understood in the architectural and engineering professions. The definition in the Condominium Act is much broader and, if the inspector does not know the statutory definition, the inspector may erroneously conclude that some of the defective or deficient conditions which he/she observes are only “maintenance” items or otherwise not the responsibility of the developer to correct.)
After discussing the scope of the survey with the board and its legal counsel and after reviewing all of the relevant documents, the inspector should then carefully inspect the property for any signs of defects or deficiencies in design, materials or workmanship. The inspector should then meet again with the board and counsel to review carefully the inspector’s findings. Counsel can then evaluate the findings of the inspector and advise the board whether or not any claims may be asserted for any of the defects or deficiencies which the inspector has identified.
Determine the Financial Condition Of The Association
The second major task is to evaluate the association’s financial conditions. It is important to determine as soon as Possible whether the developer has met all of its financial obligations to the association. Delay in asserting claims may result in not being able to prove or collect them.
As in the selection of the independent property inspector, counsel should assist the board in identifying a qualified accounting firm and in helping to focus the accountant’s attention on certain areas of the audit. At a minimum, the audit should determine whether all required capital contributions and all regular and special assessments, including any accrued interest and/or penalties, owed by the developer have been paid.
The accountant should also review all of the expenses paid by the association while it was under developer control to make sure that they were properly the association’s obligations and not the developer’s.
Finally, the accountant should work with the physical inspector and the association’s property management firm (more on the property management firm later) to review the association budget prepared by the developer to determine whether or not the budget is sufficient to meet the short and long term needs of the association. If the budget prepared by the developer is inadequate, the board will need to adjust the level of assessments and decide whether to assert any claim for low balling the budget.
Other Transition Issues
After all the association governing documents have been collected, counsel should review them to make sure that they comply with all applicable laws. From then on, counsel should help the board comply with the governing documents and applicable laws as the board conducts its business. The board and counsel should also evaluate the association’s insurance coverage and review the terms of any other contracts entered into by the board during the developer controlled period.
Selection of the right property management firm is critical to the long term success of any homeowner association. A good property management firm can be of enormous assistance to the transition board in all of the activities and evaluations outlined in this article. The stronger the relationship between the property management firm and the developer, the more important it is to replace the firm as soon as possible.
After reviewing the results of all of the inspections and analyses described above, counsel can then begin to determine whether any claims exist. The ultimate questions for the association are always the same: “What amount of damages, if any, are we likely to recover?” and “What will it cost to find out?” Answering these basic questions, however, may require extensive investigation and/or very complex and difficult analyses in order to answer a whole host of essential subquestions. For example: Who is/are the proper plaintiff(s)? Who is/are the proper defendant(s)? What type(s) of claim(s) can be asserted against each defendant? What witnesses, documents and other evidence is available to prove liability and the amount of damages? What are the statutes of limitations that are applicable to each of the claims? Although a detailed examination of each of these subjects is beyond the scope of this article, a few words about some of them may be in order.
It is sometimes difficult to determine who the proper plaintiff is for asserting a given claim. In legal terminology, this is called “standing to sue.” In some cases, only the homeowners may have standing to sue. In other cases, only the board of the association or the association itself may have standing.
It can also be difficult to determine who the proper defendant(s) should be. The developer is almost always a target. However, others may have liability as well. For example, the developer appointed members of the board have fiduciary duties to the unit owners which may be difficult for them to discharge if they have conflicting loyalties to the developer. If they have breached these fiduciary duties, they may be personally liable to the homeowners.
Perhaps the real estate sales representatives were involved in some misrepresentation of the condition or character of the property or the association. A property management firm selected by the developer that fails to perform its duty to the association and/or the homeowners during the, declarant control period may find that it has breached its obligations to the homeowners and/or the association. In some cases, counsel for the developer will handle settlements and fail to make proper disclosures to homeowners when they conduct the settlements on their homes. In such cases, the attorneys may be liable to the homeowners.
Although the most common type of damage claims are made against the developer for deficiencies in the physical property or deficiencies in the financial condition of the association, there are many other potential theories of liability against various defendants which may be useful in collecting association claims.
Delay in Ascertaining Claims
Delay in asserting claims always makes it more difficult – and sometimes impossible – for the association to recover damages for otherwise valid claims. Obviously, if the association delays long enough, statutes of limitations will run, making otherwise valid claims uncollectable (more on statutes of limitations in a moment). However, delay need not be long enough to cause the expiration of the applicable statutes of limitations in order for delay to impair or destroy the collectability of claims.
In general, the amount collected on any given claim decreases in proportion to the amount of delay. There are many reasons for this. For example, the developer may terminate the developer entity that built the condominium or may transfer assets or otherwise dissipate funds that might otherwise be available for the payment of claims. As time passes, essential witnesses die or move away; their memories fade or become jumbled. Essential documents are lost or destroyed. The availability of a key witness or piece of evidence can make the difference between a large recovery or no recovery at all.
One of the most difficult areas in association litigation relates to statutes of limitations. (“Statutes of limitations” define the period of time within which suit must be filed on various types of claims; if suit is not filed within the statutory period, the claim becomes time barred and the claim, even if otherwise valid, is lost forever.) Courts have frequently disagreed on both the duration of the statutes which apply to different types of claims and the dates when the statutes begin to run. Consequently, it can be extremely difficult to determine whether or not the applicable statute of limitations has expired with respect to any given claim.
For the association that delays in asserting a claim, however, there is a bright side to this confusion about the applicable limitations period: experienced and creative counsel can frequently develop solid arguments for extending statutes which may appear to have expired and thus preserve or revive a claim which may initially appear to have been lost. Sometimes, the mere assertion of the claim and the presentation of the arguments for extending the statute may be enough to persuade a developer that it is better to compromise and settle the claim for a reduced amount rather than take the chance of litigating and suffering a judgment for a much larger amount.
Negotiation Versus Litigation
Once claims have been identified, counsel should notify the potential defendant(s) of the claims and attempt to negotiate a mutually satisfactory settlement. However, where negotiations fail or where statutes of limitations are running and may expire before negotiations can be successfully concluded, filing suit may be necessary to preserve claims.
Where negotiations fail, of course, litigation becomes a last resort. Association litigation tends to be time consuming and costly. Before filing suit, the board and counsel should carefully weigh the probable costs of litigation against the probable benefits to be realized if litigation is successfully concluded.
The prompt identification and assertion of claims is essential to the protection of the interests of the association and its members. Although it may appear time consuming and costly to conduct the investigations and analyses outlined in this article, many years of experience in condominium law and litigation have clearly demonstrated that it is a lot less time consuming and costly than the consequences of failing to do so.