Every community association, whether a condominium or homeowners’ association, goes through a transition, or “turnover” period, when the control of the association transfers from the developer to the owners. Ideally, control of the association shifts from the developer to the owners gradually and smoothly, with both sides cooperating and avoiding ill-will or litigation. Unfortunately, a smooth, gradual turnover is not always realized. Mistakes made during this critical period can have serious and lasting effects on the association. While the turnover process is somewhat complex, often misunderstood, and occasionally bungled entirely, there are seven simple steps that the association should take during this time to avoid missteps that will surely cause problems later.
1. Gain Control of the Association as Soon as Possible
The owners should take control of the board as soon as possible so that the association can focus on owners’ concerns as opposed to the developer’s interests. Condominium associations are governed by Chapter 5311 of the Ohio Revised Code, which mandates a timeline for gradual transfer of control. Once the developer has sold 25% of the units, owners must fill the seats of not less than one-third of the board. The Condominium Act further mandates that the board must consist completely of owners within five years of the Declaration being recorded, or when 75% of the planned units have been sold, whichever comes first. Non-condominium associations (“homeowners’ associations” or “PUDs”) are not governed by the Ohio Condominium Act and, therefore, not afforded the protection of the mandated timeline. Instead, the timeline for a homeowners’ association is dictated by its governing documents and the turnover of control to the owners may not be until the last home is sold. Regardless, the owners should not hesitate to take control as soon as the opportunity presents itself. One reason for doing so is that the statute of limitations for any claims against the developer may start as soon as the problem is discovered by the owners. Gaining control of the association makes it easier to act on these discovered claims and seek remedies. Furthermore, condominium associations have the ability to undo some developer decisions. For example, the Ohio Condominium Act provides that the association may not be bound by contracts, except for necessary utilities, for more than one year after turnover.
2. Hire Professional Management
Professional management should be hired as soon as possible. A good management company will aid the association by recommending service providers, assisting with nomination and election procedures, and helping in preparation of the annual budget. Management will also welcome and interact with new owners, work with any governmental officials on issues relating to the community, and perform numerous other tasks (including those below) to ensure that the association runs smoothly.
- Collect monthly maintenance fees and maintain owner records
- Manage income, including the preparation of checks for invoices
- Prepare and maintain all association correspondence, minutes, and records as directed
- Enforce rules and regulations as formulated/directed by the board
- Follow the Declaration and Bylaws as interpreted by legal counsel
- Provide escrow information when homes are sold
- Identify maintenance projects and determine the priority and availability of funds for each project
- Keep a record of the repair and/or maintenance work that has been performed on each home
- Establish specifications for general services and repair work
3. Obtain Directors & Officers Insurance
Directors & officers insurance covers defense costs and some damages in the event that the Association is sued. This insurance will help encourage volunteer board members because they will not have to fear personal liability for non-criminal actions. Directors and officers insurance must also be obtained to provide fidelity insurance bonding on the board members. Be sure to have fidelity coverage on the board and the management company (which typically requires a management rider to the policy) in an amount that equals or exceeds the association’s assets on deposit.
4. Hire Legal Representation
Obtaining the right legal representation is extremely important for a new association’s success. Attorneys are vital for reviewing the association’s governing documents and existing contracts with third parties such as landscapers, elevator maintenance companies, and other contractors that perform services or repair work for the association. Legal services are also needed to take collection action against the delinquent owners and/or the developer, as the developer will oftentimes forego collection action against owners in an attempt to attract more buyers or will not pay the maintenance fees on all unsold homes.
It is important to hire legal counsel that is totally independent from the developer to avoid potential conflicts of interest down the road. It is equally important to obtain counsel that works exclusively in this area and is familiar with all the fine points of how the law specifically impacts community associations. A law firm that previously represented the developer should be avoided to steer clear of potential conflicts of interest. Furthermore, if the developer’s attorney drafted your governing documents, he or she may be much less likely to point out deficiencies or the necessity of amendments which favor the association instead of the developer. Law firms which do other types of work, such as general real estate, evictions, probate, or business representation should also be avoided as they may use the association forum to solicit other business for their firm.
5. Have a Transition Study and a Reserve Study Performed
An engineer’s transition study is an inspection of all the association’s common elements. The study produces a punch-list of alleged and discovered construction deficiencies so that they may be brought to the attention of the developer. The association can then avoid having to pay for defects down the road that were actually the developer’s responsibility to remedy. This study also gives the new board knowledge of warranties, permits, utility-line locations, and other valuable pieces of information that will help them better run the association. It is important to have a transition study performed sooner rather than later as the developer will become increasingly less responsive as time passes and potential claims could become time-barred under statute or specific warranties.
The second part of this process is having a reserve study performed. Ohio law requires that condominium associations provide for reserve funds in the budget so as to avoid special assessments. A reserve study will help the association determine the useful life and cost of replacement of major capital items such as roofs, furnaces, and driveways. The replacement cost of each item is divided by its useful life to determine how much money should be allocated to the reserve fund annually.
The association should hire professionals to perform the transition and reserve studies. The board should resist the desire to perform these studies themselves to save money, as most boards are not qualified to perform this type of work. Most importantly, hiring a professional reserve study company ultimately protects the board from liability.
6. Hire a Certified Public Accountant to Conduct an Audit
A completely independent accountant is indispensable in helping the association review the financial records that were kept by the developer. The accountant will determine whether (as is too often the case) developer-related expenses have been charged to, and paid for, by the association. The accountant will also look to identify financial claims against the developer for mismanagement of funds while the association was under its control. While it may be too costly to have an audit performed every year, it is imperative to do so the first year the owners have taken control of the association.
7. Collect Essential Documents
Ohio condominium law mandates that after the owners take control of the association, the developer shall deliver correct and complete records of accounts, meeting minutes, names and addresses of owners and their percentage interest in the common elements, the Declaration and Bylaws as recorded, any relevant drawings including non-proprietary plans and specifications, the location of underground utility lines, and any Articles of Incorporation of the association. While this law does not govern homeowners’ associations, it acts as a tremendous guide for HOA boards seeking records. Essentially, the board will want a copy of virtually every scrap of paper that relates to the construction, finances, governance, and management of the association, including but not limited to:
- Association’s house rules and regulations
- Insurance policies
- Employment and service contracts
- Signature cards and banking resolutions for money accounts
- Copies of prior years state and federal income tax returns
- Copies of the current budget, including backup worksheets
- Tax identification number
- Information regarding service suppliers
- Documentation regarding all liens and claims of the association
- Inventories of association equipment
- Copies of warranties on all equipment and property owned or maintained by the association
- Specifications and a list of the manufacturers of all materials used in common elements
- A listing of all construction subcontractors and principals
Properly transitioning from developer’s control to an owner-controlled community is easy if done properly and professionally. The association’s new board will only get one chance to do it properly. If the board members are willing to educate themselves about the process, surround themselves with qualified professionals, and commit to a high level of involvement, the chances of success are high. Should you have specific transition questions, do not hesitate to contact attorney David Kaman at 1-888-800-1042. Should you read this article and have additional suggestions for future owners transitioning from developer control, send your written statements to David Kaman and they may be included in updates to this article.