Full Disclosure

New homeowner association clients occasionally ask, “Why do we need to provide the management company the bank statements for Board-controlled accounts, such as CDs or money markets?”  Since the management company doesn’t draw on these monies, the confusion is understandable.

Although not directly handling these funds, the management company is required to provide a full picture on the financial health of the community.  Incomplete disclosures impact several areas:

• Insurance.  The fidelity/crime coverage must be adjusted based on actual dollar amounts held.  Besides not receiving back all funds in the event of a loss, lenders may also refuse to provide home loans if the Association is under-insured in this area.
• Tax Returns.  These could be delayed or require re-filing if the CPA does not have full, timely access to bank statements of all assets.
• Homeowners & Lender Inspection Rights.  Georgia Statutes and the Association’s Bylaws require that financials be made available for review, often within five days of a request.  Providing inaccurate balance sheets (by not listing all funds) exposes the Association to potential litigation which may not be covered by the Directors & Officers (D&O) insurance carrier.
• Speaking of D&O:  Withholding account information may be considered a violation of fiduciary duty, which can be used as an excuse to deny coverage for any D&O claim, not just one directly related to financial disclosures.  It gets expensive litigating with the insurance company afterward, trying to reverse a denial of coverage.

To ensure information is getting forwarded to your management company in a timely fashion, be sure to notify all of your lenders to automatically mail copies of bank statements to the manager.  You want to reduce human error and avoid any appearance of impropriety:  Failing to fully disclose only raises red flags.

Condo Loans

HUD hands down stricter condominium lending regulations every year!  In September 2015, HUD stated that loan approval would not be granted for communities where the Declaration of Covenants gives the Association approval authority over leasing units.  During the question and answer session, it was added that the Association cannot have the power to evict tenants. 

Although not every single loan is directly tied to FHA/HUD, 90% of all loans are impacted.  Other lenders need to be able to sell their loans on the secondary market, which can’t be done unless they conform to FHA/HUD demands.  So unless you want cash-only home sales (i.e. slum lord investor owners) dominating your community, you should look to amending your leasing language.

Even for communities with pre-approval HUD/FHA status (which must be done every two years), we are seeing each new home loan being scrutinized for community restrictions.  It’s best to proactively address this situation, before an angry mob of homeowners shows up at a meeting, unable to sell their homes.  Hopefully, your governing documents give the Board of Directors authority to automatically amend to comply with federal regulations, without the need for a community vote!

HUD also clarified that the Association can:

• Restrict total number/percentage of units that can be rented 
• Maintain a hardship exception 
• Require the landlord to provide a copy of the lease 
• Require that the lease be on a specific form
• Set minimum and maximum lease periods 
• Require that the lease conforms to the Declaration 
• Require the landlord to check the Registered Sex Offenders list
• Require rent to be assigned to Association if the unit owner is delinquent
• Provide corporate leasing restrictions

The Association cannot: 

• Ban all leasing, except in age-restricted and affordable housing communities 
• Require the owner to live in the unit for X amount of years before being allowed to lease 
• Restrict leasing by delinquent owners 
• Require tenant interviews with the Board 
• Require credit references 
• Require criminal background checks (except for the Registered Sex Offenders list) 
• Be granted automatic power of attorney 
• Have the power to void leases
• Allow short-term leasing

As always, consult with the Association’s attorney before acting upon the above information.

Lending Restrictions

Worried about what trouble your future Board might create?  A great way to lock in good governing habits is with a bank loan.  Yes, a bank loan.  All those restrictions for an Association loan guarantee that no funny business will be happening under someone else’s watch.  Just make sure the loan includes the following:

The 'proxy put'   This provision allows the lender to immediately call the loan due if a majority of the Association's Board of Directors becomes filled with 'non-continuing Directors' that were not approved by the original Board members.  Take it a step further to a 'dead hand proxy put', which prevents current Directors from bestowing 'continuing director' status to any new directors seated via a contentious election.

Governing Amendment   The lender holds veto power over any changes to community regulations.  That smoking ban will just have to wait.

Annual Audits   No, the treasurer did not pay for that Porsche with community funds.  Conspiracies are a thing of the past, when you’re required to have a CPA touch the books every single year. 

Insurance coverage    No corner-cutting here.  Great way to ensure that D&O insurance, fidelity, and workers comp coverage - the three coverages that typically get neglected - are fully in place.

Self-Managed?  No way.  That lender is going to have the last say on any changes in professional management.  And self-managed always turns out to be more costly in the long run.

Minimum Annual Budget   Yep, put the kibosh on all those crazy candidate promises of ‘lowering assessments’.  A related requirement keeps wastrels from draining your reserve funds.

First priority asset status   This allows the bank to have first dibs over any money or property the Association holds or might hold in the future.  Since HOAs rarely actually own real estate, the next best thing is having rights to all future assessments paid by homeowners.

Collections  The days of “going easy” on deadbeats are over.  Your banker expects the community to hit delinquent behavior with both barrels.  Absolutely no write-offs of debt without prior approval!  Best of all, if the delinquency rates slip above 10%, the note is called due.

Cross Default   Not cross-dressing, but close.  If the Board stiffs the plumber, it’s an automatic bank loan default.  It is also a default for any other creditor to have the ability to elect a majority of the members of the Board.

The point is this:  Requirements like those above have ramifications most of us never guessed existed, so be careful navigating past potential problems.  When your community obtains a bank loan for a major renovation/repair project, be sure your attorney is heavily involved. 

Protect Yourself

Through the years this blog has covered several aspects of Board member liability.  One additional item for your consideration is the use of indemnification agreements.  These provide a more inclusive protection than what you might find in State statutes or your community's governing documents.  These agreements contain detailed procedures and time frames - and clarify the types of claims covered.  If you decide to utilize this option, consider clarifications in the following areas:

Expenses.  Protect yourself against expenses connected with any proceeding, by expanding the definition of “Expenses” to cover items often excluded in a D&O policy:   fines & damages, experts’ and arbitrators’ fees, bonds, settlements, and income taxes resulting from payments.  Proceedings should include any threatened or pending legal proceeding such as investigations, discovery requests, and administrative proceedings.

Fees-on-Fees.  Directors are not necessarily entitled coverage for legal costs needed to sue the Association to enforce your indemnification rights - be sure this is added! 

Insurance.  Require that the Association have its D&O coverage audited to obtain the highest quality insurance available in the homeowner association industry.

Express coverage for negligence.   An all-inclusive provision may be voided because it is overly broad.  Be sure that your agreement explicitly covers all negligence except gross negligence.   Here are a couple of court cases that talk about this quirk in Georgia law:  Service Merchandise Co. v. Hunter Fan Co   "Georgia courts never imply an agreement to indemnify another for one’s own negligence in the absence of express language.”    Satilla Community Service Board v. Satilla Health Services, Inc   "Contracts indemnifying one against the consequences of his own negligence are not favored, but will be given effect where the intent is expressed in plain and unequivocal terms." 

Procedures and Timing.  The agreement can require that the Association, when settling a claim against you, include an unconditional release from all liabilities relating to the proceeding, along with an acknowledgement that you deny all wrongdoing.  Require all indemnification payments be made within 30 days, and all advances within 20 days of a written request.   In the event of an adverse ruling, you can appeal, and be indemnified for all expenses.  Include a presumption in favor of indemnification, that you have met the applicable standards of conduct allowing for indemnification, and that a judgment, settlement, or criminal conviction does not create a presumption against indemnification.  And impose a reasonably short period on any claim that the Association might have against you.

It is important that you require immediate money advances to cover defense costs, regardless of whether you are the subject of a lawsuit, investigation or witness subpoena, with coverage continuing for your legal expenses - even after you leave the Board.

The above is not to be considered legal advice, and you should consult with a legal professional before acting. 

CAUTION: Insurance Ahead

"That's what insurance is for."   Uttered by a Board member after several 300-pound marble blocks plummeted from the sides of his condominium tower. 

What sounds like a punch line for a joke will punch a hole in your financials with this attitude.   A visit by the Association's attorney and insurance broker is vital so Boards can see how coverage is stripped away in these situations.  Insurance is not a 'Get out of Jail' card when you turn a blind eye to dangerous situations. 

Such coverage is provided with the understanding that you take steps to avoid having to use it.  A review recent lessons learned shows what happens if we’re not careful:

Confirm that you are only using top-rate insurance providers. Mountainside Holdings v. American Dynasty Surplus Lines   In this situation, the umbrella insurer (the one providing additional money beyond the limits of the regular liability insurance) did not have to pay when the primary insurance went bankrupt.  The additional coverage would only have kicked in if the underlying coverage had actually been paid out.   

Check your policy for 'consent-to-settle' restrictions.  Piedmont Office Realty Trust, Inc. v. XL Specialty Ins. Co   In Georgia, proceed carefully when settling claims against where policies include consent-to-settle and no-action provisions.  In this case, the umbrella carrier for the D&O (Directors & Officers) coverage refused to cover for the full settlement amount, since it had previously already agreed to only contribute $1 million.  The client settled a suit for $4.9 million, and then tried to claim this amount against the umbrella policy, saying the carrier unfairly withheld consent.  The appeals court said that settling without first obtaining consent means you forfeit coverage and are barred from suing. 

The clock doesn't stop if years pass between 'same claims'.  W.C. and A.N. Miller Dev. Co. v. Continental Cas. Co   An adversarial proceeding held years ago had enough similarities to a lawsuit brought years later to effectively be the same claim. A claim doesn't need to be covered in your insurance for it to be classified as an “Interrelated Wrongful Act” and be treated as a single claim.

Always notify your insurer the first time round.  Hamman-Miller-Beauchamp-Deeble, Inc. v. Liberty Mutual Agency Corp   A broker received letters from an attorney claiming that a client suffered damages due to the broker's negligence. The broker waited until he was served with an actual lawsuit almost two years later before notifying his insurer.  The broker argued that the attorney letters didn't constitute a claim triggering reporting requirements. The court disagreed, since the letters said the broker was “legally responsible for...damages” making this a demand for damages.  

Don't take any action outside of your Board duties when dealing with the Association.   The Langdale Company v. National Union    This Georgia case reemphasizes the need to clearly operate only within your Board capacity.   Not having a clear delineation allowed the insurance carrier to claim a Director was operating in an uncovered capacity.  Because of this, the insurance could not be tapped by the corporation or other Board members to cover expenses.

Insurance companies are in the business of making money, so review the insurer terms with an expert to make sure you understand when you can and cannot rely on such coverage.

The Science of Forgiveness

As much as we try, it is difficult for Board members and managers to ‘let go’ when dealing with a homeowner or vendor that has wronged us or our community.  While no one is suggesting we blissfully ignore misdeeds and idiots, to forgive is critical to healthy community oversight.  Festering anger only clouds judgment and leads to burnout. 

‘Forgive’ has religious connotations for many.  However, whether or not you are a person of faith, over the last decade the physical and social benefits have been confirmed too often to be ignored. 

Getting scientific for a moment: Functional Magnetic Resonance Imaging (fMRI) brain scans traced forgiveness to the dorsal prefrontal cortex (for cognitive control), the posterior cingulate (for understanding how others are thinking) and the anterior cingulate cortex (for balancing the perception and suppression of moral pain (such as feeling wronged)).  From this, neurologist Dr. Pietro Pietrini notes that forgiveness is a moral distress painkiller.

Dr. Pietrini states, “The fact that forgiving is a healthy resolution of the problems caused by injuries suggests that this process may have evolved as a favorable response that promotes human survival.”  Forgiveness alleviates suffering.  It is a positive, healthy strategy for overcoming an otherwise stressful situation. 

In trauma burn units, anger interferes with the ability to heal. One doctor counseled a patient, “You can still pursue damages through an attorney. You’re entitled to be angry, but for now I’m asking you to abandon your entitlement and let it go, to direct your energy toward healing, and turn this over to God or nature or whoever you worship. It’s not up to you to get revenge on yourself or someone else.”

Another medical example:  In 2009 the journal Psychology & Health reported that patients with heart disease who underwent forgiveness therapy experienced higher blood flow and were at less risk of pain and sudden death, compared to those who underwent the standard treatment.

According to Professor Fred Luskin of Stanford University, “When you don’t forgive, you release all the chemicals of the stress response.”  Think about a wrong twenty times today, and your body releases stress chemicals each time, limiting both your physical and mental ability to tackle problems.

Reframe that painful memory by considering possible points of view that led the homeowner or vendor to act the way he did. This makes it more difficult to blame and demonize him, reducing the level of resentment you are feeling.

When you blame someone for how you feel instead of holding them to account for their actions, you become stuck in victimhood.  We’ve all experienced the same thing, and to get past it you have to accept that most often the person wasn’t intentionally out to personally hurt you.  How we’ve been dealing with anger hasn’t worked.  Instead, humanize the offender, and hate the wrong without hating the wrongdoer.

End Goals

We are frequently asked for advice on how Board meetings should be run.  One of the most critical pieces relates to strategy/goals.  Strategic thinking determines what we’re doing and where we’re going. To be successful, Directors must have a clear answer for both.

As a Board member, you must continuously engage in strategic planning - not just once a year.  It must be the central focus of each Board meeting.  It is really hard to create sustained, long-term value for your community when the Board (and homeowners) are blinded by short-term views.

Boards are most effective at developing strategies when partnered with a professional manager, working together based on mutual trust and respect. This means coming together throughout the year to identify important topics, consider strategic risks, and answer hard questions. Management by itself cannot conclusively cover everything in goal planning – but benefits from the collective wisdom of the Board.  

It is critical that all Board members understand the Association’s strategy and can articulate it consistently when responding to homeowners’ pointed questions and pressures.  There should be no surprises with a fully involved Board.

Placing education and discussion on strategy development into each agenda must be your priority.  All too often, the Board allows itself to get bogged down on governance and compliance issues.  Push as many of these items to your committees for processing.  If you don’t have committees, establish resolutions that capture the bulk of the situations dealt with by the Board, so management can proceed on autopilot.  

When it comes to the meetings, all Directors must arrive prepared, with all applicable materials reviewed in advance.  Plan to regularly include third-party experts for additional perspectives at your meetings.  A CPA, attorney, engineer or insurance broker provides an outside voice identifying potential disruptions to your goals.

You need to be talking about risks associated with your strategy and how these can be mitigated.  Effectively managing risks more than just protects value:  It actually helps create value by taking advantage of the unexpected.  You want to maximize opportunities and improve your community’s position compared to competing neighborhoods.

Manage this strategic risk by answering, “What is the amount of risk we’re willing to accept in pursuit of value?  What is the worst possible thing that can happen and still leave us standing?  What milestones do we need to check along the way to our five year goal?” While some things should not be changed (ex: always deposit money with FDIC-insured institutions), decisions on expansions and upgrades to the amenities are valid considerations.

The Board and management should be prepared to regularly readjust key assumptions.  Every goal has variables requiring mid-course changes.  Are you willing to alter the way you evaluate performance whether your plans exceed or fail to meet your initial expectations?

Final thought:  When bad decisions meet a good management team, the bad decisions win every time.  Don’t be quick to pin blame.  When things go wrong, take a deep breath and analyze the situation before making changes.