What If Our Reserves Are Zero?
Jun 25, 2023By Kelly G. Richardson, Esq.
Dear Kelly: What happens if the reserves go to zero? What is insolvency? B.E., Tarzana
Dear B.E.: HOAs which fail to set aside money in their reserve fund are progressively falling into an unliquidated state of insolvency because the reserve study calculates the cost of deterioration occurring each year. Insolvency means the HOA assets are less than the total of its liabilities. “Unliquidated” means that the bill for the replacement has not been received, even though an asset is deteriorated. If the HOA does not set aside sufficient money to offset that deterioration, it is unprepared for the day when the asphalt, roofs, paint, or other common area elements must be replaced. When a major component needs replacement, the insolvency becomes liquidated, in that the HOA “suddenly” needs the replacement cost- but it is not ready because it has not built up the funds to pay for it. Bankruptcy is not the answer. The best approach for HOAs is to scrupulously set aside the money each month as prescribed by the reserve study, so the HOA is ready when those major common area items come up for repair, refurbishment, or replacement. Best, Kelly
Mr. Richardson: How are the reserves used? The purposes? For any type of project? E.A., San Jacinto
Dear E.A.: Reserve funds are intended to prepare the HOA for the deterioration of major physical components. Reserve funds should be accumulated following the important information in the reserve study and cannot be used for anything other than replacing, repairing, or refurbishing the specified deteriorating capital components. Civil Code Section 55510(b) bars boards from spending reserve fund money except for repairing, replacing, restoring, or maintaining the components regarding which the money was saved. Withdrawing money from the reserve fund account for any other purpose is considered “borrowing” from the reserve fund. Per Civil Code Section 5515, boards may temporarily transfer money from the reserve fund, but must state in the board’s meeting minutes the reason why the borrowing is occurring and when it will be repaid. The money must be repaid to the reserve fund within one year. Thank you, Kelly.
Kelly: In one of your articles, “But We Homeowners Can’t Afford It!”, you mentioned reserve accounts and special assessments as means for funding, but what in a case where a major problem occurs, can HOAs take out a loan? I’m assuming so, but thought I’d ask. Thank you, your article is one of the reasons I read the Saturday paper! S.S., San Marcos
Dear S.S.: Some HOAs have bylaws or CC&Rs limiting the power of the board to borrow on behalf of the HOA, and those HOAs would need to submit proposed loans to the membership for an approval vote. Other HOAs have governing documents placing limits on the amount of borrowing the board can pursue.
The ability to obtain a loan is not guaranteed, because the HOA banks have their own lending guidelines. One common requirement is that the HOA have a certain amount of money in its reserve account, and another is that the HOA not have too many delinquencies. A healthy reserve fund can not only make it more likely that the HOA would qualify for a loan but can itself be a short-term borrowing source. Best regards, Kelly.