Recently an association inquired whether it would be a good idea to require an impound fund for all new owners in an effort to curb the community’s delinquency problems.  The idea behind the proposed impound fund, also called a reserve or escrow account, is that each new owner would be required to put an additional sum of money on deposit with the association to secure the payment of assessments.  In the event of delinquency or failure to pay, the association would have the discretion to access the impound fund to pay the owner’s assessment(s).  Then, presumably, when the fund becomes depleted, the association would demand replenishment of the fund.

The idea seemed brilliant at first.  But as we discussed it further, certain drawbacks to the plan became readily apparent.  If done correctly, such an impound fund could be useful for certain associations.  However, the following issues should be analyzed and addressed before adopting such a policy.

First, to be enforceable as a collection remedy, we would recommend that the association amend its declaration to include the authority to create an impound fund.  While many declarations give the association and its board fairly broad collection authority, this is a unique remedy that could be subject to challenge in the event that it is not specifically authorized in the declaration.  The association would not want to end up in the position of having to pay the impounded funds back to a delinquent homeowner in a collection lawsuit.  The issue of having to amend the declaration may be enough to give many associations pause in considering an impound fund, depending the difficulty of their process for declaration amendments.

The second issue that arises is how the association will enforce the requirement to pay the impound fund.  Collecting the funds at the owner’s initial purchase of the property may be relatively easy.  Upon purchase the owner is eager to live in their new house and be a part of the community.  However, years down the road that owner may be experiencing financial difficulties and unable or unwilling to replenish the impound fund.  This issue must be addressed when drafting the impound fund amendment to the declaration.  Failure to pay the impound fund may not equate to a failure to pay assessments.  The typical remedies for failure to pay assessments (late fees, interest, lawsuit, lien, foreclosure) would not apply unless separately specified.  Unless specifically addressed, the owner could theoretically pay his/her monthly assessments on time, but never replenish the impound fund.  What good is such a provision if it is not enforceable?

There are potential accounting difficulties associated with impound funds as well.  Strict policies must be put in place to determine when to use the impound funds and when not to.  The policies must address when to levy late fees and interest if there are impound funds available to pay a delinquent assessment, and whether to use impound funds to pay returned check charges.  These policies must be communicated from the association to their management company and closely adhered to.  Also, what happens in the event of the owner’s sale of his/her unit?  Is such owner entitled to a refund of the unused portion of the impound fund?  How are the use, replenishment, and further use of the funds to be accounted for upon furnishing the refund to the former owner?  This should likewise be addressed in the document amendment to avoid confusion or controversy.

Next, the association may to take a look at its current delinquency problem.  Is there a fair amount of general apathy in the community about paying assessments on time?  Would the existence of the impound fund exacerbate this problem?  The analogy that fits best here is the tenant that fails to pay the last two months of rent knowing that the landlord will likely use his security deposit to make up the difference and not pursue him any further.

Finally, there is the big-picture issue of whether an impound fund would actually decrease the association’s chances of successfully collecting all of the amounts owed by the delinquent homeowner.  In many cases, the pursuit to obtain payment from any debtor is a race against time.  If a homeowner is delinquent in the payment of association dues, chances are they are delinquent in the payment of other bills as well.  This means the simultaneous pursuit of payment from this homeowner by several or many creditors.  The squeaky wheel gets the grease.  So it is often best to be one of the first unpaid creditors to begin demanding money.  Also, under Colorado law, the first to file suit and get judgment generally has the first opportunity to force payment from the debtor through garnishment or bank execution.  Wage garnishments can only occur one at a time.  If another garnishment is issued prior to yours, you are stuck waiting in line.

Giving a cushion of several hundred dollars in the form of an impound fund may simply buy a delinquent homeowner more time to pay other creditors.  By the time the impound fund is exhausted, the delinquent homeowner’s funds may likewise be exhausted. Similarly, the time delay in collection efforts unwittingly caused by an impound fund could by the owner more time to file a bankruptcy action, or time for the mortgage holder to begin foreclosure proceedings on the delinquent owner’s unit.

The foregoing issues and the potential diminishment of the ability to collect in full must be weighed against the relative convenience and security of an impound fund.  For further information about the pros and cons of impound funds, please contact us at [email protected]

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