There are times when a community association may need to explore its funding options, such as if it is considering a large construction or renovation project for the community. A loan may be an attractive option to avoid relying on increased assessments, special assessments or reserves alone to fund the project. Ultimately, whether a loan is a good option for your community is up to the association to decide. However, if your community association is considering a loan there are several steps the association can take to get itself prepared for the loan process.
While, one process will not apply in all circumstances this article provides a general overview of steps and considerations that commonly arise in the loan approval process for special projects.
Step 1: Determine if your community association can take out a loan.
Before shopping around for loan offers, community associations must first determine if they have authority to borrow funds. Community associations should review their Declaration (also commonly referred to as covenants or CC&Rs) as it may contain language that specifically addresses the association’s authority to take out loans. The Declaration may grant express authority to borrow, may impose conditions on the association’s authority to borrow, or may prohibit borrowing altogether.
The most common conditions we see on an association’s authority to borrow is the requirement to obtain owner approval; however, the Declaration could also impose limitations on the amount that can be borrowed or the amount that can be borrowed without owner approval. Lenders will ask whether or not the community association has obtained all requisite approval to take out the loan; therefore, it is important that the Board know from the beginning whether or not an owner vote will be required as this add an extra step to the process.
If the Declaration is silent as to borrowing, then your community association may be able to rely on the general powers given to nonprofit corporations in the Colorado Revised Nonprofit Corporation Act (“CRNCA”), which includes the authority to borrow money. C.R.S. 7-123-102. However, if your Declaration prohibits borrowing then the community association will likely need to amend its Declaration before moving any further in the loan process.
Step 2: Determine if you have the collateral to secure the loan.
Most lenders require a community association to pledge or assign its right to future income as collateral (i.e., the lender wants to be able to collect homeowners’ assessments directly in the event of default). If your community association was created on or after July 1, 1992 then Section 302(n) of the Colorado Common Interest Ownership Act (“CCIOA”) allows your association to assign its right to future income only if the Declaration expressly allows such assignment. As such, the Declaration must contain language allowing the association to assign its right to future income. If the Declaration is silent then the association does not have this authority and should consider amending its Declaration.
If your community association was created before July 1, 1992 and your Declaration is silent then your community may be able to rely on the CRNCA for authority to pledge its income without having to amend your documents.
Similar to the authority to borrow, the Declaration may also impose conditions on the right to pledge income as collateral, such as requiring an owner vote. Any such conditions will need to be met prior to closing on the loan.
Step 3: Determine how your community will repay the loan.
The lender will ask and will require documentation to confirm you have the finances in order to repay the loan. Community associations may consider a special assessment, increasing regular common expense assessments, and/or using reserves. However, what works best for your community to repay the loan and what is authorized in the Declaration will vary. Nevertheless, community associations should decide on how the loan will be re-payed prior to starting the loan process as it may require extra steps. For instance, your Declaration may require owner approval for any special assessments or for increases to your common expense assessments above a certain amount. Also, if your association is subject to CCIOA and considering repaying the loan through assessments then your community may still need to follow the budget ratification process for any increase.
Step 4: Get your documents in order.
Lenders will require community associations to submit copies of their current governing documents, including, but not limited to, the Articles of Incorporation, Bylaws, and Declaration, including all amendments. Lenders also typically require minutes and/or resolutions that document Board approval of the loan (and Owner approval, if required by your governing documents). Other documentation requested by lenders can vary and the lender will often provide the association with a “checklist” of all the documents required to be produced before closing. Such other documents may include a list of accounts receivable, copy of the approved budget (reflecting the repayment of the loan), insurance certificates, list of lender accounts, tax returns, management contract, construction plans/contracts, etc.
Step 5: Know your community’s legal and financial status.
Do you have any existing loans or lines of credit? Has your community ever defaulted on a loan? Are there any pending or threatened legal actions against the association or its property (i.e., is the association being sued or do you have knowledge that the association may be sued in the near future)? These questions will be asked and can impact eligibility and/or the terms of the loan. If it determined late in the loan process that there is an existing line of credit or pending litigation, this can substantially delay the loan closing (or even result in the association becoming ineligible). As mentioned below, part of the loan approval process is to obtain an attorney opinion letter which, in part, provides an opinion as to whether the association is authorized to take out the loan, but often requires the attorney to also respond as to the questions above. As such, this information will need to be ascertained at some point and earlier is better.
Step 6: Become familiar with the loan approval process.
If borrowing is authorized and approved, the typical loan process includes:
1) Submission of documents and information to the lender.
2) A commitment letter by the lender which includes general terms of the loan and requirements for closing.
3) An attorney opinion letter on the loan, which requires the attorney to review the loan documents, the governing documents, records of the association (e.g. minutes and/or resolutions on the vote on the loan and assessments), and UCC filings (i.e., whether there are any prior existing rights over the collateral). After the attorney review, the attorney will then provide a written opinion often confirming the association’s authority to obtain the loan and enter into the loan agreement, that any assessments for repayment of the loan have been properly authorized, that the association is duly organized and in good standing with the state, and that there are no pending legal actions or proceedings against the association, etc.
Whether borrowing is in the best interest of the community will vary on the circumstances; however, getting prepared in advance will help Board members’ and owners’ expectations through the loan process.
Please do not hesitate to contact Kelly McQueeney directly at [email protected] or call one of our Altitude Community Law attorneys at 303.432.9999 if you have any additional questions concerning the loan approval process.