Whether it be an unexpected repair or an insurance deductible, homeowners associations are more commonly turning to lenders for community association loans. This is especially true for condominium associations who may be facing large insurance deductibles related to hail damage.
Loans for the Payment of Insurance Deductibles
Over the last several years there have been significant changes in the insurance industry. These changes have resulted in large increases in insurance deductible amounts. For example, for a wind and hail claim, the association’s insurance deductible amount is commonly equal to a percentage (3% or 5%) of the total value of all the buildings within the community. In the event a hail storm destroys the roofs within a condominium community, the association’s insurance will likely pay for the repairs, however the association will be responsible for the payment of that deductible. With a deductible based upon a percentage of the value of the building this may result in an insurance deductible totaling hundreds of thousands of dollars.
This could leave your association in the position of needing access to a significant amount of funds in order to cover the deductible and complete the needed repairs. Options available to an association to fund the deductible amount may include: (i) the use of reserve funds; (ii) a special assessment; or (iii) a community loan. Below is a discussion of some common issues relevant to community association loans.
When you buy a house the bank requires you sign a deed of trust pledging the home as collateral to ensure the repayment of that loan. If the loan is not repaid, the bank can foreclose and force the sale of the home to repay the loan. So what type of collateral does the bank require for a loan to a homeowners association? The association’s property such as the entrance sign, community park, detention pond, or open spaces? No. The bank has no interest in obtaining title or forcing the sale of community property as such property creates insurance and maintenance liabilities for the bank and the property likely has little or no commercial resale value.
Instead, the lender will require a pledge and assignment of the association’s right to receive assessments (homeowner dues). This is the biggest asset of an association. Such an assignment would, in the event of a default in the repayment of the loan, allow the lender to “step into the shoes” of the association to receive the association’s assessment income and use it to repay the loan. Requirements for an association to assign its right to future assessment income as collateral for a loan are governed by the Colorado Common Interest Ownership Act (“CCIOA”) and the Colorado Revised Nonprofit Corporation Act.
Post – CCIOA
For a post-CCIOA community (those created on or after July 1, 1992), Section 302(1)(n) of CCIOA allows an association to assign its right to receive assessment income as collateral for a loan, “but only to the extent the declaration expressly so provides.” So first there must be express authority in the association’s declaration of covenants authorizing the assessments to be used as collateral. If no such authority exists, then an amendment to the declaration of covenants would be required to provide such authority. In addition, a review of the association’s governing document will be necessary to confirm if the loan and assignment can be approved solely by the association’s board of directors or if a homeowner vote will be necessary.
Pre – CCIOA
For a pre-CCIOA community (those created before July 1, 1992), the requirements of Section 302 of CCIOA do not apply. Instead, such associations can rely upon Section 7-123-102(1)(g) of the Colorado Revised Nonprofit Corporation Act. That provision allows an association to “make contracts and guarantees, incur liability, borrow money, issue notes, bonds, and other obligations, and secure any of its obligations by mortgage or pledge of any of its property, franchises, or income.” Therefore, absent any express authority to assign assessment income as collateral for a loan in the declaration of covenants, such an assignment is authorized pursuant to this statutory authority. However, the association will still be required to comply with any procedural requirements for the loan and assignment set forth in its governing documents which may call for a vote by the homeowners.
Attorney Opinion Letters
In the event the association wants to move forward with a community loan, the lender will likely also require an opinion letter from the association’s attorney. The opinion letter is essentially an insurance policy written by the association’s attorney. In the opinion letter, the attorney states that the attorney has reviewed all of the association’s governing documents, relevant meeting minutes, voting materials, and other pertinent documents.
The attorney then provides representations and opinions to the bank in the letter to induce the bank to make the loan. The representations and opinions include such things as: (i) the association is in good standing with the Colorado Secretary of State; (ii) the association has obtained required approval for the loan whether that be approval from the board of directors and/or the association’s homeowners; (iii) the association’s governing documents allow for the loan; (iv) the individuals who will be signing the loan documents on behalf of the association have been properly authorized to do so; (v) the loan documents, once signed, will be valid and enforceable against the association; and (vi) the association has properly levied assessments in amounts required by the lender to repay the loan.
The association’s board of directors should review the governing documents and consult with legal counsel before considering a loan. This will give the board an understanding of the voting and procedural requirements needed for any loan and whether any amendments to the governing documents will be necessary. If amendments are needed, that process should start sooner rather than later in order to avoid delaying the loan process.
The board of directors should also check with the association’s insurance provider to ensure they understand the deductible amounts for various types of claims and how the deductible is calculated. It is also prudent for the association to routinely convey insurance information to their homeowners so that homeowners can have informed conversations with their personal insurance providers as to coverage options.
In the event the association is in need of funds for the payment of an insurance deductible or for some other unexpected expense, a community loan may be a good option. If you have questions or would like to further discuss a potential community loan please contact an Altitude Community Law attorney at 303.432.9999.