FHA RESERVE REQUIREMENT

QUESTION: Regarding the FHA 60% reserve funding requirement; just what does the 60% mean?

ANSWER: As reported last week, starting November 1 the FHA will not insure loans in condo developments where the association's reserves are less than 60% of the funding levels called for in the association's most recent reserve study. The 60% reserve requirement is not a national standard, it was issued by the Santa Ana HUD/FHA office. Since the Santa Ana office serves the Western region, their rule controls all loan guarantees in California.

Reserve Requirements. In addition to requiring 60% reserve funding for existing condominium associations, the Santa Ana office obligates condo conversions to 100% reserve funding. Below describes how the new requirements work.

Existing Condos. If an association's roof costs $100,000 to replace in 20 years, then $5,000 must be set aside annually for the next 20 years. Assume the roof is now 10 years old; to be fully funded, the association must have $50,000 in its reserve account for the roofs. To meet the Santa Ana requirement, the association needs at least 60% of the $50,000, i.e., $30,000 cash on hand for the roofs. To arrive at the total cash for all reserve items, the same calculation is applied to each item in the reserve study. If all components taken together total $1 million as of today's date, then the association must have 60% of $1 million in the bank, which means $600,000.

Condo Conversions. If the development is a condo conversion, the association needs 100% of the reserve study's fully funded requirement. In the roof example above, condo conversions need the entire $50,000 in roof reserves to qualify for FHA loan guarantees. Keep in mind that roofs are only one component. If all components taken together total $1 million, then the association must have $1 million in its reserves to qualify.

Bona Fide Reserve Study. An obvious way to meet the FHA requirement is to doctor the reserve study to reduce the $1 million funding requirement to whatever amount is currently in your reserves. That would be a very bad idea. Directors would face potential liability for fraud (not covered by insurance) and breach of fiduciary duties. In addition, the FHA requires that associations use a bona fide site visit reserve study for their calculations. Bona fide means "made in good faith without fraud or deceit."

Thank you to Robert Nordlund of Association Reserves, Inc. and Clifford Treese of Association Information Services for their input on this question.

COMMENT: It's understandable the FHA would not want to guarantee loans in weak associations. Unfortunately, the Obama Administration's  timing is terribly short-sighted. The new requirement is being imposed when the housing market is already distressed and associations are suffering record foreclosures. FHA insured loans are vital to the housing market because they enable buyers with modest incomes to purchase homes. On November 1 when the new regulations go into effect, tens of thousands of condominiums in California will become virtually unsalable. This will further depress the housing market and drive more condominiums into foreclosure. Not a smart move. -Adrian Adams

WILDFIRE
SMOKE DAMAGE CLAIMS

The wave of recent wildfires has resulted in a great deal of smoke and soot damage to common areas in associations near the burn areas. Typically, this is a covered loss under the association's insurance policy.

Adams Kessler has partnered with another law firm to assist association boards pursue both visible and invisible damage claims with their insurance carriers. If your HOA was situated in or around the recent fires, contact us for a free consultation about fire and smoke damage.

PAYING UNUSED VACATION
UPON TERMINATION

The Court of Appeal recently upheld an employer’s policy limiting employees’ vacation benefits. Owen v. Macy's, Inc.(2009) 175 Cal. App. 4th 462. The employer’s policy allowed employees to earn vacation benefits after 6 months on the job. However, the benefit vested only twice a year: 50% in May, and 50% in August--a policy clearly described in Macy's employee handbook. When the employer terminated employees in April without paying for unvested vacation time, Plaintiff sued demanding payment.

RECOMMENDATION: For associations with employees, boards need to review their employee handbooks. When associations give vacation benefits, their handbook should explain (i) when employees start earning it, (ii) how it accumulates, (iii) when employees can use it, and (iv) the maximum vacation that can be accumulated. Once the vacation time vests, employees are entitled to keep it until used, or until receiving compensation at termination. To keep costs under control, associations should consider capping the total amount of vacation time employees can earn. Contact us for more information.

Matthew Gardner, Esq.
Adams Kessler PLC

SOLAR PANEL POWER
PURCHASING AGREEMENTS

You recently ran a question in your newsletter about loan financing for the installation of solar panels. Other funding options are Solar Leases and Power Purchase Agreements (PPA). Under a Solar Lease or PPA, a third party pays for and owns the solar installation, taking advantage of the tax benefits and selling the electricity generated to the association. The advantages to the association are (a) no or minimal up-front costs, (b) lower energy rates and (c) certainty about the rates/tariffs the association will be paying for energy for years to come (typically 15-20 years).

There are some contractual risk management issues to be addressed and PPAs are quite different from any other contracts boards may have encountered before, but I have negotiated several agreements over the past six months and it can be done. -Linda Cummings, Esq.

If you are interested in Solar Leases or Power Purchase Agreements, you may contact Linda Cummings directly. -Adrian Adams