ANNUAL BUDGETS

  2-Minute Video

Duty to Levy Assessments. Boards have a duty to impose regular and special assessments sufficient to carry out their duties under the governing documents. (Civ. Code § 5600(a); Park Place v. Naber.) Their primary duties are to (i) maintain the common areas, (ii) fund the reserves for maintaining the common areas, (iii) insure the common areas (per statute and the CC&Rs), and (iv) enforce the governing documents.

DUES VERSUS ASSESSMENTS
“Dues” is such a common term in the industry that it has been accepted as meaning regular monthly assessments, while “assessments” are generally understood to mean “special” assessments. Even so, there are industry professionals who do not like the use of the term.

"Assessment" Argument. Those who dislike the term argue that it is inappropriate to use "dues" when referring to regular monthly (or quarterly) assessments levied at the beginning of an association's fiscal year because dues are voluntary, such as membership dues to a health club, while an association's assessments are mandatory. Therefore, regularly assessed payments pursuant to an annual budget should be called "assessments" not dues.

"Dues" Argument. Those who defend the term "dues" point to the Oxford English Dictionary definition of the word. The dictionary defines dues as a general term covering any type of monies due, including assessments. Therefore, all assessment are dues by definition. The word “dues” is better understood by homeowners. Members often refer to "monthly dues," since they are fixed and regular. They are “due” every month, like rent or a mortgage payment. Whereas, “assessment” for something extraordinary being levied, such as a special or emergency assessment.

Observation: There is no right or wrong answer. The use of "dues" versus "assessments" is a matter of preference.

PREPARING A BUDGET
Boards have a duty to assess the membership sufficient to carry out their duties as directors. In addition, budgets must be balanced since boards cannot not impose an assessment that exceeds the amount necessary to defray the costs for which it is levied. (Civ. Code 5600(b).) Any increase in annual assessments (dues) requires the preparation, approval, and distribution of a budget within certain statutory guidelines and deadlines as described below.

1.  Pro Forma Budget. A pro forma operating budget is typically prepared by management or a budget committee or the board (or a combination of the three). An operating budget encompasses all expenses for the fiscal year including contributions to reserves. The budget must estimate revenue and expenses on an accrual basis. (Civ. Code § 5300(b)(1).) As nonprofit organizations, associations must budget so that revenues do not exceed expenses, i.e., total income minus expenses should equal zero. There are two techniques for preparing budgets:

Zero-Base Budgeting. This approach starts each year's budget from a zero base, i.e., at the beginning of the budgeting process all budget line items have a value of $0 and must be justified. (i.)  Advantages. Since each line item starts at zero, the budget committee must justify each item in the budget. This should bring to light any wastage and obsolete operations. (ii) Disadvantages. This approach can be very time consuming.

Incremental Budgeting. In incremental budgeting the current year's budget serves as a basis for next year's budget and is simply adjusted. The most common methods of adjustment are:

i.  CPI Adjustment. The easiest and least effective method is to simply take the Consumer Price Index (the measure of inflation published by the government) and apply it to all line items. The disadvantage is that not all items in a budget are affected by the CPI. This results in some line items being over-budgeted and others being under-budgeted. 

ii.  Variance Projections. This is the method used by most associations. Since most line items in an association's budget are necessary rather than discretionary (utilities, insurance, maintenance, etc.), the budget committee starts with the current year's budget and looks at variances projected through the end of the fiscal year. This gives the committee an estimate of actual expenses for the year for each line item so it can adjust expenses up or down, as needed.

2.  20% Limitation. Notwithstanding more restrictive limitations placed on the board by the governing documents, the board of directors may increase regular assessments (dues) by up to 20% of the association's preceding fiscal year without membership approval. Membership approval is defined as a majority of a quorum of members constituting a quorum, casting a majority of the votes--"quorum" means more than 50 percent of the owners of an association. (Civ. Code § 5605.) The 20% increase is based on the association's regular assessments for the prior year. This includes operations and reserves contributions as defined in the budget.

Overall vs. Individual. The statute is a little unclear on whether the 20% increase must be calculated to see if it increases any one member's dues by more than 20%. The general consensus in the legal community is that the limitation applies to the totality of the assessment increase. The statute specifies 20% of the association’s regular assessments, not 20% of any individual owner’s assessments. With variable and hybrid assessments, it is possible that a 20% increase in the prior year's budget could result in an individual's increase to be 21% or 22%, while other members might experience an 18% or 19% increase. 

Affordable Housing Units Limitation. An association that records its original declaration on or after January 1, 2025, may not impose an increase of its regular assessments on the owner of a deed-restricted affordable housing unit that is more than 5% plus the percentage change in the cost of living, not to exceed 10% greater than the preceding regular assessment for the association’s preceding fiscal year. (Civ. Code § 5605(c).)

3. Assessment Comparisons. It is difficult, if not impossible, to arrive at any meaningful "average" monthly assessment comparison between associations because of significant differences from one development to the next. The factors that impact assessments include:

• Age of the Development: the older it is, the more expensive it is to maintain it;
• Utilities: some properties are master metered for water, gas and/or electricity; others are not;
• Insurance: deductibles and levels of insurance may vary significantly; in addition, some carry earthquake insurance and others do not;
• Common Areas: pools, clubhouses, tennis courts, streets, parking lots, lighting, type of roofing, type of structure, quality of plumbing, etc. vary from property to property;
• Deferred Maintenance: the longer maintenance has been deferred, the more costly the repairs;
• Management Philosophy: expectations by the membership for extra or upgraded services for security, cable TV, concierge services, holiday parties, etc. (owners in Beverly Hills condominiums probably have higher service expectations than owners in Fresno);
• Number of Units: the more units, the lower average cost per unit to maintain the common areas; and
• Geographical Location: properties located on or near the beach have higher maintenance costs than those not on the beach; the same is true for properties above the snow line.

DISTRIBUTE BUDGET REPORT
Once the budget has been approved by the board, an "Annual Budget Report" must be prepared. The Report must contain the following (Civ. Code § 5300(b)):

• A pro forma operating budget.
• A summary of the association’s reserves.
• A statement regarding any deferral of reserve item repairs.
• A statement whether special assessments are anticipated related to reserves or reserve components.
• A statement of how reserves will be funded.
• A statement of how the reserves were calculated.
• A statement regarding any outstanding association loans.

Deadline. The Annual Budget Report must be distributed to the membership not less than 30 nor more than 90 days before the end of the association's fiscal year. (Civ. Code § 5300(a).)

• Summary. In lieu of a full report, the board may distribute a summary and reserve summary with a written notice (in at least 10-point bold type on the front page of the summary of the budget) that the complete budget is available at the business office of the association or other location and copies can be made, if requested, at the association's expense. (Civ. Code § 5320.)
• Request for Full Report. If a member requests a copy of the full budget report rather than a summary, the association must provide it (Civ. Code § 5320) by individual delivery (Civ. Code § 4040.)
• Email Distribution. Unless members authorize delivery by email, budgets must be distributed in non-electronic form, i.e., paper.
• Disclosure Checklist. See disclosure checklist.
• Re-mailing Budget Report. Sometimes absentee members forget to update their contact information and the budget package is returned to the association. See re-mailing the budget report.

NOTICE OF INCREASE
Associations must provide individual notice pursuant to Section 4040 to the members of any increase in the regular or special assessments of the association, not less than 30 nor more than 60 days prior to the increased assessment becoming due. (Civ. Code § 5615.) See Calculating Notice Requirements.

Failure to Meet Deadline. Failure to distribute the annual budget report at not less than 30 nor more than 90 days prior to the end of the fiscal year voids any increase in regular assessments approved by the board of directors. Any such increase must then be approved by a majority of a quorum of members. (Civ. Code § 5605(a).)

MIDYEAR BUDGET INCREASE (Unexpected Expenses)
Sometimes a board discovers partway into a fiscal year that unexpected significant increases in utility rates or insurance premiums push operating expenses into negative territory and create a significant operating deficit. When this happens, boards have the following options for funding unexpected midyear expenses:

1. 5% Assessment. Boards can approve a special assessment of 5% or less. If the amount is insufficient, the board must explore other options as described below.
2. Emergency Assessment. Boards can approve a special assessment greater than 5% if it qualifies as an emergency.
3. Membership-Approved Increase. Boards can present a special assessment or amended budget to the membership for approval. If the membership disapproves, the board must look for alternatives to address the expense.
4. Reserve Borrowing. Boards can borrow from reserves to cover unexpected expenses and then repay the borrowed amount the following year.
5. Budget Reductions. Boards can look for items in the budget to reduce or eliminate so as to offset unexpected expenses.
6. Midyear Budget Increase. The benefit of amending the budget is the board can increase assessments by up to 20%. There is no prohibition in Civil Code § 5300 precluding a board from revising the budgetary information required by subsection (b). Assuming the original budget was timely distributed, the board will have met its one-time statutory obligations under Civil Code § 5605(a) and should be entitled to both revise the budget and increase regular assessments up to 20% as needed after the fiscal year has begun. In addition, Civil Code § 5615 refers to “any increase in the regular assessments.”

If boards do not have the power to increase regular assessments midyear, then Section 5615 has no meaning. The 30 to 60-day timing differs from the 30 to 90-day timing in Section 5300 applicable to beginning-of-year increases. If Section 5615 is intended to apply to beginning-of-year increases only, then any association that distributes the budgets 61 to 90 days before the beginning of the fiscal year (to comply with Section 5300) can’t raise assessments because they just violated Section 5615. Therefore, section 5615 can only apply in the context of midyear increases in regular assessments.

In many associations, the largest unexpected and unbudgeted expense is a substantial increase in insurance premiums. In an unpublished case, the court of appeal concluded that a one-time charge ($1,000 per unit) to cover operational costs (insurance premiums and other costs) is not a special assessment if it stays within the 20% limitation. Instead, it is a regular assessment. (Taggart v. N. Coast Village.) 

Miscellaneous. See "Cost Centers," "Allocation Methods," and "Fee Limitations."

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