Borrowing Defined. Without a vote of the membership, boards are allowed to borrow from reserves to meet short-term cash flow problems or other expenses. (Civ. Code § 5515(a).) (Some CPAs refer to reserve borrowing as designated investments, accrued obligations, internal asset designation, or asset allocation.) Examples of short-term cash flow problems include:
- Delinquencies. To cover shortfalls created by delinquencies.
- Insurance. To pay for unexpected increases in insurance premiums.
- Termites. To pay for unplanned termite treatment.
- Common Area Damage. To pay for unexpected damage to the common areas.
- Litigation. To pay litigation legal fees.
- Settlements. To settle claims.
- Amendments & Restatements. To pay to amend or restate CC&Rs and bylaws.
Other Expenses. The term “other expenses” referenced in section § 5515(a) is sufficiently broad to permit a temporary transfer of reserve funds to the general operating account to fund expenses such as those related to a restatement of an association's governing documents. However, the statute clearly contemplates temporary transfers that are intended to be repaid promptly. Although not expressly limited to emergency or extraordinary expenses, transfers from reserves should not be for routine and anticipated operating expenses since they are supposed to be funded by regular or special assessments sufficient to perform the association’s obligation under the governing documents and the Davis-Stirling Act. (Civ. Code § 5600(a).)
Suspending Reserve Deposits. Although there is no statute or case law on the issue, some believe suspending reserve deposits qualifies as borrowing from reserves. The argument is that monies allocated to the reserve account are pledged in the reserve funding plan annually published to the membership, as well as the operating budget mailed to all members prior to the start of the fiscal year. Those funds are then collected from the membership for that purpose. Intercepting reserve monies before they are deposited into the reserve account or waiting until after they are deposited produces the same result--reserve monies are being used for non-reserve expenses.
The counterargument that suspending reserve contributions does not qualify as borrowing is found in Civil Code § 5515. It states that the statute applies only to the “temporary transfer of moneys from a reserve fund to the association’s general operating fund” which does not occur. There is no transfer from the reserve fund. The fact that money is budgeted for a specific purpose is not binding and does not mean it cannot be redirected elsewhere if the need were to arise. Budgets are projections and sometimes unexpected expenses occur that must be met, such as a sudden significant increase in insurance premiums or utility costs. To meet those unexpected expenses, reserve transfers can be temporarily reduced or suspended.
Notice of Intent to Borrow. Boards are required to give notice of their intent to borrow reserve funds by listing it as an agenda item in its notice of board meeting. The notice must include the reasons the reserve transfer is needed, some of the options for repayment, and whether a special assessment may be considered. If the board authorizes the transfer, it must issue a written finding, recorded in the minutes, explaining the reasons for the transfer, and describing when and how the money will be repaid to the reserve fund. (Civ. Code § 5515(c).)
Repay Within One Year. Monies borrowed from the reserves must be repaid to the reserve fund within one year of the date of the initial transfer, except that the board may, after giving the same notice required for considering a transfer, and, upon making a finding supported by documentation that a temporary delay would be in the best interests of the association, temporarily delay the repayment. (Civ. Code § 5515(d).) Associations are allowed to levy special assessments to replenish reserve funds.
Borrowing for Litigation. Associations are allowed to borrow from reserves to pay for litigation, including construction defect litigation.
Temporary Transfer. The use of reserve funds for litigation is deemed a "temporary transfer" (Civ. Code § 5520). When temporary transfers are made, boards must explain to the membership the reasons for the transfer and when and how moneys will be repaid to the reserve fund. In addition, the funds must be restored within one year of the date of the initial transfer. (Civ. Code § 5515.)
Reserve for Expenses. Even though you anticipate litigation expenses next year, they do not qualify as a reserve item. Reserve accounts are for monies "identified for use to defray the future repair or replacement of, or additions to, those major components that the association is obligated to maintain." (Civ. Code § 5550.) Legal expenses do not meet the definition of a "component" nor do they meet National Reserve Study Standards.
Operating Expense. The appropriate place for anticipated legal expenses is the association's operating budget. This will likely increase your budget which may require a dues increase or a special assessment for the next fiscal year. In addition, even though a temporary delay in restoring borrowed reserve funds is allowed, boards must exercise prudent fiscal management in maintaining the integrity of the reserve account "and shall, if necessary, levy a special assessment" to repay the funds within one year. (Civ. Code § 5515.)
Balcony Inspections. Because the statutorily required inspection of the structural elements of condominium balconies and other elevated structures is directly related to reserves needed to repair those structures and because the definition of "replacement cost" includes related expenses, inspection costs can be included in an association's reserve budget. Using reserves to pay for the inspection is not deemed a borrowing.
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