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CAPITAL IMPROVEMENTS

QUESTION: We need to replace our roof. We have money in reserves for that purpose but one of our owners, a CPA, insists that replacing the roof is a capital improvement requiring membership approval. That can't be right. Do we need approval?

ANSWER: No, the board does not need membership approval to use reserve funds to replace a roof. That falls within the duty and authority of the board. Your CPA-homeowner is using a tax-related definition for capital improvement that does not apply to community association reserves. In the business community, a capital improvement is anything that (i) enhances the value of a property, (ii) extends the useful life of an asset, or (iii) adds to its value. If you were to use a CPA's definition, virtually every reserve expenditure is a capital improvement requiring membership approval. This broad definition has no practical application in common interest developments (CIDs).

CID Definition. For CIDs, a different definition is needed, one that gives associations more flexibility to address the changing needs of the community as well as the changing technology of construction materials. For our purposes, a capital improvement is (i) any significant new common area amenity or (ii) substantial discretionary improvement to an existing common area amenity.

Discretionary Improvements. Capital improvements must be funded. If the cost of the improvement is small, the board may be able to squeeze funds from the operational budget or borrow from reserves. If needed, they can impose a special assessment up to 5% without membership approval. However, if the discretionary addition is something new to the common areas which was not previously part of the development's original construction, and a special assessment exceeding 5% is required, the board must seek membership approval. Examples include the construction of a clubhouse, tennis court, swimming pool, or gym. In this scenario, the special assessment is driving the approval requirement.

Mandatory Changes. Capital improvements that do not require membership approval are (i) those required for safety purposes, and (ii) government mandated improvements. The voluntary addition of a retaining wall to stabilize a slope for safety purposes does not require membership approval. The installation of a fire control system ordered by local fire authorities does not require membership approval. Refurbishment of a swimming pool that incorporates ADA handicap upgrades falls within the board's authority.

Upgrades to Materials. Boards should take advantage of improved building materials and designs whenever possible. However, discretionary upgrades that are appreciably more expensive may need membership approval. For example, replacing chain link fences costing $25,000 with slump stone costing $100,000 requires membership approval. Replacing lobby carpet that costs $62,000 with tile at $120,000 requires membership approval. Upgrading carpet from $62,000 to a higher quality at $70,000 does not require membership approval if difference in cost falls within 5% of the annual budget.

An exception is a mandated upgrade. If an association repairs its 30-year old elevators and the city orders a substantial upgrade to integrate the elevators with the building's fire alarm system, this "capital improvement" does not require membership approval because it is not voluntary. The upgrade is required regardless of the membership's approval or disapproval. Depending on the circumstances, the board could impose an emergency special assessment. If the board wanted to borrow the money, it would likely require membership approval.

Material Alteration in Appearance. Any repair or replacement that constitutes a material alteration in the appearance of the development should require membership approval even if the cost does not exceed the 5% restriction. For example, replacing a decorative fountain with a statue is a material alteration to the appearance. Failure to get membership approval could result in litigation. Replacing wood shingles with fireproof shingles to satisfy fire codes does not require membership approval. Even though the new shingles exceed the 5% restriction, the membership cannot veto the change.

Even though it may be in the board's authority to approve such expenditures, any significant discretionary changes in appearance (such as using red clay tile to replace existing gray slate) should be submitted to the membership. The vote can either be advisory in nature or a formal vote approving or disapproving the change. At a minimum, members should be made aware of the pending change and invited to a meeting to comment on the change.

Privately Funded. Private funding for improvements is allowable.

Recommendation: Because of the uncertainty created by the 5% capital improvement restriction, associations should define "capital improvement" whenever they amend or restate their governing documents.

Cases that address capital improvements:
Behm v. Victory Lane Unit Owners' Association (1999) 133 Ohio App.3d 484.
George v. Beach Club Villas Condominium (2002) 833 So.2d 86.
Litvak v. 155 Harbor Drive Condominium Association (1993) 244 Ill.App.3d 220.
Ocean Club Condominium Association v. Gardner
(1998) 318 N.J. Super. 237.
Ralph v. Envoy Point Condominium Association (1984) 455 So.2d 454.
Tiffany Place Condominium Association v. Spencer (1982) 416 So.2d 823.

ASSISTANCE: Associations needing legal assistance can contact us. To stay current with issues affecting community associations, subscribe to the Davis-Stirling Newsletter.

Adams Stirling PLC