Duty to Buy?
Adams Stirling PLC
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DUTY TO BUY EARTHQUAKE INSURANCE

QUESTION: Several times over the past ten years the board has gone to the membership for a vote on earthquake insurance. Each time it was soundly defeated. The high premiums, high deductibles and low pay-out simply didn't make sense to the majority. Is the board obligated to set aside the vote and purchase earthquake insurance anyway?

ANSWER: That is a tough question. Unless required by their governing documents, associations are not obligated to buy earthquake insurance. Even so, the better course of action for condominium associations in high-risk areas is to buy earthquake insurance. This is especially true since individual members cannot insure the structure around their units, only the association can.

Fiduciary Duty. When members vote against earthquake insurance, they have no duty to act in the best interest of other members, only in their own best interests. Boards, on the other hand, have a fiduciary duty to make decisions that are in the best interests of the association as a whole. Since earthquakes can be devastating, that would argue in favor of overriding the membership's vote if the association is located in an area vulnerable to earthquake damage.

Accordingly, boards should consider factors such as the location of fault lines, the type of soil upon which the structures are built (are they vulnerable to liquefaction?), the type of construction in the development (wood frame, steel & concrete, etc.) and premium costs, deductibles and pay-out levels.

Funding the Insurance. If the board decides to set aside a membership vote, it faces a practical problem--how to fund the insurance? The board can either increase annual dues or impose a special assessment. For most associations the cost of earthquake insurance is more than the 5% special assessment limitation imposed by the Davis-Stirling Act, which effectively eliminates this funding option.

The other option is to increase annual membership dues up to 20% to cover the cost. However, the dues increase only applies to next year's budget. If the board wants to immediately purchase earthquake insurance, it can bridge the funding gap by borrowing money from reserves and repaying it within one year.

Not Overriding the Vote. If the board chooses not to override the members' vote, its decision is governed by the Business Judgment Rule, which means directors are not subject to personal liability if their decisions are made in good faith, in the best interests of the association and with such care as an ordinarily prudent person would use.

RECOMMENDATION: Obviously, these are not easy decisions for boards to make. Whichever direction they go, to buy or not to buy, the decision should be well supported in the minutes and explained to the membership.

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