Bank Account Requirements
California Financial Institutions. As provided for in Civil Code § 5380, managing agents, either persons or entities, who for compensation or, in expectation of compensation, exercise control over the assets of the association who receive funds belonging to an association must deposit them into:
- An escrow account with a bank, savings association, or credit union in California, insured by the federal government,
- An account under the control of the association, or
- A trust fund account maintained by the managing agent in a bank, savings association, or credit union in California.
A “managing agent” does not include a full-time employee of the association, a regulated financial institution operating within the ordinary course of business, or an attorney at law acting within the scope of their license.
Managing Agent Separate Accounts. Associations must set up a bank account that keeps their funds separate and distinct from their managing agent’s funds. (Civ. Code § 5380(b)(3).) The managing agent must maintain a separate record of the receipt and disposition of all funds, including any interest earned. With a limited exception, the managing agent may not commingle the association’s funds with their own money or with the money of others.
Operating and Reserve Funds. While it may be a good idea to keep operating and reserve monies in separate accounts, the Davis-Stirling Act is ambiguous. The Financial Accounting Standards Board (FASB) guidelines do not require separate accounts. From a tax perspective, case law generally refers to the requirement for separate bank accounts. However, two cases states that separate bank accounts are not required if there is an adequate accounting for the separate “funds.” (Board of Trade v. Commissioner (1996) 106 T.C. 369, separate bank accounts are not required; Maryland Country Club, Inc. v. United States (4th Cir. 1976) 539 F.2d 345; the court concluded separate bank accounts are not required for capital and operating funds, provided accurate records are kept.) Because of the ambiguity, an association is not breaking the law by keeping funds in a single bank account and tracking dfunds in separating accounting accounts. Even so, the safe approach is to open separate bank accounts.
In the Association's Name. All monies the association receives must be deposited in an account with signature cards established in the association’s name. Reserve Funds. A “Reserve Account” refers to funds the association has set aside to defray the future repair or replacement of, or additions to, those major components that the association is obligated to maintain. (Civ. Code § 4177.) Except for temporary borrowing, boards may not expend reserve funds for any purpose other than the repair, restoration, replacement, or maintenance of, or litigation involving the repair, restoration, replacement, or maintenance of, major components that the association is obligated to repair, restore, replace, or maintain and for which the reserve fund has been established. (Civ. Code § 5510(b).) There are also signature requirements for transfers and prudent investment policies that boards need to follow.
Fund Transfer Requirements
Written Authorization to Transfer Funds. Starting January 1, 2019, boards of directors were required to provide prior written authorization for large funds transfers. Effective January 1, 2022, the legislature established a two-tiered system based on the association’s size. Under Civil Code § 5502, transfers from reserve or operating accounts cannot be made without prior written approval from the board unless the amount of the transfer is less than the following:
♦ The lesser of five thousand dollars ($5,000) or 5 percent of the estimated income in the annual operating budget for associations with 50 or fewer separate interests.
♦ The lesser of ten thousand dollars ($10,000) or 5 percent of the estimated income in the annual operating budget for associations with 51 or more separate interests.
Changes were also made concerning funds accepted or received by a managing agent on behalf of an association at the association’s request. Such funds must be deposited into an account in a bank, savings association, or credit union in California insured by the Federal Deposit Insurance Corporation, National Credit Union Administration Insurance Fund, or a guaranty corporation subject to Section 14858 of the Financial Code.
Transfer Defined. As initially written, the Assembly bill expressly referenced “electronic transfers.” The word “electronic” was removed as the bill made its way through the Senate. The Digest from the Senate Floor Analysis still referred to the bill’s purpose as prohibiting “electronic transfers from homeowner association accounts without prior board approval.” Other types of transfers likely include wire transfers, telephone transfers, etc., which may explain the omission of the word “electronic.” However, “transfer” is broadly defined as the movement of funds from one place to another. While it may not be strictly required, the more conservative approach requires board approval of any transfer of funds, including by checks.
- Recurring Expenses. If routine budgeted transfers on a recurring basis require approval (e.g., property taxes, water bills, power bills, contributions to reserves), a board could approve those transfers in advance. For example, the board could approve all budgeted utility transfers at the beginning of each year for the entire year.
- Reserve Transfers. The same solution can be used for monthly transfers into reserves that exceed $10,000. Boards can approve a resolution or motion in the minutes, giving written approval to the management company to make such transfers.
Cannot Delegate This Duty. Can the approval requirement be delegated to management? The language in Civil Code § 5380(b)(6) and § 5502 expressly state prior written “board” approval. Civil Code § 4085 defines “board” as an association's board of directors. Accordingly, boards cannot delegate approval authority to management. It could, however, delegate it to an “Executive Committee” composed entirely of directors. Any act or decision by a majority of the directors on the Committee is deemed an act of the board. (Corp. Code § 7212.)
Bank Signature Cards
Banks use bank signature cards to minimize the risk of cashing fraudulent checks. Unless an association's bylaws state otherwise, the board decides who should be signers of checks. Some boards put all directors on bank signature cards to ensure that at least one director is always available to sign checks. Others restrict the number of authorized signers for stricter control of expenditures. Banks once compared the signatures on checks to those on the signature cards. However, with the advent of electronic banking, signature cards have little significance in the industry.
Two Signature Operational Checks. There is no requirement that two directors sign checks against the operating account--it is, however, best practice. It ensures that at least two sets of eyes are on expenditures.
Reserves - Two Signatures. Even though banks no longer monitor signatures, the Davis-Stirling Act requires that at least two directors authorize all reserve transfers by associations. For reserve accounts, at least two directors must approve the transfer of funds from reserve accounts. For operating accounts, there is no statutory requirement for board signatures, but that requirement can be found in the governing documents. Some HOA bylaws require the signatures of two directors on all checks; some require at least one officer's signature, but most are silent on the issue. (Civ. Code § 5510.)
Bank Processing Policies
Inclearings & Automation. Unlike over-the-counter checks, which are deposited at the same bank they are drawn against, "inclearing" checks are deposited at other financial institutions and processed by those institutions through a clearing house such as the Federal Reserve before returning the check to the bank of origin. Once checks enter the system, they are scanned and processed in bulk using high-speed automation instead of being processed one check at a time by a live person. It saves banks time and money and speeds the transfer of funds. It also means banks can no longer compare checks against signature cards.
Banks Held Harmless. Banks can still place an alert on accounts if so requested. It means a lone board member cannot walk into a branch and clean out a two-signature account. Even so, language in the signature card and bank disclosure documents hold the bank harmless if the bank honors a one-signature check. That means an association cannot go after the bank if a board member absconds with the money. Instead, the HOA must go after the director.
Davis-Stirling Requirements
Electronic Signatures. Whether by design or not, the Davis-Stirling Act does not require signatures on a check. Instead, the Act requires a more nebulous requirement of two signatures to withdraw funds without specifying where or how the signatures are employed:
The signatures of at least two persons, who shall be members of the association's board of directors, or one officer who is not a member of the board of directors and a member of the board of directors, shall be required for the withdrawal of money from the association's reserve accounts. (Civ. Code § 5510(a).)
The statute intends to ensure that two directors or a director and an officer know about and authorize the withdrawal of reserve funds. If two directors issue written instructions to the association's management company to make a transfer, the statutory requirement appears to be satisfied.
Email Approval. Since electronic signatures are now recognized to be the same as signatures on a piece of paper, they can be used to authorize the transfer of reserve funds. Accordingly, email authorizations from two directors to the management company also satisfy the requirement. Management companies should be careful to preserve those instructions so they have a paper trail showing each transfer was authorized. Otherwise, the management company could find itself in hot water if the transfers were ever challenged.
Governing Documents. Despite the above analysis, associations should review their governing documents before changing how they handle reserve transfers. Their CC&Rs or bylaws may contain more stringent requirements for handling reserve funds. If so, those procedures must be followed.
Recommendation: Because the two signature rule applies to associations and not banks, boards cannot rely on banks to monitor checks for them. Instead, boards must adopt internal controls and carefully monitor their reserve accounts for unusual activity. There need to be safeguards on withdrawing both reserve and operational funds. An additional protection is for boards NOT to authorize debit cards, credit cards, or ATM withdrawals on reserve accounts. In addition, boards still have the option of requiring all transfers from reserves to be done by check and requiring all reserve checks to be signed by two directors. Boards should consult legal counsel, their CPA, and their management company before deciding on a particular policy.
Insuring the Association’s Funds
Federal Deposit Insurance. The Federal Deposit Insurance Corporation (FDIC) insures the safety of checking and savings deposits in member banks up to $250,000 per depositor per banking institution (not per bank branch). That means an association can have a dozen $250,000 CDs from twelve different banks, thereby having $3 million covered by FDIC insurance. If a board places $500,000 in a single bank (for a jumbo CD to receive a greater return on its money) and the bank fails, the association loses $250,000. Boards should not exceed $250,000 per financial institution (unless the bank has private insurance to cover the monies). Instead, they should spread their association’s money across various FDIC-insured institutions. One way to conveniently spread the money is to use brokerage firms or banks in the CDARS program. See the FDIC website for more information about deposit insurance.
Private Insurance. Even if an association’s governing documents do not require FDIC-insured investments, boards should ensure their monies are insured. Some banks carry private insurance to cover deposits, including deposits that exceed FDIC limits. Other banks use surety bonds that insure the bank rather than individual accounts. While this reduces the association’s risk, it is not risk-free. There are two problems with the bond: (i) the bank is the named insured, not the association, and (ii) the insurance is limited to a specific dollar amount--if the bank fails, the insurance will only pay to its policy limits regardless of the aggregate amount in depositor accounts. It means any gap in coverage falls to the depositors, who may be paid only pennies on the dollar. If boards elect to use non-FDIC-insured accounts, they should ensure their governing documents allow them to place funds in non-FDIC-insured institutions.
Crime Insurance. Beginning January 1, 2019, associations must purchase what the statute calls a “Fidelity Bond.”
Investing the Association's Funds
See "Investing Reserve Funds."
ASSISTANCE: Associations needing legal assistance can contact us. To stay current with community association issues, subscribe to the Davis-Stirling Newsletter.