Best practice: transitioning to HOA11th Feb 2019
A development is not a residential estate – it’s a place with houses in a greater or lesser stage of completion. But there comes a time when the developer steps out, and the homeowners association steps in – and from that moment, the estate becomes a community – a place where people live.
What is transition?
Transition is a term that has evolved in recent years to describe the general process by which the control and responsibilities of the governing board of a community association are transferred from the developer to the persons who bought homes in the community association. Although it includes the assumption of the obligation to maintain the physical assets for which the association is responsible and is often viewed only in that narrow context, the transition process is much broader in scope. It includes the transfer of governance, the acceptance of the common property, and the accounting for funds. Transition is not a single event, such as the election of an owner-controlled governing board or the execution of a settlement agreement regarding construction defects in the common property. It is a multistage process of many events taking place over a period of time.
A primary component of the transition process is the assumption of responsibility for the governance of the association through control of the board, which is responsible for the operation and administration of the community association and the maintenance of the common property. Preferably, this should be a gradual process that allows the owner board members the opportunity to receive proper training and to gain experience.
Also, a progressive transfer of control helps protect the developer from unfriendly and financially harmful actions by the owner members of the board while the developer still retains a substantial economic interest in the project.
In some estates, legislative or regulatory mandates require that turnover of control of the governing board from the developer to the owners occur over the course of development. Commonly, the statutory guidelines require the election of a minimum number of owner board members at various stages of sales based on the number of projected closings that have actually occurred, beginning at 25% and continuing to 75%. At this point, the owners usually elect the entire board with the exception of one developer representative who can remain until the completion of sales for the project.
Thoughtful document drafting will create a governance structure within which transition is viewed as successful by all stakeholders – if all those stakeholders take responsibility for their roles in the process. Though there are differences from community to community and estate to estate, transition is most successful in associations where the following practices occur:
- Educate owners as to what a community association is and isn’t.
- Educate board members.
- Recognise the duties owed to the association and owners, and establish policies that enable the board to carry out these duties.
- All board members act in a fiscally responsible manner.
- Engage professional management.
- Hire independent legal counsel to represent the association.
- Support the homeowner board through the completion of the community.
- Maintain a good relationship among the association, the developer, and the owners until the development period ends.
Preparation of the documents
Documentation includes the articles of association, conditions, restrictions and bylaws, and an initial community association budget. Throughout the construction and conveyance process, the developer typically controls the decisions of the association. It is critical that the developer manage the expectations of the home owners through this process. By creating an acceptance procedure and maintenance manual for home owners, addressing potential issues, soliciting home-owner involvement, and turning over the amenities and open space areas to the association, developers can create community and avoid confrontation. Here are some guidelines:
- Draft governing documents that focus on the developer’s right and ability to control the development of the project and sale of the units rather than its right and ability to control the board.
- Create governing documents that enable rather than impede the business and financial management of the association.
- Create a governance structure that encourages involvement by owners and other residents.
- Create a transition team within the governing documents.
- Include alternative dispute resolution in the governing documents.
- Establish reasonable schedules for turnover.
The governing documents should provide for a transition process that establishes:
- when and how elections of owners to the board occur
- who is entitled to vote and whether class voting is allowed
- how developer-appointed board members are removed or resign
- the continued right of the developer to control the development of the community association until completion
- what documents, financial audits or reports must be delivered to the owner-elected board.
Effective communication is probably the most important element in the success of any community association. Especially during the developer control period, a successful communications system can forestall the development of cliques and factions, enable the association to provide services that owners want, and help owners develop a sense of trust in the developer, reducing or eliminating the acrimony that often follows the transition to owner control. An effective communications programme is composed of several components, each of which is an essential part of the programme. These are the home owners, the on-site sales force and/or estate agents, managers, the developers and the developers’ attorneys. Ideally the developer should strive to create a community of residents who are proud of their homes and who view the developer as part of the team committed to the success of their association.
Developers can be exposed to liability ranging from breach of contract, fraud, or for violating government statutes.
Homeowners associations can also be exposed to litigation for breach of fiduciary duty, discrimination or a failure to keep common areas in a state of repair and maintenance. And lenders who loan money to developers can, in some instances, be liable for construction defects or misrepresentations pertaining to the development.
In order to minimise the risk of litigation, hire independent specialists who help owner boards navigate the transition from developer to owner control. These include the engagement of independent counsel and accountants for the association at an early stage of transition, usually no sooner than the first transition election when 25% of the units have been sold. Emerging strategies to discourage litigation include a comprehensive risk-management programme that would take place at the completion of the architectural and engineering drawings, and continue until the completion of construction, when the owners take control of the association. It would include reviews of the budget, building compliance, coordination between architectural and engineering designs, and a punch list with input from the home owners.
Checks and audits
And, before final handover, the board should do a physical and common elements audit, and an organisational audit, and commission an engineering inspection of the property.
The engineering inspection will include checking the condition of the physical property, a capital reserve study, a recommended maintenance schedule, and a comparison of the actual construction with the approved plans and applicable codes.
When doing the physical and common elements audit the association should:
- determine the condition of the common elements and other physical portions of the community through appropriate engineering or contractor inspections
- confirm with legal counsel that the association owns all the common elements
- review the existing reserve study
- take a hard look at assessments and budgets.
The organisational audit consists of:
- corporate audit for the association
- governing document review
- covenant enforcement audit for issues of breach of covenants, design review, consistency in enforcement, status of claims, possible waiver issues.
Insurance provides protection for losses, so it is essential to ensure there is no gap in cover during the transition process.