Q: I live in a condominium, and the developer has just recently turned over control to the unit owners. Going through the budget, it appears that the developer did not pay any of the reserve requirements while the developer still owned condominium units. As a result, our association will be forced to pass a special assessment for a number of repair items, and we probably will have an increase in our condominium fee to establish a proper reserve. Does the developer have the right to avoid paying these reserves?
A: The first thing to do is to read the bylaws and the declaration. Try to find out whether these documents permit the developer to pay less than the full share on each unit owned by the developer. Some bylaws specifically require that all unit owners--including the developer--must pay the full condominium fee on each unit they own. Other documents permit the developer--before control is turned over to the association--to pay only the operating expenses of the condominium association, thereby avoiding the requirement of having to pay the full condominium fee each and every month.
If the documents require the developer to pay the full condominium fee, you need go no further. Consult your association attorney, and make a formal demand on the developer for full payment. Needless to say, I am assuming that your association has already completed a "turnover of control audit," whereby an accountant or CPA has fully analyzed all of the condominium association transactions from the day the association first was created.
But even if the documents permit the developer to pay less than the full condominium unit fee, a recent California case must be called to the attention of everyone concerned with condominium development. In the California case, Ravens Cove Town Homes Inc. vs. Knuppe Development Co., the California Court of Appeals held that in situations such as you have outlined, the developer had a fiduciary duty while it was in control of the board of directors, and the failure to establish an appropriate reserve fund was a breach of that fiduciary duty.
The Ravens Cove case is a landmark opinion in the developing area of condominium law, and should be carefully read by developers and condominium unit owners alike.
According to the court, replacement reserves "have to be accumulated because the association . . . cannot assess its members in sufficient amounts in a short period of time to pay for the work and materials required for major repairs and improvements . . . and cannot borrow funds for this purpose as a result of the nature of its assets.
Accordingly, the court found that the failure to establish reserves was a violation of the developers fiduciary duty not only to the condominium association, but to "unknown persons who would purchase and become members of the association." According to the court, the developers "may not make decisions for the association that benefit their own interests at the expense of the association and its members."
Addressing the standard conduct required of a member of the Board of Directors, the court indicated that "individuals on the board are held to a high standard of conduct, the breach of which may subject each or all of them to individual liability. . . ."
The court said:
"Here the individual directors and officers of the association had a fiduciary relationship to the homeowner members analogous to that of a corporate promoter to the shareholders. These duties take on a greater magnitude in view of the mandatory association membership required of the homeowner.
"We conclude that since the association's original directors (comprised of the owners of the developer and the developer's employes) admittedly failed to exercise their supervisory and managerial responsibilities to assess each unit for an adequate reserve fund and acted with a conflict of interest, they abdicated their obligation as initial directors of the association. . . . Thus the individual initial directors are liable to the association for breach of basic fiduciary duties of acting in good faith and exercising basic duties of good management."
This seems to be a trend in condominium law. Developers should be forewarned that they have a strong fiduciary obligation to future members of the association, and cannot act in their own selfish interests.
But here is a word of caution: while the Ravens Cove case is only applicable to the initial board of directors, the strong language of the court should be a warning to all members of any board of directors. A fiduciary duty is applicable--whether or not the board of directors is appointed by the developer or elected by the association members.
Benny L. Kass is a Washington attorney. Write him in care of The Washington Post, 1150 15th St. NW, Washington 20071.