Preparing for the Inevitable: Raising Assessments and How to Do It
Whether it’s to pay for repairs to the common area, replenish reserve funds, pay for increased utilities, stay even with inflation, raise funds for a new project addition such as a playground or pool (also known as capital improvement), or even help pay for litigation, there will come a time when a homeowners association will need to raise its assessments. This article explains why, how, and when to raise assessments, and how to best communicate it to the membership. When you go through this process keep in mind everyone knows that the cost for a gallon of milk has gone up along with a gallon of gas, so increases in assessments should not be a surprise. Our association boards shouldn’t have to approach the news of assessments increases with shame or threats of retribution, the truth is it is just a “sign of the times.”
First, it’s important to know how assessments work. An association’s annual or “regular” assessments should total the amount of expected expenses for the year which are collected from the membership. These regular assessments are deposited in the operating account and some of the funds may be saved in a reserve account for designated line items as identified in the association’s annual budget. As the association incurs expenses, the operating funds are used to pay for such expenses. If the association has reserve funds set aside for, as an example, major repair items, such as a pool or a roof, then the association can use those reserve funds as that is what the reserve funds are intended for. But when there are additional ongoing operating expenses that arise in which the operating account is insufficient and in which reserve funds can’t be used for that purpose*, the association will have to raise its regular assessments or may need to levy a special assessment based on urgency and need. (Note*: Associations do have the ability to borrow from reserve funds for ongoing operating expenses but are required to pay back the borrowed reserve funds which typically result in raising assessments.). Below is a summary of the methods of raising assessments.
1. The 5% Rule: Civil Code § 5605 allows the Board of Directors, by a majority vote, to immediately levy a special assessment in an amount up to a five percent (5%) of the budgeted gross expenses of the current fiscal year. Raising assessments by this method is usually only for when the association needs just a little bit of extra funds in smaller amounts which is why membership vote or approval is not required. So for example, if an association’s total budgeted expenses/annual budget is one hundred thousand dollars ($100,000), this means the Board can specially assess a total of five thousand dollars ($5,000) against the entire membership; this $5000 is then divided amongst the membership and assessed to each member based on the association’s CC&Rs assessment structure, either equally, variably, or a hybrid of both. Since this is a “special assessment,” it can be levied at any time as opposed to an association’s regular assessments which are pre-calculated and set prior to the start of the fiscal year.
2. The 20% Rule: Civil Code § 5605 also allows the Board of Directors, by a majority vote, to levy up to a twenty percent (20%) increase in the regular assessment amount from the prior fiscal year. This is an easy way for an association to raise its assessments because no membership approval is required, and it is typically used for future or long term expenses based upon budget calculations since this method of raising assessments is not immediate like a special assessment. An association could levy a 20% increase in the regular assessments that takes effect at the start of the next fiscal year, and then repeat this as needed for each successive fiscal year. The downside to this method of raising assessments is that an association may not receive the funds it needs for an immediate expense.
3. Emergency Assessment: Civil Code § 5610 allows the Board of Directors, by a majority vote, to levy an emergency special assessment under certain circumstances. An emergency expense is defined as an extraordinary expense (i) required by an order of a court; (ii) required to repair or maintain the development or any part of it for which the association is responsible where a threat to personal safety on the property is discovered; and (iii) required to repair or maintain the development or any part of it for which the association is responsible that could not have been reasonably foreseen by the Board in preparing and distributing the annual budget report. Under the last circumstance, the law requires that the Board pass a resolution containing written findings as to the necessity of the extraordinary expense involved and why the expense was not or could not have been reasonably foreseen in the budgeting process, and the resolution must be distributed to the members with the notice of assessment. This method of raising assessments is very powerful because it allows for an immediate special assessment by the Board of Directors in an amount that may otherwise exceed the 5% and 20% limits discussed above. This provision in the law exists because an association may need a large sum of emergency funds immediately which would otherwise be subject to a special assessment secret ballot vote by the membership which could be rejected. Caution: Be mindful of the fact that courts will scrutinize this form of immediate assessment levy, if disputed, to confirm that the manner in which the assessment is levied is supported by the facts.
4. Membership Special Assessment by Secret Ballot: Finally, the most common method of raising assessments is by a special assessment vote approved by the membership. There is no limit to the amount of a proposed special assessment except that it must be based on the amount anticipated to be needed. Civil Code §§ 4070 and 5605(c) supersede language in an association’s CC&Rs and state that a majority of a quorum (defined as fifty percent (50%) or more of the membership) can approve a special assessment. This vote would be subject to the secret ballot process and requires at least thirty (30) days to conduct. As a reminder, state law effective in 2020 requires that an association has adopted election rules in order to conduct any election including an election for a special assessment vote. Warning! If an association doesn’t have election rules, an election can’t occur until ninety (90) day after adoption of election rules.
Regardless of the method of levying and increasing assessments, before any assessment increase is due, Civil Code § 5615 requires that an association provide thirty (30) to sixty (60) days’ notice of the increase. However, an association should also check its CC&Rs for any further restrictions about the notice required for assessment increases; for example, some CC&Rs may require a sixty (60) day notice.
Although the power to levy assessments exists it is not uncommon for an association to face membership opposition or experience problems in raising assessments. For any assessment increases, it is best to be open and transparent with the membership and give them as much advance notice as possible. An association may consider townhalls or additional meetings prior to any meeting and election to actually vote on raising assessments in which questions can be asked and answered. In addition, depending on the amount of a special assessment, be mindful of the fact it may be difficult for owners to pay the assessment increase timely so an association may also want to consider obtaining stop gap or transitional loans and/or offering owners payment plans subject to a written payment plan agreement. Payment plans can also be offered, within the board’s discretion, for regular assessment increases for those owners having difficulty in meeting their financial obligations to the association.
Given the various methods of raising assessments, the compliance requirements, and issues that may arise when trying to raise assessments, an association should work closely with its manager and/or legal counsel to determine the best way to raise assessments to address the financial needs of the association.