By now, most people involved in the operation of common interest communities in Minnesota have heard that the statutory requirements for replacement reserves have been amended and that the new amendments become effective starting with the fiscal year commencing on or after January 1, 2012. This article is intended to address some of the frequently asked questions that have come up regarding those changes.
Question: We are a townhome community formed prior to June 1, 1994. Do the new changes apply to our association?
Answer: No. The amendment to Minnesota Statutes 515B.3-114, which has been codified as the new section 515B.3-114(1), applies only to those associations that are otherwise governed by the Minnesota Common Interest Ownership Act (“MCIOA”). MCIOA applies to all condominiums regardless of when formed and to townhome, planned communities and cooperatives formed on or after June 1, 1994, as well as older associations that have amended their governing documents to “opt in” to MCIOA. If your association is not subject to MCIOA, the reserve amendments do not apply. However, the 2010 changes to the resale disclosure requirements that now require associations to disclose the components for which they are reserving does apply to all associations whether or not they are otherwise subject to the remaining provisions of MCIOA.
Question: Does the new statute require associations to be fully funded and able to pay for replacements solely through reserves?
Answer: The amended section states that the association shall include in its annual budgets “replacement reserves projected by the board to be adequate, together with past and future contributions to replacement reserves to fund the replacement of those components … which the association is obligated to replace by reason of ordinary wear and tear or obsolescence”, subject to several exceptions. My reading of this language is that the board ought to be planning to fund the replacement of components fully through contributions to reserves unless it meets one or more of the stated exceptions.
Question: What are the exceptions to the replacement reserve requirements under the amended statute?
Answer: The exceptions set forth in the amended statute exempt associations from having to reserve for 1) components with a remaining useful life of more than 30 years; 2) components that will be paid for directly by the unit owners for replacement of limited common elements in accordance with the governing documents; or 3) components for which the replacement has been approved through an alternative funding program in accordance with subsection 5 of the statute.
Question: How does the alternative funding program work?
Answer: Unless otherwise required by the declaration, an association can elect not to reserve for certain components whose replacement is planned to be paid for by special assessments or by assessments levied under 515B.3-115(e)(2) (relating to common expenses benefitting fewer than all members). In order to opt not to reserve for said components, the decision must be approved by the board and by 51% of the votes allocated to unit owners. This approval is good for the current and 3 following fiscal years before a new vote would need to be taken. The statute is unclear whether, in the case of special assessments, the special assessment must have been already approved in accordance with the association’s governing documents before this election can be made not to reserve for a component or if an association can elect not to reserve for components that it hopes to fund by special assessment in the future and then separately obtain the requisite approval for the special assessment at some later date.
Question: Does the amended statute require associations to obtain a professional reserve study?
Answer: No. There is no requirement that an association have a professional reserve study conducted. If the board and/or property manager are willing and able to do the work needed to determine the remaining useful life of the various components that the association is obligated to replace and the estimated cost of replacement in order to determine how much the annual reserve contribution should be, that is sufficient to satisfy the statutory requirements. Similarly, associations need not hire a professional reserve company to perform the required review every three years.
Question: Does the new prohibition on taking or borrowing money from the reserve account to fund operating expenses mean that associations can no longer reserve for painting, seal coating, and other major maintenance expenses?
Answer: The new statutory language makes it clear that funds that are being reserved for the replacement of components in the association must be kept separately from all other accounts that the association maintains for operating expenses and that funds in the replacement reserve account may not be used for operating expenses. However, it does not prevent associations from maintaining separate “operating reserve” accounts to be used for the funding of larger maintenance and repair projects. Associations should consult with their tax advisor to make sure that these operating reserve accounts are properly set up to avoid any possible tax consequences of having surplus operating funds at the end of the year.
Question: Is there a penalty for failing to comply with the new reserve requirements?
Answer: There is no penalty provision built into 515B.3-114(1) for associations that fail to comply with the new reserve requirements. However, as with all provisions of MCIOA, 515B.4-116 provides a right of action for homeowners and other parties damaged by the failure of the association or other parties to comply with any statutory provision and further provides that the prevailing party in such an action may recover its attorney’s fees and costs in bringing the action. In other words, the association and/or its board of directors can be sued by one or more homeowners for failing to comply with the statutory requirements and could be facing a judgment that includes an award of attorney’s fees and costs. Further, an award for attorney’s fees and costs may not be covered damages under the association’s applicable insurance policy, meaning that those amounts would have to be paid out-of-pocket.