As many readers know, there is a 2010 legislative initiative to amend the Minnesota Common Interest Ownership Act. As of the drafting of this article, a bill has not yet been submitted to the legislature; however, many important and significant changes to MCIOA are currently on track for inclusion in the anticipated 2010 legislation.
A significant component of the proposal would amend several provisions of MCIOA to address issues regarding association replacement reserves. This article provides a summary of some of the most significant changes regarding replacement reserves that are likely to be included in the proposed legislation.1
The current version of Minn. Stat. §515B.3-114 provides as follows: The annual budgets of the association shall provide from year to year, on a cumulative basis, for adequate reserve funds to cover the replacement of those parts of the common interest community which the association is obligated to replace. These reserve requirements shall not apply to a common interest community which is restricted to nonresidential use.
The current language of Minn. Stat. §515B.3-114 provides a broad requirement for associations to fund reserves, leaving out the specifics. Problems arose in many associations in recent years related to replacement reserves, on a scale not contemplated by the Act. These problems led to a call for greater legislative protections for associations in this area. A proliferation of troubled CIC projects, along with the general economic downturn, led to underfunded replacement reserves in many associations. It became increasingly common for associations to tap into replacement reserves for general operating expenses and other uses other than their intended purpose.
These problems have led to a significant increase in litigation related to reserves, often by fledgling associations against their developers, for failure to establish adequate reserves, failing to establish adequate budgets, and violating declarant and board duties, among other claims. Although MCIOA, along with other State and Federal laws, provide certain protections to associations, litigation is a burden on a fledgling association. The proposed reserve amendments are designed to help prevent the circumstances that lead to litigation in the first place.
Further, lending requirements have tightened for Fannie Mae approved and FHA insured loans, including requirements that associations fund their replacement reserves. To obtain Fannie Mae lending approval for condominiums, lenders must review the association’s projected budget to determine that it is adequate, that it provides for the funding of replacement reserves for capital expenditures and deferred maintenance at least 10% of the budget, and that it provides adequate funding for insurance deductible amounts. To be eligible for FHA insured financing, lenders must review an association’s annual budget and determine that the budget is adequate, and includes allocations to ensure sufficient funds are available to maintain and preserve all amenities and features unique to the condominium project; provides for the funding of replacement reserves for capital expenditures and deferred maintenance in an account representing at least 10% of the budget; and provides adequate funding for insurance coverage and deductibles.
Under the proposed MCIOA amendment regarding reserves, the association shall include in its annual budget replacement reserves projected by the board to be adequate, together with past and future contributions to replacement reserves. The association’s annual report shall now contain a statement of the association’s total replacement reserves, the components of the CIC for which the reserves are set aside, and the amounts of the reserves, if any, that the board has allocated for the replacement of each of those components.
Unless required by the declaration, the annual budget need not include reserves for limited common elements, nor need the budget include reserves for components with a useful life of more than 30 years.
If it wasn’t doing so before, the association must now keep the replacement reserves in an account or accounts separate from the association’s operating funds. Further, the association cannot use the replacement reserves to fund operating expenses or borrow from the replacement reserves to fund operating expenses; however, the association can pledge the reserves as security for a loan.
The association must re-evaluate the adequacy of its replacement reserves at least every third year after the recording of the declaration. This method of re-evaluation is within the association’s discretion, and there is no statutory requirement of a formal reserve-study.
Unless otherwise provided in the declaration, the association retains the power to fund certain replacement costs through special assessments. This situation can only happen after termination of declaration control, and requires approval by both the board and by a majority of votes in the association (other than the declarant or its affiliates).
Like the current reserves provision, the proposed changes would not apply to non-residential CICs unless otherwise required by their declarations.
To allow time for CICs to adjust to the new requirements, the proposed changes regarding reserve requirements would not take effect until the fiscal years commencing on or after January 1, 2012.
1 This summary does not purport to cover all relevant chapters or sections. Further, the provisions summarized here are proposed legislation only. Due to the legislative process, said provisions may not become law, or may become law in a different form. The information in this article is general information and does not constitute legal advice regarding action to be taken in any particular case. The reader should consult with their attorney for assistance with making decisions in conformance with these and other legislative developments.