Transferring Power from a Developer to Homeowners in an HOA
Getting in on the ground floor of a new master-planned community is very exciting. If you are fortunate enough to be in such a scenario, you likely now have a budding interest in how the developer of the HOA community will eventually transfer power to the homeowners.
In a nascent HOA community, a new homeowner has the option to sit back and permit the developer to govern the community until all the lots or units in the development are sold. Yet, this can be risky and may cost you money/time in the long run if there are any complications in the completion of the work. In turn, it is in your interests to get involved in the governing process of your community early and often. Below are a few thoughts that will assist with this.
1. Everyone on the Board Owes a Fiduciary Duty to the Homeowners
The developer, formally referred to as the declarant, will appoint people of his choosing to govern the budding community through the HOA board of directors. As people begin to buy into the community, the new homeowners will soon elect members of the board so that the community is now governed by both employees/representatives of the developer and by a few elected homeowners.
It is pretty clear from the outset that this scenario is rife with the possibility of uneven incentives. The motivations of the homeowner board members are clear enough: they want to maintain the value of their newly purchased homes and will act to preserve community-held assets. Yet, for the developer and his representatives, the incentives are murkier. Sure, the declarant desires that the buyers of his properties are satisfied with their purchase as real estate is a reputation business—it would get around the community pretty quickly if a developer was acting unscrupulously. On the other hand, we would be naïve to not acknowledge the obvious fact that these developers are profit-seeking entities. As for us, a dollar saved is a dollar earned.
Yet, importantly, no matter the financial incentives of those sitting on the board, they all owe a uniform fiduciary duty to the new homeowners. Although the allies of the developer may be sympathetic to the principle of keeping expenditures down, if this is done to the detriment of the other members of the HOA, this action could lead to legal liability for the board member in question and perhaps for the declarant as well.
Because of these possible contrasting incentives for board members appointed by the developer, it is best to get involved in community governance as soon as feasible. The transfer of power from the developer to the homeowners takes a year or two, so all of us will be working together for quite some time. Be open with the developer, no need to be accusatory, and tell him you want representation on the board to make sure everything is going to plan.
2. Retain the Necessary Third-Party Experts
With the transition taking a little time and to help the process move smoothly, it is best to bring in third-party experts to ensure that all the parties are upholding their responsibilities as spelled out in the CC&Rs. An engineering expert can be of great help in confirming the common areas are compliant with the building code and are in need of no further investment.
Additionally, you may want to retain a third-party accountant to assist with the financials of the transition. As part of the fiduciary duty to its members, the board must keep an adequate reserve fund for possible unexpected expenditures. The third-party accountant will ensure that all parties are providing their required contributions as stated by the CC&Rs without any of the added distress from fellow board members questioning the motives of the recommendations.
Lastly, it is in everyone’s interest to retain legal counsel for the board to ensure that the transition is completed in accordance with state law, which unfortunately are not uniform across the country. Because HOA legislation differs so much by jurisdiction, local counsel is essential to ensure the transfer is completed as the law requires. Additionally, counsel will assist in clarifying for the board of directors what is required of them by the fiduciary duty owed to the other members.
3. A Little Extra Work During the Final Transfer is Worth the Trouble
So more and more properties have been purchased by individuals; it is apparent that the developer’s rule over the community is about to come to an end. Most states have a statute like Colorado that sets the terms of transfer of governance from the developer to the homeowners. For example, Colorado’s Colorado Common Interest Ownership Act states that “[r]egardless of the period of declarant control provided in the declaration, a period of declarant control terminates no later than the earlier of sixty days after conveyance of seventy-five percent of the units that may be created to unit owners other than a declarant.” (Emphasis added).
In Colorado and other states like North Carolina, once the 75% threshold of home sales has been met, an election is scheduled for 60 days subsequent to elect a board of directors exclusively comprised of homeowners. Note that these statutes only set an upper limit for how long a declarant may govern a community—a developer is permitted to release control as soon as he sees fit. The law does not prevent an early transfer of power to homeowners.
Before the final transfer of power takes place, it is in both the declarant’s and community’s best interests to sign a memorandum of understanding with respect to the terms and conditions of the release of governance to the homeowners. This is actually not required by law, but it benefits all the parties involved—one of the best means of avoiding future litigation is to clarify in writing the assignment of duties. You purchased a home in a planned community for added peace of mind; diligence in the transfer process will pay off mightily in the future.