MARYLAND HOMEOWNERS ASSOCIATIONS
Transition of Association Governance from Declarant to Lot Owner Control
Legal Requirements and Transition Checklist
“Declarant transition” is the process by which the governance of homeowners associations are transferred from declarant to lot owner control. This article contains and overview of legal requirements governing the transition process followed by a “transition checklist” for transitioning lot owner-controlled boards of directors.
PERIOD OF DECLARANT CONTROL
A declarant initially controls a homeowners association because it owns all unsold lots in the newly created community. As such, the declarant has the controlling votes associated with majority ownership and can appoint its own employees as the initial members of the governing board of directors and thereby control how the homeowners association conducts its affairs. This is referred to as the “period of declarant control,” during which the declarant makes all decisions on behalf of the association.
The declarant also creates an association’s governing documents, allowing it to dictate, subject to applicable law, the procedures and time periods under which control will eventually be transferred to the lot owners. Declarant transition for Maryland homeowners associations is the point at which control is transferred to the unit owners.
The period of declarant control continues until a “transition meeting” is held to elect members of the board of directors from amongst the association’s membership (i.e., the lot owners). A declarant -controlled homeowners association must hold the transition meeting within 60 days from the date that at least 75% of the total number of lots are sold to the public for residential purposes. Maryland Homeowners Association Act (“HOA Act”) §11B-106.1 (a)(1). Declarant transition of of control over Maryland homeowners associations begins with the transition meeting.
The transition meeting can be held earlier if the declarant specifies a lesser percentage of conveyances or sales in the governing documents as a trigger for the 60 day period to commence. HOA Act §11B-106.1(a)(2).
OVERLAPPING TERMS OF DECLARANT-APPOINTED BOARD MEMBERS
The terms of board members appointed by the declarant during the period of declarant control must end 10 days after a replacement board member is elected at the transition meeting. HOA Act §11B-106.1(c). This law is designed to prevent overlapping terms of declarant-appointed and lot owner-elected board members. So long as lot owner members of the homeowners association are willing to run for the positions on the board of directors and sufficient purchasing lot owners vote, declarant transition of control over a Maryland homeowners associations should result in a lot owner-elected board of directors.
Within 30 days following the transition meeting, a declarant is required to turn over specified documents and assets to the newly elected board of directors. HOA Act §11B-106.1(d). This includes financial records, contracts, architectural plans, condominium funds, unit owner records, etc. A complete list of these items is set forth as an Appendix to this article. Declarant transition for Maryland homeowners associations is a time to inventory and collect condominium documents and assets.
TERMINATION OF CONTRACTS
Following the transition meeting, the newly-elected, owner-controlled board of directors has a right, without liability, and upon 30 days prior notice, to terminate any association contracts entered into during the period of declarant control to handle financial matters, maintenance, or other services for the community. HOA Act §11B-106.1(e). Therefore, declarant transition for Maryland homeowners associations provides an opportunity to review and terminate association contracts. However, this right to terminate does not apply to contracts for the “the provision of utility services or communications systems.” HOA Act §11B-106.1(e)(2) (ii).
The following is a transition checklist that should be addressed by the initial, lot owner-controlled board once it assumes control over the association from the declarant
Document/Asset Inventory & Request
Conduct an inventory of association documents and assets. Make a formal written request of the declarant to turn over all documents, funds and assets listed in Appendix A to the extent not already done so. These must be turned over within 30 days of the transition meeting.
Review all contracts entered into during the period of declarant control to handle the homeowners association’s financial matters, maintenance, or other services. If there are any concerns, obtain competitive vendor proposals for comparison purposes. Contracts that do not appear to be in the best interest of the association can be terminated, without liability, upon 30 days in notice. The association’s right to terminate does not apply to contracts for the provision of utility services or communications systems.
Audit Financial Records
Have an independent auditor examine and audit the association’s financial records during the period of declarant control to ensure that all monies were properly collected and accounted for. For example, an auditor can determine whether the correct amount of assessments were collected, whether the association’s reserve accounts were properly funded, or whether there was any inappropriate use of association funds to pay declarant obligations. In some cases, an auditor may determine that the declarant owes the homeowners association a substantial amount of money.
Transition and Reserve Studies
Obtain transition and reserve studies in order to identify construction defects and determine whether the declarant-created budget and reserve account are adequate to maintain, repair and replace the common areas of the community over time. For example, if a common area clubhouse roof is found to be in need of immediate replacement because of construction deficiencies, then a declarant-created reserve budget based on a projected roof replacement in 30 years is grossly insufficient.
The Transition Study: the purpose of a transition study (also referred to as a “deficiency report” or “warranty analysis”) is to evaluate construction of the common areas to identify construction defects while warranties are still enforceable so they can be submitted to the declarant for warranty repair.Timely transition studies are essential because defects in newly constructed communities may not be apparent when owners first take control of the association. Defects in the original construction can remain hidden for years until they manifest themselves in the form of property damage. Left undiscovered and unrepaired, even minor construction deficiencies can result in extensive property damage requiring associations to borrow money and assess unit owners. Moreover, when defects are not identified in a timely manner, warranty rights may be barred by expiration of warranty periods or statute of limitations. Architectural and engineering firms can identify construction defects early on and investigate suspicious conditions before warranty rights expire so timely notice can be given to the declarant. Once defects have been identified and then corrected by the declarant, the association can establish an accurate reserve budget.
The Reserve Study: A reserve study does not seek to evaluate construction. Rather, its purpose is to determine the amount of annual assessments that should be placed into a reserve account to pay for future repair or replacement of the major community components for which the association is responsible, such as clubhouses swimming pool, sidewalks, roadways, storm water management ponds, streetlights, etc. A normal useful life, or “life expectancy,” is assigned to each of these components (e.g., a 30-year clubhouse roof), as well as an estimated cost to repair or replace those components at the end of their useful life. Based on these projections, a reserve analyst estimates the amount of money that the association should allocate to its reserve account each year so that the necessary funds will be available for future repairs and replacement. This type of planning avoids a one-time huge assessment for major repair/replacement projects.
Retain Legal Counsel
General Counsel: Retain general counsel to work with the board members and its management company handling a the wide variety of general legal issues that face a homeowners association, such as interpreting governing documents, preparing legal opinions, delinquent assessment collection, contract negotiation, dealing with threatened litigation, amending governing documents, etc.
Warranty/Construction Defect Legal Counsel: Request a free consultation from an attorney with expertise in homeowner association construction law. Such an attorney can advise the association when applicable warranties and other legal claims expire and how to preserve the association’s legal claims while negotiating proper repairs with the declarant. Armed with such information, a transitioning homeowners association can make informed decisions. This legal consultation should be requested as soon as the newly elected board assumes control of the association to ensure that no warranty and other legal rights are allowed to expire.
Review Insurance Coverage
Review association insurance coverage obtained during the period of declarant control. Make sure coverage complies with governing documents, industry standards, and applicable laws (e.g., master policy, property insurance, comprehensive general liability insurance, fidelity insurance, directors & officers/errors & omissions policy). In the event of a lawsuit, having proper coverage will not only provide the homeowners association with a legal defense and pay any judgment, but can also provide immunity to directors and officers and cap association liability to the amount of insurance coverage.
General Housekeeping Matters
There are a number of housekeeping matters not covered by this checklist involving homeowner association governance and business that will need to addressed by the first board to transition from declarant control. An association’s property manager and/or its attorney typically guides the board in these matters. Some examples include: selecting officers (President, Vice President, Secretary and Treasurer); appointing committees (e.g., architectural review committee); scheduling meetings required by the governing documents (e.g., annual and regular meetings of association); defining maintenance obligations and establishing a maintenance schedule; amending declarant -created governing documents and promulgating new rules and regulations based on the needs and concerns of the lot owner-controlled association, etc.
NOTE ABOUT AUTHOR: Nicholas D. Cowie is a partner in the law firm of Cowie & Mott, P.A. He has been representing community associations for over 29 years. Mr. Cowie contributed to the drafting and worked to obtain passage of House Bill 667, enacted on October 1, 2009, which created the laws discussed above that strengthen the rights of Maryland homeowners associations in the transition process.
DOCUMENTS & ASSETS TO BE TURNED OVER BY DECLARANT
Deeds to the common areas
Articles of incorporation, declaration, and all recorded covenants, plats, restrictions, and any other records of the primary development and of related developments
By laws and rules of the primary development and of other related developments as filed in the depository of the county
The minute books, including all minutes
All books and records, including financial statements, minutes of any meeting of the governing body, and completed business transactions
Policies, rules, and regulations
The financial records from the date of creation to the date of transfer of control, including budget information regarding estimated and actual expenditures by the homeowners association and any report relating to the reserves required for major repairs and replacement of the common areas
All contracts to which the homeowners association is a party
The name, address, and telephone number of any contractor or subcontractor employed by the homeowners association
Any insurance policies in effect;
Any permit or notice of code violations issued to the homeowners association by the county, local, State, or federal government
Any warranty in effect and all prior insurance policies
The homeowners association funds, including operating funds, replacement reserves, investment accounts, and working capital
The tangible property of the homeowners association
A roster of current lot owners, including their mailing addresses, telephone numbers, and lot numbers, if known
Individual member files and records, including assessment account records, correspondence, and notices of any violations
Drawings, architectural plans, or other suitable documents setting forth the necessary information for location, maintenance, and repairs of all common areas
NOTE ABOUT AUTHOR: Nicholas D. Cowie is a partner in the law firm of Cowie & Mott, P.A. and has been representing community associations for over 29 years. Mr. Cowie is licensed in Maryland and Washington DC and has extensive experience representing homeowners assocition with transition issues including developer assessment disputes and construction deficiency claims. Mr. Cowie participated in the drafting and efforts to obtain passage of Maryland laws that benefit transitioning homeowners associations by requiring developers to turnover specified documents and extending warranty periods.