Transition of Association Governance from Developer to Unit Owner Control
Legal Requirements and Transition Checklist
“Developer transition” is the process by which the governance of a condominium association is transferred from developer to unit owner control. This article contains an overview of the legal requirements governing the transition process and a “transition checklist” for transitioning unit owner-controlled boards of directors.
TRANSITION LAW OVERVIEW
PERIOD OF DEVELOPER CONTROL
A developer initially controls an association because it owns all unsold units in the newly created condominium association. As such, the developer has the controlling votes associated with majority ownership and can appoint its own employees as the initial members of the board of directors and control how the association conducts its affairs. This is referred to as the “period of developer control,” during which the developer makes all decisions on behalf of the condominium association.
The developer also creates a condominium association’s governing documents, allowing it to dictate, subject to applicable law, the procedures and time periods under which control over the association’s board of directors will eventually be transferred to the unit owners.
THE TRANSITION MEETING
The period of developer control continues until a “transition meeting” is held to elect members of the board of directors from amongst the the condominium unit owners. A developer-controlled condominium association must hold the transition meeting within 60 days after the date that units representing 50 percent of the votes in the condominium have been conveyed by the developer to the purchasing unit owners. Maryland Condominium Act (“ MD Condo Act”) §11-109(c)(16)(i)1. The transition meeting can be held earlier if the condominium developer specifies a lesser percentage of conveyances or sales in the governing documents as a trigger for the 60 day period to commence. MD Condo Act §11-109(c)(16)(i)2.
OVERLAPPING TERMS OF DEVELOPER-APPOINTED BOARD MEMBERS
The terms of board members appointed by the developer during the period of developer control must end 10 days after a replacement board member is elected at the transition meeting. MD Condo Act §11-109(c)(16)(iii). This law is designed to prevent overlapping terms of developer-appointed and unit owner-elected board members.
Within 30 days following the transition meeting, a condominium developer is required to turn over specified documents and assets to the unit owner-elected board of directors. MD Condo Act §11-109(c)(16)(iv), §11-132. 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.
TERMINATION OF CONTRACTS
Following the transition meeting, the newly-elected, unit 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 developer control for the purpose of handling the financial matters, maintenance, or other services for the condominium. MD Condo Act §11-109(c)(16)(v). The condominium association’s right to terminate, however, does not apply to contracts for the “the provision of utility services or communications systems.” MD Condo Act §11-109(c)(16)(v)2.B.
Below is a transition checklist of items to be addressed by the first unit owner-elected board once it assumes control over the association from the developer.
Document/Asset Inventory & Request
Conduct an inventory of association documents and assets. Make a formal written request of the developer to turn over all documents, funds and assets listed in Appendix A (below) 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 developer control to handle the 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.
Audit Financial Records
Have an independent auditor examine and audit the association’s financial records during the period of developer control to ensure that all monies were properly collected and accounted for. 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 developer obligations. In some cases, an auditor may determine that the developer owes the condominium association a substantial amount of money.
Transition and Reserve Studies
Obtain a transition study and a reserve study in order to identify construction defects and determine whether the developer-created budget and reserve account are adequate to maintain, repair and replace the condominium common elements over time. For example, if a common element roof is found to be in need of immediate replacement because of construction defects, then a developer-created reserve budget based on a projected roof replacement in 30 years is grossly insufficient.
a. 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 elements to identify construction defects while warranties are still enforceable so they can be submitted to the developer for warranty repair. Timely transition studies are essential because defects in newly constructed condominiums may not be apparent when unit 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 the applicable 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 developer. Once defects have been identified and then corrected by the developer, the condominium association can establish an accurate reserve budget.
b. 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 condominium components for which the association is responsible, such as roofs, exterior walls, sidewalks, roadways, etc. A normal useful life, or “life expectancy,” is assigned to each of these components (e.g., a 30-year 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 condominium 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
a. 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 Maryland condominium association, such as interpreting governing documents, preparing legal opinions, delinquent assessment collection, contract negotiation, dealing with threatened litigation, amending governing documents, etc.
b. Warranty/Construction Defect Legal Counsel: Request a free consultation from an attorney with expertise in condominium construction defect law. Such an attorney can advise the association when applicable Maryland warranties and other legal claims expire and how to preserve the association’s legal claims while negotiating proper repairs with the developer. Armed with such information, a transitioning condominium association can make informed decisions. This free 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 developer control. Make sure coverage complies with governing documents, industry standards, and applicable laws (e.g., 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 condominium 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 association governance and business that will need to addressed by the first board to transition from developer 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); updating resident agent information with the State Department of Assessments and Taxation; scheduling meetings required by the governing documents (e.g., annual and regular meetings of association); defining maintenance obligations and establishing a maintenance schedule; amending developer-created governing documents and promulgating new Rules and Regulations based on the needs and concerns of the unit owner-controlled association, etc.
DOCUMENTS & ASSETS TO BE TURNED OVER BY DEVELOPER
NOTE ABOUT AUTHOR: Nicholas D. Cowie is a partner in the law firm of Cowie & Mott, P.A. and has been representing Maryland condominiums for over 25 years. Mr. Cowie is licensed in Maryland and Washington DC and has extensive experience representing condominium associations with developer transition issues including financial disputes regarding payment, collection and use of assessments as well as construction defect claims. Mr. Cowie participated in the drafting and efforts to obtain passage of Maryland laws that benefit Maryland condominiums and their associations in the transition process by requiring developers to turnover specified documents and by extending warranty periods for Maryland condominiums and HOAs.
NOTE ABOUT TERMINOLOGY: Under the Maryland Condominium Act, a condominium association is referred to as a “council of unit owners,” which is the legal entity that governs the affairs of the condominium as set forth in the MD Condo Act §§11-101(f) and 11-109 (Maryland Real Property Article, Annotated Code of Maryland). A council of unit owners can be an incorporated or unincorporated and its members are comprised of all unit owners.