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Should association reserves be invested in a non-FDIC-insured firm?

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Question: About six years ago our homeowner association was sued. Three of five board directors were also individually sued for breaching their fiduciary duties, causing big rises in our monthly fees. In addition to the insurer’s attorneys defending the association, the three directors immediately voted to hire individual attorneys at titleholders’ expense. Those directors — and the management company that advised them to do what they did to get sued — cost owners well over $1 million. Because of those directors, our insurance premiums remain high, maintenance substandard, plumbing systems in chronic disrepair, infrastructure dated and crumbling. Driveways are cracked and the landscape is decrepit. With three bad directors off the board, their staunchest supporter and management company lackey became president. His idea of maintenance entails a yearly “painting over” of buildings needing structural, wood and stucco repair. To prevent future judgment attachments, he said reserve accounts were immediately closed.

Because the president shares nothing with them, new directors are blissfully uninformed, claiming to know nothing, yet they vote as he instructs. The president invested all our reserve money in a type of assessment recovery firm claiming fantastic rates of return, saying management invests in the firm and they recommended we do the same. The assessment recovery firm is a ruthless collection company specializing in strong-arm tactics with liens and foreclosures. Our allocated reserve payments are funneled over to that firm, which is not a bank and not FDIC-insured. Should owners be concerned?

Answer: Yes, there is great cause for concern. Since your board has already accepted bad advice that resulted in being sued for breach of fiduciary duties, all directors will need to pay closer attention to decision-making details. Board directors should concentrate on prudent, if not conservative, fiscal administration in maintaining the integrity of reserve funds (California Civil Code section 5515 mandates this) rather than allowing themselves to be hoodwinked by the whims of a management company.

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Directors are held to higher standards because board duties differ substantially from management company obligations. A president does not take direction from management personnel, nor does he act alone. The board acts as a body whose fiduciary obligations are non-delegable: All decisions, including each director’s vote, must include reasonable inquiry and investigation. Directors who do not actively perform due diligence pursuant to association-related business do a disservice to themselves as well as titleholders who trusted them enough to elect them to the board.

Directors are fiduciaries because their actions affect each titleholder’s personal assets as well as association operations and monetary holdings. A management company’s interest is in its contract with the association and in getting a paycheck financed by sufficient funds. Titleholders have a vested interest in real property for which they paid earnest money. Aside from insolvency, it is irrelevant where management banks or invests its own money, as its internal decisions are not pertinent to directors’ decision-making obligations in protecting association and titleholder assets.

Presidents who hide information and knowledge from other directors are dangerously incompetent, because an admission or acknowledgment or promise by one director binds all directors as to every matter within the scope of their directorship.

Under the law, notice and knowledge gained by the president is imputed to all board directors, and each is the association’s general agent, thereby invoking the legal maxim: “Notice to one is notice to all.” Ample case law supports the premise that regardless of how many directors there may be, they are but a single person in law, and “notice to one director is notice to all directors.”

Owners trust directors as independent thinkers not easily influenced by third-party vendors such as management personnel or assessment recovery firms. A director’s duty does not consist of going along with whatever the president says. Nor is pleading “I didn’t know” an adequate defense when it comes time to invoke the association’s indemnification policy. Directors are not excused from liability for failing to keep themselves informed or for claiming they have no knowledge of facts that they could easily have ascertained by making a reasonable inquiry. Directors are presumed to know that which it is their duty to know, and the law will not permit them to avoid personal responsibility for their corporation’s misconduct by turning a blind eye to what goes on around them.

An assessment recovery firm is not a local bank. The board’s duty is to avoid making risky investments, thus subjecting titleholder assets to liability. Trusting association funds to any institution not FDIC-insured is an unnecessary risk of titleholder assets.

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Proper use of the reserve account is mandated as part of directors’ fiscal duties under Civil Code sections 5500 and 5510. The board shall not expend money designated as reserve funds for any purpose other than repair, restoration, replacement or maintenance for which the reserve fund was earmarked. Even the president must follow the law when removing reserve funds and “investing” them elsewhere, with those actions disclosed in meeting minutes.

Temporary reserve fund transfers to the association’s general operating fund to meet short-term cash flow must also follow statutory requirements in Civil Code section 5515.

Investing in a type of assessment recovery firm merely because a management company said to do so is not prudent, nor does it adequately maintain the integrity of a reserve account.

Zachary Levine, partner at Wolk & Levine, a business and intellectual property law firm, co-wrote this column. Vanitzian is an arbitrator and mediator. Send questions to Donie Vanitzian JD, P.O. Box 10490, Marina del Rey, CA 90295 or noexit@mindspring.com.

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