Delaware Community Association Statutes UNIT PROPERTY ACT (“UPA”)

Reserve StudyRebuild Insurance EvaluationTransition Study –What are They and Why Do We Need Them?

Delaware Community Association Statutes • UNIT PROPERTY ACT (“UPA”) • 25 Del. C. § 2201, et seq., (1963) • DELAWARE UNIFORM COMMON INTEREST OWNERSHIP ACT (“DUCIOA”) • 25 Del. C. § 81-101, et seq., (effective September 1, 2009) Maryland • To date, Maryland has not adopted any specific statues related to reserve studies • Legislation is pending in the 2017 General Assembly. House Bill 651 would require Condominiums and Homeowners Associations to conduct reserve studies every five (5) years

Legal Obligations • The board of directors has a legal obligation to: • Act in the best interest of the association • Manage and protect its assets

Fiduciary Duty Defined Board members must discharge their duties in good faith, with the care an ordinarily prudent person in a like position would exercise under similar circumstances in a manner the director reasonably believes to be in the best interests of the Association. Board members are held to be accountable and potentially liable both for their own wrongful actions or conduct and for their failure to act in the collective best interests of all members of the Association.

Triad Of Duties • Duty of Care (Due Diligence) • Duty of Loyalty (No Self Dealing) • Duty to Act Within the Scope of Authority (Statute and governing documents)

Duty Of Care • Requires that directors use the amount of care which a ordinarily careful and prudent person would use in similar circumstances and consider all material information reasonably available in making business decisions. • To establish a breach of the duty of care, a claimant must prove a director took an action that was grossly negligent. • Gross negligence is defined as a reckless indifference to or a deliberate disregard of the whole body of stockholders or actions which are without the bounds of reason.

Business Judgment Rule • Absent evidence of fraud, bad faith, or self-dealing, the court should presume that in making a business decision directors acted in an informed manner and in the belief that their action taken was in the best interests of the corporation. • Under the business judgment rule, a board's decision will be upheld unless it cannot be attributed to any rational business purpose. • Does not apply when directors breach their duty to perform a function required by statute or the governing documents-inaction is a breach of the director’s fiduciary duty. • Case Law

Duty Of Loyalty • Director must pursue the best interests of the company in good faith. • Directors breach this duty when they place their own interests, preferences, or appetites before the welfare of the corporation. • One of the most common instances of a breach of this duty is when a director receives a personal benefit not shared by all stockholders. • Bad faith conduct on the part of directors also may give rise to a breach of the duty of loyalty.

Formal Reserve Policies • A reserve study ensures conduct evidencing good faith, loyalty and the Board’s Due Diligence. Reserve Policies Should Address: • The Board’s Duty to budget sufficiently to address the funding requirements of the Reserve Study • Prohibitions on co-mingling reserve and operating funds • Investment stipulations-Safety first • Authorized and prohibited use of funds-must be consistent with governing documents • Reserve Study Intervals

Borrowing Reserve Funds (Reserve Transfers) • Prohibition on spending reserve funds for purposes other than what is set forth in statute or governing documents • Process for Borrowing: a) Notice of Intent to Borrow • Written Resolution of Board of Directors Explaining: 1) Reasons for Borrowing 2) Describing Repayment Method to Replenish Reserves b) Reserve Funds for Litigation-check governing documents

Repair and Replacement ReserveDelaware Statute • The UPA was amended to require reserves when DUCIOA was adopted • UPA §2211 Duty of council to maintain a repair and replacement reserve. • UPA Allowed a 8 year phase in under § 2245. • Both DUCIOA and UPA now require a budget for a condominium or cooperative to include as a line item a payment into the repair and replacement reserve sufficient to achieve the level of funding noted in the reserve study, or maintain said reserve at such level (DUCIOA §81-302(a)(2)/UPA §2244). • Concepts of the Reserve Study in Statute • Independent; • Engineering, architectural or construction contractor or other qualified person; • Current (every five years); • Comprehensive –covering all systems and looking out 20 years.

Budget Process Delaware DUCIOA • § 81-324. Adoption of budget. • (a) The executive board shall, at least annually, prepare a proposed budget for the common interest community. In a condominium or cooperative, the proposed budget shall include a line item for any required funding of a repair and replacement reserve. Within 30 days after adoption of any proposed budget after the period of declarant control, the executive board shall provide to all unit owners a summary of the budget, including any reserves and a statement of the basis on which any reserves are calculated and funded…

Repair and Replacement Reserve – Delaware Statute Definitions • Repair and Replacement Reserve means a reserve fund maintained by the council or executive board of a condominium or cooperative solely for the repair and replacement of common elements, and for no other purpose, including operating budget shortfalls or other expenditures appropriately addressed by a contingency reserve. • Reserve study means an analysis, by 1 or more independent engineering, architectural, or construction contractors or other qualified persons, performed or updated within the last 5 years, of the remaining useful life and the estimated cost to replace each separate system and component of the common elements, the purpose of which analysis by 1 or more independent engineering, architectural, or construction contractors or other qualified persons, is to inform the executive board and the association of a condominium or cooperative of the amount which should be maintained from year to year in a fully funded repair and replacement reserve to minimize the need for special assessments. • Fully funded means a repair and replacement reserve which contains that balance of funds which (i) when supplemented by a fixed, budgeted annual addition, will meet fully, without supplementation by borrowed funds or special assessments, the cost of each projected repair and replacement noted in the reserve study no later than the date when each such repair or replacement is projected to be required by the reserve study, and (ii), with all budgeted contributions and expenditures for repairs and replacements projected out no less than 20 years, will never fall below a positive balance.

The minimum percentage of the annual budget of a condominium or cooperative that must be assigned to the repair and replacement reserve will depend the number of the following systems or components to be maintained: Hallways Stairwells Management or administrative offices Roofs Windows Exterior walls Elevators HVAC systems Swimming pools exercise facilities Clubhouses Parking garages or surface parking lots Masonry bridges used by motor vehicles Bulkheads Docks Minimum Percentage Four or More – minimum 15% Three – minimum 10% Two or fewer – minimum 5% The association's accountant may certify that the funds in the repair and replacement reserve are in excess of the sum required to constitute a fully funded repair and replacement reserve. The executive board shall then refund or credit the surplus of the excess sum to the unit owners. If there is no current reserve study, the minimum percentages of the association's budget to be assigned to the repair and replacement reserve shall be the minimum percentages listed above. Reserve As A Percent of Budget

Other Delaware Law Reference to Reserve • DUCIOA §81-315 - Assessments. • (a) Declarant pays all common expenses, including funding any repair and replacement reserve until the association has been established and makes a common expense assessment. • DUCIOA §81-318. Books and Records. The Association shall maintain: • (1) Detailed records of receipts and expenditures affecting the operation and administration of the association and other appropriate accounting records, including those for the repair and replacement reserve... • DUCIOA §81-409 Resale of Units • (5) In a condominium or cooperative, a statement of the current balance in the repair and replacement reserve; • (6) A statement of any capital expenditures approved by the association for the current and succeeding fiscal years, including a statement of the amount of such capital expenditures to be taken from the repair and replacement reserve; • (7) In a condominium or cooperative, a copy of the most recent reserve study;

Delaware Statutory Insurance Obligations • UPA §2238 - Insurance. • The council shall, if required by the declaration, the code of regulations, or by a majority of the unit owners, insure the building against loss or damage by fire and such hazards as shall be required or requested without prejudice to the right of each unit owner to insure each such unit owner's own unit for each such unit owner's own benefit. The premiums for such insurance on the building shall be deemed common expenses. • DUCIOA §81-313. - Insurance: • Property Insurance – after application of deductible must be not less than 80 percent of the actual cash value of the insured property at the time insurance is purchased…exclusive of land, excavations, foundations and other items normally excluded from property policies. • Liability Insurance – as determined by the board but not less than any amount specified in the declaration. • Fidelity Insurance

Duty To Protect Cash Assets In Reserve Accounts • Checks and Balances/Internal Controls • Segregate Roles • Set Check Limits Without Board Authorization • Require Board Signatures for Withdraws • Investment Policy • What Investments Are Acceptable • Who has Authority to Make Decisions • What Terms Must be Met

Hypotheticals • A condominium Association consisting of 100 units had a reserve study done in 2016 which recommended an increase in the reserve fund of $30,000 annually for the next five years. Many of the owners are on a fixed income and cannot afford such a steep increase. Is it a breach of fiduciary duty if the Board does not follow the reserve study recommendations? • An Association borrows money from its reserve account to pay operating expenses and does not pay it back. In 5 years a special assessment is required to adequately fund the reserve account in order to repair roofs. • Is the Association liable for breach of fiduciary duty? Are individual directors liable?

Presenter Contact Information Chad J. Toms, Esquire 209 Fifth Street, Suite 200 Bethany Beach, Delaware 19930 Phone: 302-357-3253 Facsimile: 302-357-3273 Ctoms@wtplaw.com • Raymond B. Via, Jr., Esquire • 7501 Wisconsin Avenue, Suite 700W • Bethesda, Maryland 20814 • Phone: 301-804-3611 • Facsimile: 301-804-3651 • RVia@wtplaw.com

Delaware Community Association Statutes UNIT PROPERTY ACT (“UPA”)