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Special Assessments

By Kurtis Shenefiel, Compass Management
and Jeffrey A. Barnett, Esq.

Introduction: Why Special Assessments?

'Special Assessments' - the term conveys a host of meanings. To boards and managers, it is a tool to achieve the funding needs of the homeowners association. To homeowners, special assessments have a much different and negative connotation. They are a threat to financial security, and imply possible mismanagement or wrongdoing by others. In the this paper, and the accompanying presentation, we will explore the contexts in which special assessments arise, discuss legal procedures to implement and collect special assessments, and suggest techniques to maximize member acceptance of special assessments. These techniques should help bridge the gap between the perceptions of the board and the homeowners when fiscal emergencies arise.


Contexts in Which Special Assessments Arise.

Association boards have wrestled with special assessments in a variety of circumstances caused by both nature and man. Disaster damage can result in large, uninsured losses. For example, the Loma Prieta and Northridge earthquakes caused major damage to common interest developments that were either not covered by insurance at all, or which fell within large earthquake insurance deductibles. In the Oakland Hills fire, infrastructure elements such as landscaping, sidewalks and streets were not insured for fire loss, but were damaged or destroyed in the horrific firestorm. The repair and replacement of such uninsured damage is typically financed by either a "stand alone" special assessment or a special assessment coupled with a disaster loan. The alternatives to special assessment funding are few. If a portion of a condominium project is damaged and rebuilding is not to occur, a partition action may be required which will involve substantial attorneys' fees for both the association and its members, and the lenders and others with a financial interest in the outcome must become engaged in the process.

Human frailties give rise to special assessments at least as often as the forces of nature. Deferred maintenance coupled with underfunded reserves is a certain recipe for special assessments. Directors are often tempted to defer maintenance rather than raise assessments. The inevitable consequences occur. Neglected roofs and siding fail, and water intrusion damages expand the financial burden on the Association. When the funding crisis is finally acknowledged, a 100 unit subdivision can easily be facing repair expenses in the six and seven figures.

Even when directors carefully plan for future maintenance needs, however, funding emergencies arise. The erratic swings in fire and earthquake insurance premiums have given rise to special assessments in some associations. In the unusual but sadly recurrent cases of fund embezzlement, special assessments are also necessary to restore the lost money. Defects in design or construction of the original project, or defective repairs, can also give rise to substantial unanticipated financial liabilities. The expenses to repair these deficiencies and to pursue legal remedies for the resulting damages also can trigger the need for special assessments. Finally, capital improvements such as the construction of a clubhouse, the building of a new swimming pool or the conversion of carports to garages can be financed through special assessments.


What Special Assessments Must the Board Levy?

A. California Civil Code Section 1366(a) provides in part:

Except as provided in this section, the association shall levy regular and special assessments sufficient to perform its obligations under the governing documents and this title.

B. California Civil Code Section 1364(b)(2) provides in part that upon the approval of a majority of all members of a planned development form of common interest subdivision, the responsibility for repair and maintenance of separate interests as may be occasioned by the presence of wood-destroying pests or organisms may be delegated to the association, and the association is then entitled to recover the costs thereof as a special assessment.

C. California Civil Code Section 1365.5(c) generally provides that the board of directors shall not expend funds designated as reserve funds for any purpose other than the repair, restoration, replacement, or maintenance of, or litigation involving the repair, restoration, replacement, or maintenance of, major components which the association is obligated to repair, restore, replace or maintain and for which the reserve fund was established. However, Civil Code Section 1365.5(c)(2) provides that the board may authorize the temporary transfer of money from reserves to the association's general operating fund to meet short-term cash-flow requirements or other expenses, provided the board makes a written finding, recorded in the minutes, explaining the reasons that the transfer is needed and describing when and how the money will be paid to the reserve fund. The statute specifies that the transferred funds shall generally be restored within one year of the date of the initial transfer. This law further provides that the board shall exercise prudent fiscal management in maintaining the integrity of the reserve account, and shall, if necessary, levy a special assessment to recover the full amount of the expended funds within the time limits required by that Section. Special assessments levied pursuant to this statute, however, are subject to the limits specified in Section 1366 of the Civil Code, described below.


Limitations on Special Assessments Without Membership Approval.

Civil Code Section 1366(b) limits the power of the board to impose a special assessment without approval of the membership. The board is authorized to levy special assessments which in the aggregate exceed five percent (5%) of the budgeted gross expenses of the association for that fiscal year. The five percent formula is generally agreed to apply to all of the budgeted gross expenses, including both the operating budget and the reserve contribution for the fiscal year. If a larger special assessment is required, the approval of the owners is required. The required vote under Civil Code Section 1366(b) is a majority of a quorum of the members, where a quorum consists of more than fifty percent (50%) of the owners of an association.

The statute states that the membership vote must occur at a meeting or election of the association conducted in accordance with Chapter 5 (commencing with Section 7510) of Par 3 of Division 2 of Title 1 of the Corporations Code and Section 7613 of the Corporations Code. This is a complicated way of stating that the vote must occur at a regularly noticed meeting of the members, voting in person or by proxy, or else can be conducted in accordance with the procedure for action by written ballot without a meeting.


The Emergency Exceptions.

Although Civil Code Section 1366(b) generally limits the board's power to levy special assessments to those aggregating five percent (5%) of the budgeted gross expenses of the association, or less, the statute identifies four emergency situations which justify the board levying a larger special assessment without vote of the members. These are limited to the following:

A. An extraordinary expense required by an order of a court. This exception could be construed as relating to an uninsured judgment against the association. It may also refer to a court authorization to levy a special assessment where the board is unable to obtain membership approval, but the association requires the funds in order to continue operations or to perform a vital function.

B. An extraordinary expense necessary to repair or maintain the common interest development or any part of it for which the association is responsible where a threat to personal safety on the property is discovered. Associations have considered employing this exception in instances where staircases or balconies have dryrotted to the point of collapse constituting a hazard and immediate repairs or shoring is necessary for public safety. Arguably, the Section could be used to fund security services or security improvements where a threat of criminal harm is identified in the common area.

C. An extraordinary expense necessary to repair or maintain the common interest development or any part of it for which the association is responsible that could not have reasonably foreseen by the board in preparing and distributing the pro forma operating budget under Section 1365. If this exception is relied upon, however, the board must pass a resolution containing written findings as to the necessity of the extraordinary expense involved, and why the expense was not or could not have been reasonably foreseen in the budgeting process. This resolution is required to be distributed to the members with the notice of assessment. The extent to which this emergency exception may be relied upon is questionable given the mandate of the Davis-Stirling Act in Civil Code Section 1365.5(e) that the board conduct a reasonably competent and diligent visual inspection of the accessible areas of the major components which the association is obligated to repair, replace, restore or maintain, at least once every three years, and that the board review this study annually and consider and implement necessary adjustments to the board's analysis of the reserve account requirements as a result of that annual review.

D. The fourth exception is no longer applicable. It related to the first payment of the earthquake insurance surcharge under Insurance Code Section 5003, which occurred in 1991.


Notice of the Levy of Special Assessments.

Civil Code Section 1366(c) provides that the association shall furnish notice by first-class mail to the owners of the separate interests of any special assessments of the association not less than thirty (30) nor more than sixty (60) days prior to the assessment becoming due. Civil Code Section 1366(d) further specifies that special assessments levied pursuant to the governing documents are delinquent fifteen (15) days after they become due. Therefore, at least 45 days' delay will occur between the notice of the special assessment and the delinquency date. Special assessments are collectible in the same manner as regular assessments. See Civil Code Section 1367, providing that special assessments levied in accordance with Section 1366 are a debt of the owner of the separate interest at the time the assessment is levied and requiring a pre-lien notice to the owner. Under Section 1367(b) special assessments, together with costs of collection, late charges and interest become a lien on the separate interest when a notice of delinquent assessment is recorded.


Special Individual Assessments or Reimbursement Assessments.

Declarations of Covenants, Conditions and Restrictions often provide that special individual or reimbursement assessments may be levied against an owner as a means of securing the obligation of an owner to repay the association for damage to the common area or other repairs for which the Association is responsible. The governing documents sometimes also authorize the imposition of special individual assessments as a mean of collecting monetary penalties. Special assessments of this type cannot be imposed until the owner is afforded notice and an opportunity to be heard regarding the charges. At a minimum, this procedure will entail furnishing a minimum of fifteen (15) days' written notice to the owner of the alleged violation or damage, the proposed penalty or reimbursement sum and the date, and the time and place of the hearing at which the owner may review the evidence in support of the claim and present the owner's own evidence. Alternatively, the owner may have the opportunity to require that such a hearing occur, but may waive the hearing by not timely requesting it. A five (5) day hold must be placed on the effective date of the penalty. See generally Corporations Code Section 7341.

California Civil Code Section 1367(c) provides that monetary penalties (but not late charges) imposed by the association as a disciplinary measure for failure of the member to comply with the governing documents, may not be characterized nor treated in the governing instruments as an assessment which may become a lien against the member's subdivision interest enforceable by the sale of the interest under Civil Code Sections 2924, 2924b, and 2924c.


Limitation on the Amount of Special Assessments.

California Civil Code Section 1366.1 prohibits an association from imposing or collecting any assessment or fee that exceeds the amount necessary to defray the costs for which it is levied. Boards imposing special assessments must ensure that the files and records of the association include a supportable basis or justification for the special assessment, such as a contractor's estimate or bid. Where major special assessments are contemplated, it is desirable that an architect or construction consultant assist the board in developing a bid package and obtain competitive bids for the work, to establish the validity of the sums to be raised through the special assessment.


Disclosure of Proposed Special Assessments.

Under California Civil Code Section 1365(a)(3) the pro forma operating budget distributed annually must include a disclosure of whether the board of directors of the association has determined or anticipates that the levy of one or more special assessments will be required to repair, replace, or restore any major component, or to provide adequate reserves therefore. In addition, Civil Code Section 1368(a)(4) requires the disclosure by sellers of a true statement in writing from an authorized representative of the association as to the amount of the association's current regular and special assessments and fees. Subsection (5) requires further disclosure of any change in the association's current regular and special assessments and fees which have been approved by the association's board of directors that have not become due and payable as of the date the disclosure is provided. Under Civil Code Section 1368(b) the association is required to furnish this information to the owner within ten (10) days of the mailing or delivery of a written request for it.


Marketing the Special Assessment.

Selling the special assessment to the members requires time and tact. The Board must be scrupulously honest in its communications concerning the background facts giving rise to the special assessment. A reasonable plan must be presented to the members to resolve the funding needs of the association that is consistent with the governing documents and applicable California law. Due consideration must be given to addressing questions of legal responsibility. The Board must be considerate of the emotional reaction of the members, which is the single greatest hurdle in implementing special assessments.


Jeffrey A. Barnett, APC practices in the following cities and counties: San Jose, Santa Clara, Sunnyvale, Mountain View, Palo Alto, San Mateo, Foster City, Redwood City, Menlo Park, South San Francisco, Fremont, Milpitas, Santa Cruz, Scotts Valley, Los Gatos, Capitola, Watsonville, Monterey, Carmel, San Carlos, Alameda, San Mateo, San Benito, Stanislaus, and El Dorado.