Wednesday, August 3, 2016

HOA Disputes: Consider Mediation or Arbitration Before Going to Court

HOA disputes are not the same as regular business disputes. Sometimes conflicts escalate, but your HOA lawyer should work hard to keep you out of court if possible. Mediation/arbitration is a great option for avoiding legal debacles in HOAs like the ones described in this article:

Neighbor Disputes Turn Wealthy Areas Into War Zones

Mediation is the process of meeting with an indepdendent, trained and licensed mediator (often, but not always, an attorney) who helps the parties work out a mutually-agreeable settlement of their dispute. The mediator does not have any power to render a verdict or to force the parties to agree, but is trained in "getting them to yes".

Arbitration is more like a private trial. The parties agree to abide by the arbitrator's determination, and have the right to present evidence and testify in a mini-trial. The parties and the arbitrator agree to how the process will work ahead of time and how formal or informal it will be. A legally-binding verdict results.

While North Carolina has a statute (NCGS 7A-38.3F) encouraging mediation in HOA disputes, it is not mandatory and either party can opt out of mediating an HOA dispute. Serious legal disputes can cost $10,000 or more in legal fees even before litigation, and trials can cost $20,000 to $50,000 or more. These costs usually are not worth the ultimate result for either side. HOAs should consider enacting formal policies encouraging mediation and/or arbitration of disputes, both between homeowners and between homeowners and the HOA, and helping shoulder some of the costs. 

It's in everyone's interest to avoid costly court battles and help maintain harmonious and neighborly relationships. Mediators are trained and licensed to do just that. Call us if we can assist you in resolving a dispute.

Sunday, March 6, 2016

Your Homeowners Association’s Governing Documents: Please Don’t Call Them Bylaws!

Our HOA Ninjas here at Moretz & Skufca have a little pet peeve when it comes to terminology: folks who refer to the governing documents for their community association as “the bylaws.”  So (to borrow from Shakespeare) what’s in a name?  Turns out that when it comes to homeowners association documents, names mean a lot.  There are articles, bylaws, declarations, CCRs, deed restrictions, board resolutions, policies and procedures, and rules and regulations, among other animals.  Help us stop the malapropism trend by understanding these different documents and how they relate to one another.  (Note that while we use North Carolina nomenclature here, these concepts apply to community associations in virtually every state.)

Articles of Incorporation

An HOA’s articles of incorporation, also known as its “charter”, legally create the corporation when filed with the Secretary of State’s office, and confer upon it all of its legal authority, as well as its non-profit status.  Think of the articles of incorporation as your community association’s Declaration of Independence – the document that creates a new entity out of thin air.  Since a corporation has no legal authority to act in any manner not authorized by its articles of incorporation, the articles are typically very broadly-worded and non-specific in order to avoid inadvertently limiting the corporation’s authority to do business.  Articles for homeowners associations must limit membership to lot owners only and include language specified by the IRS in order to qualify as a non-profit.  Your HOA will almost never deal with its articles once they are filed. 


The bylaws establish a corporation’s internal governance, voting and administrative procedures.  These include details about membership and board meetings, board elections, descriptions of the officers, how they are appointed and their authorities, and other similar matters.  Think of your homeowners association's bylaws as its Constitution – the rules of how the people will elect their representatives and what those representatives can do.  Bylaws need not be filed with the Secretary of State or recorded with the local register of deeds.  (While many HOA declarations have the bylaws attached to them when they are recorded with the register of deeds, this is not legally required.)  You will typically refer to your homeowners association's bylaws only when there are questions regarding elections, special assessments or how other important matters may be voted upon by the membership and/or the board.  Generally, bylaws are fairly boilerplate and should not require a lot of thought or attention by your board or your members unless there are major issues facing your HOA.

This is where our pet peeve comes in.  We often hear folks refer to their declaration of restrictive covenants, or to all of their homeowners association’s governing documents, as “the bylaws” (cringe). Please don’t do this!  The bylaws are a specific document, different from the other documents governing your HOA.  If you need to refer to them all together, the proper term is “governing documents.”  Use the word “bylaws” only when referring to the bylaws themselves.

The most important document for your homeowners association is the declaration of covenants, conditions and restrictions, or, for condominiums, the declaration of condominium (sometimes called a "master deed" in South Carolina) – what we call the “declaration.”  These are also referred to variously as the “covenants”, the “restrictions”, or the “CCRs.”  These are recorded with the register of deeds where the association is located prior to any lots being sold, which causes the provisions of the declaration to “run with the land” and be binding upon all current and future owners of each lot.  The declaration states what can and cannot be done with a lot owner’s land and the homeowners association’s common areas, and provides details as to how the HOA is to be operated.  In this latter regard there can be substantial overlap between the declaration and the bylaws, and this may be part of the confusion we see in terminology.  In general, the declaration controls over the bylaws if they are in conflict.

Deed Restrictions

An aside about deed restrictions.  Some subdivisions have “deed restrictions” in addition to, or in lieu of, a declaration.  The term generally refers to a document which places limits on what can be done with a lot owner’s land, but which does not create a full homeowners association operational structure like a declaration does.  This type of restriction was used primarily in the old days before homeowners associations with detailed declarations became prevalent, but deed restrictions can also be used now to place additional or special restrictions on a subset of lots within a larger HOA, or for small subdivisions where no formal HOA is required.  We avoid using this term except in these limited situations.  Modern declarations include deed restrictions (specific restrictions on what can be done on the owners’ lots) in addition to lots of other details regarding the operation of the community association, so “declaration” is the proper term for modern, detailed declarations of restrictive covenants as opposed to simple limitations on lots.

Everything Else 

The final category of governing documents is board resolutions, policies and procedures, and rules and regulations.  While these different terms are often used based upon type or level of formality, they are all positions formally adopted by the board of directors setting forth how a particular matter or situation will be handled now and in the future.  We refer to them generally as the homeowners association’s “policies.”  Policies serve to spell out in detail matters that may be addressed more generally in the declaration or the bylaws. 

While the articles of incorporation, the declaration and the bylaws ultimately control the governance of your homeowners association (in that order), the board of directors has the legal authority to adopt policies which are in general accordance with the authority granted by those documents.  For example, an HOA’s declaration may restrict leasing to no more than 15% of the homes in the subdivision, but it may not go into specific detail regarding how the leasing restrictions are to be implemented.  The board has the legal authority to adopt a policy describing how a homeowner may apply to lease his or her home, defining who is considered to be a tenant versus a guest, how a waiting list will be maintained, and other similar details.  Conversely, the board could not adopt a policy restricting leasing if such a restriction were not set forth in the declaration.

Policies can usually be adopted by the board acting alone, and need not be recorded or filed anywhere – although the best practice is to make sure they are made known to the members, usually by mailing, newsletter or website.  The board should be sure that the board meeting minutes reflect the research and consideration underlying the adoption of a particular policy, including the board’s consultation with its management company and professional advisors if necessary, and should take care that the policy is well thought out and written down in clear and specific detail.

We hope this discussion has shed some light on the various common HOA documents and the proper terminology for each.  If we can provide further information to assist your HOA, don’t hesitate to contact us.

Please give us a call or drop us an email if our HOA law team can assist your HOA or management company with your governing documents, or if we can be of assistance in any other way. We appreciate your reading our HOA law blog and encourage you to share it with others who may be interested. Thank you!

Thursday, December 17, 2015

Tax time for HOAs?

As the year draws to a close, many of us are engaging in year-end tax planning for ourselves and our businesses. Since homeowners associations are almost always non-profits, HOA board members and managers may think that tax planning for HOAs is not necessary. While most HOAs won’t owe taxes, there are still tax-related issues to be aware of this time of year.

HOA Tax Returns

HOAs file Form 1120-H, the U.S. Income Tax Return for Homeowners Associations, which is a fairly simple, one-page return designed to determine if the HOA has earned non-exempt income and related expenses during the tax year. Here’s a link to the form and here’s a link to the instructions. It is important that Form 1120-H be filed each year in order to claim the special tax-exempt status accorded by the Internal Revenue Code to HOAs. The return is due by March 15 of each year but can be extended, although of course taxes are calculated on a calendar year basis in most cases – so you must act before December 31 if you anticipate any tax issues.

Exempt vs. Non-Exempt Income

While most HOAs don’t have any taxes due because all their income is considered “exempt”, any non-exempt income is taxed at a rate of 30%, which is very high. Worse, significant non-exempt income in a particular year, especially if repeated over multiple years, can jeopardize the HOA’s non-profit status, so HOAs must be very careful about earning income which could be considered non-exempt.
  • Exempt function income is income generated from membership dues, fees and assessments, including interest charged to members and late fees. This type of income is generally tax exempt.
  • Non-exempt function income includes income generated from investment interest and dividends, vending machines, and any income received from non-members, including rents received from non-members for use of HOA facilities.  This type of income is generally taxable.

Generally, 60% of an HOA’s income and 90% of its expenses must be from or for exempt purposes, or it can lose its non-profit status with the IRS. If this is a concern for your HOA in a particular year, consider filing a regular Form 1120, the U.S. Corporation Income Tax Return, instead of an 1120-H. This form takes into account all of the HOA’s sources of income and expenses, but may result in less tax, because the tax brackets start at 15% for the first $50,000 of income rather than a flat rate of 30%.

“Involuntary Conversion” Proceeds

The issue of non-exempt income can arise when an HOA receives insurance or condemnation (also known as eminent domain) proceeds – referred to generally as “involuntary conversions” in IRS parlance. Involuntary conversion proceeds are typically considered non-exempt income, and it is usually important that they be spent on specific HOA expenses related to the repair, replacement or acquisition of common areas or improvements in order to ensure that the 90% rule mentioned above is met.

If your HOA is due to receive involuntary conversion proceeds, it is very important to consult with your tax and legal advisors BEFORE receiving the money regarding the timeline for spending the money to avoid taxes. The usual replacement period is two years beginning the first day of the first tax year after the year when the proceeds are received.  In order to qualify for this deferral, the HOA must file an election with its tax return the year the proceeds are received. It is often wise to postpone receipt of the proceeds until after January 1 if the proceeds are due to be received toward the end of the year to allow more time to spend them. Be careful if your replacement period ends in the current year.

Involuntary conversion proceeds should never be refunded to the homeowners individually. The Internal Revenue Code and most state laws, including North Carolina’s, prohibit the income of a non-profit from being received by any member, officer or director of the non-profit. If the proceeds are not able to be spent on repairs or improvements, use them to reduce the assessments for coming years rather than issuing refunds to the members.


HOAs are required to issue 1099s to their vendors. These are required to be sent out by January 31st of each year and are required to be mailed to the IRS by February 28th each year. The most common vendors for HOAs are repairs and maintenance services, attorneys and management companies. We recommend HOAs get a W-9 from vendors with the required information so that 1099s can be prepared and mailed out on time.

Who’s Preparing the Taxes?

Be sure your HOA understands who is responsible for preparing and filing your taxes. For simple HOAs with management companies, the management company may handle this and may not even ask the board of directors to review it before filing. More complex HOAs should be more directly involved with the tax preparation process. In any event, although not absolutely necessary, it is wise for the board of directors to review and approve the Form 1120-H and any state tax forms before they are filed, just to avoid errors and be sure the management company is being given proper oversight. If there has been significant non-exempt income, discussions with your tax professional should have occurred long before the end of the year. All HOAs should have a good accounting firm as a part of their team. We use Gordon, Keeter & Co. in Concord, North Carolina.

Property Taxes

Let’s not forget property taxes. In most states, common areas are not subject to property taxes, or are taxed at a de minimus value. In North Carolina, a filing must be made with the local tax assessor to obtain this exemption. (It only needs to be filed once and is good forever thereafter.) Most tax assessors will accept this filing up to June 30, which is the end of the fiscal year for local governments in North Carolina, but typically will not apply the exemption retroactively. So if there is common area to be turned over to your HOA, be aware that taxes may be due on it for the entire year in which it is turned over, and that your HOA must file with your local assessor to be sure the new common area is deemed exempt for future years. Check with you local tax office well ahead of time if you are in this boat.

Tax assessors are growing more aggressive in assessing HOAs for back property taxes on common areas or foreclosed homes owned by the HOA. In the past, many tax assessors might have foreclosed their tax liens on such property, but they did not typically seek payment directly from the HOA. Tax laws in North Carolina state that any future owner of property is personally liable for back taxes on that property. Tax assessors can attach the HOA’s bank accounts without any requirement for due process. So be careful in this situation, especially if your HOA is considering taking title via foreclosure to a home which has significant past-due property taxes.

I hope this tax information is helpful to your HOA as you wind down the year. Contact us if we can assist your HOA with any year-end issues. Thank you to CPA Ladoska Keeter at Gordon, Keeter & Co. for her assistance with this post. Best holiday wishes from all of us here at Moretz & Skufca!

Wednesday, November 18, 2015

No Class Certification in Case Alleging Condominium Association and Management Company Charged Excessive Fees

The North Carolina Court of Appeals recently decided a case involving several homeowners’ claims that their condominium association, through its management company, was charging excessively high fees and late charges that were not permitted by the condominium’s governing documents.  We want to point out that these were simply allegations - the only part of this case that matters from a legal perspective is that the homeowners asked for class-action status, which was denied. 
For discussion purposes, there is not much distinction between the laws that govern condominiums and homeowners associations. All condominiums and HOAs are governed by declarations that specify the particular restrictions for the condominium or subdivision.  The rule of law is that the declaration (in conjunction with the bylaws, the association’s policies and rules and regulations), specifies the fines and late fees that can be assessed against homeowners for delinquent assessments, and the laws step in to fill legal gaps in the declaration or to place limits on the association’s discretion to levy fines and late fees.

In this case, the plaintiff homeowners alleged that the condominium association permitted its management company to assess fees that exceeded the statutory limits.It should be mentioned that this is an older condominium association, meaning that an amalgam of laws control the fees and charges.  The plaintiffs also asked the court to allow the case to proceed as a class-action lawsuit against the management company and the association.  The class-action status was rightfully rejected by the lower court in our opinion.  The plaintiffs appealed the court’s denial of class-action status, and this decision upheld the denial.  This was not a final decision on the merits of the case, so the case goes on, albeit without class-action status.

From a purely legal perspective, this case did not say a lot that was new.  However, we believe that this case is important to remind associations and their management companies to periodically take stock of the fees and fines that are assessed against homeowners to determine that all charges are compliant with the governing documents and within the bounds set by the law.  The fees and fines should be set forth either in the association’s governing documents or by a properly approved resolution or policy.  The maximum amount of late fees that can be assessed, for any particular month, is $20.00 or 10% of the amount overdue, and this amount can be charged only once per month.  The laws do allow the association to assess attorneys’ fees in many circumstances, although the association must provide the homeowner with proper notice beforehand.  These are only a few examples of charges that should be considered, so be sure to check with your management company or attorney to confirm that your HOA's charges are authorized by law.

Please give me a call or drop me an email if our HOA law team can assist your HOA or management company with the compliance process, or if we can be of assistance in any other way. We appreciate your reading our HOA law blog and encourage you to share it with others who may be interested. Thank you!

Monday, February 16, 2015

Supreme Court Loosens Up Construction Warranty Claims

The North Carolina Supreme Court does not often render decisions that directly affect HOAs, but on December 19, 2014, the Court issued an opinion in Christie v. Hartley Construction that may impact your HOA, and will certainly impact many consumers and construction contractors.

In 2004, the Christies, the plaintiffs in the case, were building their dream home and the builder suggested they purchase a stucco-like material called “SuperFlex” for the exterior. If properly maintained, the SuperFlex was promised to last decades, even in heavy sun, rain, salty air, and freezing conditions. The SuperFlex manufacturer even provided a lengthy written 20-year warranty for its product.

In spite of the promised durability of SuperFlex, a mere seven years later the SuperFlex began to flex, and then to crack and blister, causing moisture to penetrate the home. But no worries, the very specific 20-year warranty would protect the Christies, right? They sued in 2011 to enforce the warranty.

Not so, said the trial court. You see, North Carolina has a longstanding “statute of repose” for improvements to real estate (which includes most types of construction work on real estate). A statute of repose is like an outside statute of limitations. Whereas when a statute of limitations begins to run can depend on when the problem is discovered, a statute of repose says that a lawsuit cannot in any circumstances be filed later than a particular time period. In this case, the statute of repose for construction defects is and always has been six years.  (The ambitious or bored among you can can read it here - look at subsection (a)(5)(a).) This six-year statute of repose is intended to prevent builders and contractors from facing the possibility of an open-ended period of potential lawsuits.

No matter what, the trial court said, the statute of repose prevents a homeowner from suing to recover damages for improvements installed more than six years ago.  The 20-year warranty was worthless after six years.  On appeal, the North Carolina Court of Appeals agreed.  According to the court, this was obviously an improvement to real property and the statute of repose is clearly six years, so the homeowners had to abide by the statute of repose and the warranty was unenforceable, even though the written warranty was very clearly for 20 years. This had been the rule for many years and was not a difficult call for the court.

But the N.C. Supreme Court thankfully reversed the lower courts.  The Supreme Court held that a very important general rule of law is that parties can freely contract, and if the SuperFlex manufacturer wanted to provide a warranty beyond the statute of repose’s 6-year period, then it was free to do so. 

If a seller of improvements to real estate has such confidence in its product that it provides a lengthy written warranty, there is no reason for it later to be able to shield itself behind the statute of repose.  In unusually harsh language, the Court stated that allowing a seller to disavow its warranty would result in “a sham, useful only to beguile the unsuspecting”.  Accordingly, the 20-year warranty stands and a number of years of legal precedent were overruled, and rightly so in our view.

Although this decision may not impact too many HOAs or condominiums since most construction lives up to its promises, there could be situations where it comes into play.  We do sometimes see situations where an HOA purchases an improvement to its real estate, (e.g. to improve its clubhouse), only to find out down the road that the construction fails.  Imagine how miffed the board and the members are when they find out that the ironclad warranty they purchased along with the construction is as worthless as the shoddy construction.  Now these HOAs may have a remedy where before they had none. 

Please give me a call or drop me an email if our HOA law team can assist your HOA or management company with the compliance process, or if we can be of assistance in any other way. We appreciate your reading our HOA law blog and encourage you to share it with others who may be interested. Thank you!

Thursday, August 28, 2014

Changes... to Your HOA's Restrictive Covenants

The North Carolina Court of Appeals recently rendered an opinion reiterating that all amendments to the restrictive covenants (“CCRs”) governing a planned community must be reasonable.  As background, the existing law is that amendments to the CCRs must be reasonable in light of the developer’s original intent for the subdivision.  This rule arose in the context of an HOA in the western part of the state, Ledges of Hidden Hills, where the members adopted amendments to the CCRs that imposed obligations on all owners to pay annual assessments, whereas previously, only minimal payments were required of owners.  The North Carolina Supreme Court struck down the amendments, stating that amendments must be reasonable and consistent with the expectations of homeowners who purchased in reliance on the CCRs.  The case is available here.

By way of background, several years after the Ledges case, the NC Supreme Court took up the CCR amendment-reasonableness question again in Southeastern Jurisdictional Administrative Council versus Emerson (available here).  In Emerson, a religious-themed subdivision, created in the early 1900s, adopted an amendment to its CCRs to require service charges from homeowners to fund certain amenities.  This subdivision was not governed by the Planned Community Act and there was no homeowners’ association, making the case somewhat different than Ledges, although the underlying themes are applicable to modern HOAs.  Unlike the Ledges case, the Supreme Court determined that the amendment requiring service charges was reasonable and consistent with the intention of the parties when they purchased properties in the subdivision.  Specifically, a purchaser “could have reasonably anticipated” that service charges would be imposed to pay for the numerous amenities in the subdivision.  Notably, one of the justices gave a strong dissenting opinion, basically arguing that the court waffled in its decisions because Emerson was inconsistent with the earlier Ledges case.  Whether the Emerson case is just an outlier without much impact on the broader HOA community remains to be seen, because its outcome has not been routinely followed by courts. 

On July 1st, the appellate court decided Wallach v. Linville Owners Ass’n, Inc. (available here), relying in large part upon the reasonableness standard from the Ledges case.  In Wallach, the court was confronted with an amendment to the CCRs that greatly increased assessments levied against lots owned by builders.  As an enticement to builders, the original CCRs required builders only to pay 25% of annual assessments, and these assessments were deferred until the home was sold to a buyer.  The members decided to amend the CCRs to require builders to not only pay the full assessment amount (100%) going forward, they had to pay all deferred assessments within 30 days of the amendment.  Several builders and vacant lot owners filed a lawsuit to declare the amendment invalid.
The court held that the amendments were unreasonable and invalid because they were a complete reversal of the developer’s intent in the original CCRs.  When builders purchased lots, the reduced assessments were “essential to the original bargain” that enticed builders to purchase lots in the first place.  The members could not later amend the CCRs to the detriment of builders who purchased with the expectation of reduced assessments, which would violate the original intent of the developer when the CCRs were filed.

Although Wallach is consistent with the Ledges rule, its guidance to HOAs may be limited. After the Wallach lawsuit was filed, the legislature amended the Planned Community Act that governs most HOAs, stating that in many cases, amendments to CCRs are “presumed” valid. The import of this presumption is that anyone who seeks to invalidate an amendment to the CCRs faces a higher burden than faced by the builders in Wallach.  It also remains to be seen whether any of the parties appeals Wallach and whether other courts rely upon its interpretation of the Ledges case.      
In the long run, does our advice to clients change as a result of Wallach?  Not really.  We already caution clients that amendments to the CCRs should be reasonable.    

Friday, June 20, 2014

Spring Showers Bring Summer Weeds - How to Achieve Homeowner Compliance in Your HOA

Now that summer is here, many HOAs and their members are dusting off the grill, repairing the lawn mower and opening the pool to the summer crowds.  Spring and summer bring new life to HOAs but also bring new problems in making sure members keep lots up to the HOA’s standards. 
How does the HOA deal with that neighbor whose grass is always 6 inches too high or whose yard is always below the standards required by the HOA?  This is an all too common problem and one that creates many headaches among HOA boards of directors. 

First of all, be sure that your HOA has written standards or guidelines describing clearly what it expects as far as yard and home maintenance.  Doing so makes violations much easier to enforce and helps insulate the board from charges of favoritism or discrimination.

When a homeowner is in violation and has been given notice but still has failed to comply, then what?  The board can impose fines against the offending homeowner, but sometimes this can be too heavy-handed.  Some boards want a lighter approach.
An option to consider is suspending community privileges or services.  The statutes allow a board to suspend a member’s privileges or services (no pool access plus 90-degree heat equals a strong incentive for the homeowner to mow that grass). 

The law says that the CCRs that govern the community can set forth a procedure for suspending community privileges or services. The CCRs should be reviewed to determine what procedures must be followed and which community privileges or services can be suspended.  If the CCRs are silent about the procedure, the statutes say that the homeowner must be given written notice and an opportunity to appear at a hearing before privileges or services can be suspended.  The details can be found here
One question we sometimes receive is whether access to the community is a privilege that can be restricted, typically in a gated subdivision.  The answer is no.  The HOA cannot restrict any homeowner from accessing his or her lot.  If an HOA does suspend privileges or services, it must be careful not to deactivate a key card or fob that controls the gates to the community, if it is gated.

We are also asked if, in communities where the HOA provides the household water supply, water can be turned off to noncompliant homeowners.  The answer is yes, but we encourage providing substantial written notice and only doing so where are all other avenues have been exhausted.

Some HOAs are successful in encouraging members to keep up their lots by creating contests and the like.  An example is publishing a monthly “best yard” feature on the website or in a newsletter.  We recommend that any winner be compensated by a yard sign, bragging rights and pride, or at most a small gift card.  Generally, monetary prizes or reductions in dues should be avoided.  These types of contests can also lead to greater involvement in the HOA, which pays off in higher compliance levels and more volunteers for committee and board positions.

Of course, if these options prove unpersuasive, assessing fines and filing liens or other legal action may be the next steps.
Please use the comments below to share with us your success stories in getting your homeowners involved in their communities – and don’t forget the sunscreen this summer!

Please give me a call or drop me an email if our HOA law team can assist your HOA or management company with the compliance process, or if we can be of assistance in any other way. We appreciate your reading our HOA law blog and encourage you to share it with others who may be interested. Thank you!