Owners Who Don't/Won't Pay

When meeting with boards, one of the things that I inevitably hear they are struggling with is what to do about the owners that simply don’t pay.  This has always been a problem and with the downturn in the economy it’s just gotten worse.  While there is no sure fire way to make everyone pay on time, the board can certainly take some steps to encourage owners to pay while allowing recourse for those who don’t.  Boards should first look to their governing documents to find out what is already laid out for delinquencies.  When are the assessments due and how long is the grace period?  Are there provisions for late fees or interest?  If so, the board already has a good backbone for enforcement.  If not, there are provisions in ORS 94 and ORS 100 that allows associations to impose reasonable late fees and interest against account that are past due.  Also per ORS, owners are personally liable for all assessments imposed.When the board has the basic information, the next step is to formally adopt a payment resolution that provides all of this information in a written form to all owners.  For more information about this resolution, please see my article entitled, “Resolutions!” posted on November 10, 2011.  It is prudent to have an expert in this field prepare the resolution for the board (the HOA’s attorney or community manager are best suited to this task).  This resolution, once adopted, should be sent to all owners of record before any new enforcement steps are undertaken.

At this point, the best thing the board (or the management company) can do is follow the steps outlined in the resolution exactly.  If the assessments are due on the 1st day of each month and late if not received by the 10th day of that month, then within the next few days follow up should be done.  At minimum, a statement should be send (via first class mail) showing the assessment, late fee, and any other penalties that the payment resolution provides for.  This statement should also include contact information - phone number, e-mail address - in addition to the payment remittance address, in case the owner has a question about the delinquency.  Owners are entitled to understand their account and any charges on it, so it’s better to make it easier for them to get their questions answered.

If owners continue not to pay, eventually the board will have to get a law firm involved.  Boards should talk to their law firm to determine if they do collections, and if so how they are compensated for their work.  Some firms bill as they go, so the association pays the legal charges up front and then is reimbursed those costs by the delinquent owner when s/he brings the account current.  Other firms will do the work and not charge the association anything up front but simply collect it from the owner as part of the delinquency.  Both arrangements have their advantages and disadvantages, so if the board doesn’t already have a relationship with a law firm (which it should; it’s better to know an attorney and not need him/or then suddenly discover one is needed and have no idea who to contact), both options should be explored to determine which will be best for the association.

Before the delinquent owner and his/her account are turned over to the law firm for collections, however, it is prudent to make one last attempt to collect the debt.  Management companies like to call this a ten-day demand letter, and that’s exactly what it is:  a letter that gives the owner ten days to pay his/her account in full before it is turned over to the attorney.  This letter should always include the following language, “This letter is an attempt to collect a debt and any information obtained will be used for that purpose.”  I also think it is prudent to include in the letter an opportunity for the owner to get on a payment plan, just in case s/he cannot pay the full amount due.  This payment plan cannot simply be, “I’ll pay when I can.”  A payment plan is a specific, written agreement, entered into by the owner and the association, that puts forth concrete deadlines that the owner must meet as well as the consequences for the failure to meet those requirements.  For example, let’s say an owner is behind by $500 (including assessments, late fees, interest, etc.).  A reasonable payment plan would be for that owner to pay the regular assessments on time and before the end of the month each month pay an additional $50.  This payment plan would bring him/her current within 10 months.  Once the payment terms have been worked out and are agreeable to both parties, a written agreement should be mailed (or e-mailed) to the owner, signed, and returned to the association.  This agreement should also detail what will happen if the owner fails to make a payment as agreed upon (or goes into foreclosure); in that case, normally the account is immediately turned over to the law firm for collections.  Likewise, the association should have a deadline on when the signed payment resolution should be returned by (10 days is generally considered reasonable) and the date it goes into effect.  These things are necessary to protect the association's interests.

Boards should remember that, even though their fellow owners are their friends and neighbors, they are charged with a fiduciary duty, which in this context means that personal feelings and relationships can’t be allowed to get in the way of doing what is right for the association, and holding all owners responsible for returning their assessments.

Year End Responsibilities

Many associations have their fiscal year as the calendar year (January 1 - December 31).  If that is the case with your association, it’s time to start getting the year end financial work done.  What does that mean?  Well, like any business, an HOA is responsible for providing 1099s, filing its taxes and preparing and distributing an annual financial statement.  Depending on the amount of income, a financial review may also be required.  Let’s look at each of these issues in turn.

Form 1099-MISC.  Most HOAs will have to file at least a few of these forms.  Any vendors paid for services of more than $600 (with the exception of corporations; these are mostly exempted from this requirement) should receive a Form 1099-MISC from the HOA.  All law firms must also have a Form 1099-MISC, whether or not they are a corporation.  There are very specific rules and instructions for the completion of these forms, which can be reviewed at this link:  http://www.irs.gov/pub/irs-pdf/i1099msc.pdf.  If you have additional questions, contact a CPA.

Federal Taxes.  HOAs, although sometimes mistakenly thought as non-profit corporations (truly, they’re really not-for-profit, which is not the same from the government’s standpoint), must annually file taxes with the IRS.  HOAs file either Form 1120 or Form 1120-H.  Federal taxes are due March 15 for HOAs on a calendar fiscal year (a month earlier than personal returns are due).  There is generally a significant tax benefit to HOAs who qualify for and file Form 1120-H, but in addition to other qualifications, an HOA must annually adopt IRS Revenue Ruling 70-604 at the annual meeting.  This ruling allows HOAs to roll over any excess member income to the next tax year without being taxed on that income.  This should be done every year at the annual meeting (it should be a standing agenda item) and must be done by the owners (the board cannot approve this ruling on the owners’ behalf).  For more information on this, see this fascinating article by Gary A. Porter, a CPA:

http://www.revenueruling70-604.com/index.php?option=com_content&view=article&id=3&Itemid=14

For more information about Form 1120-H, see http://www.irs.gov/pub/irs-pdf/i1120h.pdf.

Oregon State Taxes.  Most Oregon HOAs are no longer required to file Form 20 (as of the 2012 tax year).  HOAs that may need to do so are ones that have non-trivial income from interest and other non-member-assessments.  For more information, see my article from March 1, 2013 entitled, "Oregon HOAs and Corporate Minimum Tax."

I do not recommend that HOAs, even small, self-managed ones, have a board member take on the liability of filing the HOA’s taxes, either federal or state.  Instead, have a CPA familiar with HOAs take over that potential liability for you.

Annual Financial Statement.  Regardless of income received in the year, each year the board is responsible for having an annual financial statement, consisting of at least a balance sheet and an income/expense statement, prepared and a copy distributed to each owner within 90 days of the end of the fiscal year.

Annual Review.  Oregon statutes now require that an association who has income in excess of $75,000 must have a review by an independent CPA.  Many boards know about this clause but misunderstand it.  To determine if the HOA is subject to this requirement, total income for the year must be evaluated, not just income from owner assessments.  So if there was a special assessment applied or if the HOA received an insurance settlement, these funds are also considered income and for the purposes of determining the review must also be added to total income for the fiscal year.  Likewise, any income for the HOA, whether from coin op (laundry facilities), rental of HOA-owned parking spots or otherwise, must be included in this total to determine if the income exceeds $75,000.  If it does, an HOA must have the review done unless 60% of the owners vote not to do the review.  This vote only applies for a single fiscal year and must be repeated each year the owners do not want to have the review done (Note that it is the owners who must make this affirmation, not just simply the board.  From this fact alone, and with the inherent difficulty most associations face simply trying to reach quorum, I suggest boards simply comply with the statute and have the review done).

For more information, please consult a CPA.  CPAs familiar with HOA rules and regulations may be found through the CAI-Oregon website:  http://www.mydigitalpublication.com/publication/?i=71867.

For more information about requirements in statute, please also see:

Condominiums (ORS 100.480):  http://www.leg.state.or.us/ors/100.html
Planned Unit Developments (ORS 94.670):  http://www.leg.state.or.us/ors/094.html

Rental Restrictions

With the current state of the economy, I have been hearing more and more often that my boards are interested in rental restrictions, which usually means limiting the number of homes that can be rented out within the HOA.  There is a feeling, true or not, that renters do not take as much pride in the community they live in as an owner would.  Of course this has always been the perception of renters (at least as long as I’ve been in this industry), but with the economy being slow, there is also the added burden of lenders not wanting to approve mortgages in associations that have a lot of rental properties.  This basically means that an owner may find it hard to refinance in a community with many renters or a prospective owner may not qualify for a mortgage within that renter-filled association.
So how should a board determine if it’s worthwhile to pursue rental restrictions?

One thing boards often underestimate with rental restrictions is the time, effort and cost involved in adopting rental restrictions, which always* requires an amendment to the governing documents of the community.  Before a board begins the expensive and lengthy process of an amendment, it is prudent to determine if sufficient interest exists in the community:

Discuss the proposed rental restriction at a board meeting.  While owners generally do not participate at a board meeting, the president has the right to allow any owner to participate during the board meeting.  The best and easiest way to do this is for the board to discuss it’s proposal and then take a straw poll of the owners present to see if they would approve such an amendment.  Depending on the number of owners present at the meeting, this may not be 100% conclusive of how a vote would go, but at least this gives the board a reality check from those present.

Send out a postcard/flyer advertising a town-hall meeting to discuss the amendment or to solicit comments/concerns. Sometimes owners who don’t normally attend board meetings (too busy, don’t prioritize them, don’t care) will attend a meeting if it will directly impact them and those that do not may be willing to send in a e-mail with their thoughts.  This also can give the board a better idea if the amendment has support or not. If the HOA has a website or a social media site, information about the meeting and the proposed amendment should also be provided there.

Check your figures.  Boards sometimes overlook the obvious, especially when it comes to rental restrictions or caps.  If the community already has 40% of its homes rented, it is unlikely those owners will vote in favor of a rental restriction, and as such the amendment has little chance of passing.  Just to be very clear, let’s say there are 100 homes in the community.  Of these, 40 are rented.  Assuming the other 60 are owner-occupied and would vote in favor of such a restriction, that only provides 60% of the needed approval for an amendment to pass.  It is unlikely that from those 40 rented home the board will get an additional 15 homes (or more, as your governing documents may require) to vote in favor of the rental cap, especially if it means those owners may not continue to rent their homes out.

The amendment process is a lengthy and expensive one and should not be undertaken without significant interest in and support from the owners.

(For more about the amendment process itself, please take a look at my posting on December 1, 2011, called “Amending Governing Documents”).

All of the documents that I’ve come across over the years have always required an amendment to put in a rental cap, but boards should check with their attorneys to confirm before pursuing this matter further.

Amending Governing Documents

The board has discussed it and decided:  it’s time to amend those out-of-date, confusing or incomplete governing documents.  Maybe they want to enact a rental restriction or prohibit basketball hoops; maybe they want to set term limits.  Whatever changes the board wants to make, the road to amending governing documents is a long and arduous one, requiring a serious commitment by each board member.  The board needs to be prepared and plan ahead to avoid the pitfalls that can happen when working towards getting an amendment approved.

What are the common pitfalls board encounter?

Lack of support.  In most cases, governing documents require at least 75% of all owners to vote in favor of an amendment.  If 75% of the owners are not likely to vote in favor of the amendment, then it’s not worthwhile using the time, energy and funds towards drafting it.  For example, the board is concerned about the number of rentals in the community and wants to limit them.  If rental homes already make up 30% of the association, it’s very unlikely that those owners would vote in favor of the amendment, thus the association will not obtain the votes it needs to pass.

Delaying involving the manager/attorney.  The association’s manager and attorney should be part of the process of developing and reviewing the language of any proposed amendments.  Why?  Managers can help the board determine the practicality and enforceability of the changes, while attorneys can help ensure the board does not make any changes that violate laws or that contradict other sections of the governing documents.  They can also help you determine the correct percentage of owners required for the amendment to pass.  An attorney can also ensure that the format of the amendment is correct; if the spacing is wrong, the county won’t record it, and that’s a lousy thing to discover at the end of this grueling process!

Allowing insufficient time.  Amendments do not happen in a day or  a week and shouldn’t even if they could.  An amendment affects the association and its owners from the date of the recording onwards, so it’s critical to ensure it is exactly what the board wants and the association needs.  There are also many hands that need to be involved:  the board to determine the need, the manager/attorneys to draft it up, the manager to mail the draft and ballot out to all owners, the board members to walk the neighborhood and collect ballots (yes, the board should plan to have to do this if you want an amendment to pass!), and the attorney submitting all the documentation plus amendments to the county for recording (condominiums may also need to obtain approval from the Oregon Real Estate Agency).  This process takes time and effort.

Failing to provide sufficient information.  Owners are critical in the success or failure of an amendment since they are the ones who decide (whether they cast their ballots or not) if the amendment will succeed.  The board needs to provide written rationale and reasoning - maybe applicable board meeting minutes - about why this amendment is necessary and desirable for owners.  The manager should work with the board to help them determine what information owners might need or want to know so that this can be provided as part of the amendment mailing.  Boards need to communicate with their owners in advance of the mailing so that owners know to watch for the ballot and amendment and return it promptly; this can be done at a board meeting, on the association’s website or Facebook page, on the community notice board, or any other common communication method.

Amending governing documents can be highly frustrating but very worthwhile in the end.  Boards can make this process less burdensome by ensuring they have the support of their owners, involving their manager and attorney early on in the process, providing plenty of information and rationale to all owners, and allowing plenty of time to get it all done.

This article was previously published in the CAI-Oregon newsletter in 2010.