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The Budget Process - A License to Steal?

Some developers, in order to maximize marketability or to comply with a municipality's desire to provide for low or middle income housing, create multi-type unit developments. For instance, the first phase of the development may be developed as a condominium regime (the "Condominium") and the second phase of the development may be developed as free standing or attached single-family homes (the "Homes"). Both the Condominium and the Homes are included in a master homeowners association (the "Association") which is created to own, operate and maintain certain common areas owned by the Association (the "Common Area") which are improved with roadways and recreational facilities to be used and enjoyed by both the owners of the Condominiums and the Homes (the "Members").

Typically, the Association's By-laws empower the Association's board of directors to operate and maintain the Common Area and, to a limited extent, to maintain the exterior appearance of the Homes and the lots on which they stand. The Association's board of directors creates a budget each year and assesses the Members to raise the funds in accordance with the budget. The sponsor of these multi-type unit developments usually files a certificate of incorporation creating the Association to have a single class of membership. The Association's board creates its budget and assesses each Member equally, presumably in accordance with §507(b) of New York's Not-for-Profit Corporation Law. This statute provides that "[i]nitiation fees, dues or assessments may be levied on all classes of members alike or in different amounts or proportions for different classes of members, as the certificate of incorporation or the by-laws may provide, but in all cases the fees, dues and assessments payable by members of one class shall be determined upon the same basis." Board members and their counsel often construe "the same basis" to mean equally.

While it makes sense for the Condominium owners to pay an equal share of the budgeted line items which relate to the operation, maintenance and repair of the Common Area, the Condominium owners should not be required to pay an equal share (or for that matter, any share) of the budgeted line items which relate to the operation, maintenance and repair of the lots and Homes. Any line item in the budget which relates to both the Common Area and the lots and Homes should be properly allocated between the two. The budget can easily be manipulated by the Association's board so that the Condominium owners (who are already paying assessments to the Condominium to operate, maintain and repair its common elements) pay for the maintenance and repair of the lots and Homes. It is also easy for the board to use funds earmarked for the Common Area for the lots and Homes. For instance, the Association could deposit a portion of the assessments in a reserve fund for future capital repairs to the Common Area and the lots and Homes and, thereafter, use all of the reserve funds for capital repairs to the lots and Homes.

We believe that not only is this practice unfair to the Condominium owners, it is illegal. While §507(b) of the NFPCL states that "assessments payable by members of one class shall be determined upon the same basis," it does not require that all assessments be equal. In Roxron Estates, a New York appellate court held that it was proper for an Association to charge sponsor, who owned unimproved lots, a lower assessment than the owners of improved lots because of the differing costs of maintaining improved properties as opposed to unimproved properties. While the resulting assessments differed, they were determined upon the same basis (the cost of maintaining the properties). Similarly, it is appropriate that the Association charge the Condominium owners, who do not benefit from the maintenance and repair of the lots and Homes, a lower assessment than the assessment charged to the Home owners, who do benefit from the maintenance and repair of the lots and Homes.

Moreover, the board Members owe a fiduciary duty to all of the Members. They should not act in a manner which may treat a group of Members unfairly, nor should they act in a manner which may be self-serving. If a board Member is a Home owner, he or she will benefit by the over assessment of the Condominium owners or the misapplication of funds for use to repair or maintain the lots and Homes.

We recommend to our homeowners association clients which contain multi-type units that, rather than commingle the two budgets together, the board should create two separate and distinct budgets, one for the Common Area and one for the lots and Homes. These budgets should be based upon the amounts actually charged by service providers for their services as they relate to the Common Area and the lots and Homes rather than upon a "loose" allocation made by the board. In doing so, the board members will be more likely to resist the temptation of using the budget process as a license to steal.

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