Commercial Owners Associations/Residential Owners Associations The Same — But Different

Justin M. Lewis | Ward and Smith

What are commercial owners associations, and are they really that different from residential owners associations? 

Commercial owners associations are nonprofit corporations that govern planned communities, condominiums, or a combination of the two, in which the lots and/or units are used for non-residential purposes.

Commercial owners associations are governed by the same statutes as residential owners associations: Chapter 55A of the North Carolina General Statutes (the Nonprofit Corporation Act), Chapter 47C of the North Carolina General Statutes (the Condominium Act), Chapter 47A of the North Carolina General Statutes (the Unit Ownership Act) and Chapter 47F of the North Carolina General Statutes (the Planned Community Act). 

While some of the obligations and responsibilities of commercial associations are the same as residential associations (the collecting assessments from the members, maintaining the common elements, and enforcing the rules and regulations), there are some issues that are more important, or are unique, to commercial associations.

Parking

Typically, parking is not an issue in residential communities.  Owners of lots park on their lots and owners of condominium units park in what are often limited common elements parking spaces dedicated to particular units. 

But for a commercial community, parking is very important to the owners.  Adequate and convenient parking for the employees, and most importantly, the customers, is vital to the success of the business.  Some commercial communities have ample parking in the common elements, but business owners may want some designated parking close to their lot or unit; and, in a community with limited parking, it may be necessary for each lot or unit to be allocated some limited common elements parking to ensure easy access for customers. 

This issue should be addressed in the declaration when the commercial community is formed.  If it is not, an amendment to the declaration may be necessary, which often will require the consent of a certain percentage of the owners.

Signage

Signs are usually prohibited in residential communities or subject to rules that establish duration, size, and location on political signs and “for sale” and “for rent” signs. 

In a commercial community, signs are necessary to identify and advertise the owners’ businesses.  While some regulations as to the size, number, and type of signs are desirable, signs should be allowed in commercial communities.  In addition to signs on a lot or unit of the business, commercial communities often maintain monument signs or electronic signs in the common elements that identify the various businesses.  The governing documents should address how these signs are managed by the owners association so that each business is given a fair opportunity to advertise its business. 

Use Restrictions

While governing declarations establish and restrict the uses of lots and units within particular communities, those uses will differ between residential and commercial development.

As implied by the designation, declarations creating residential communities promote typical neighborhood/non-commercial activities and restrict or prohibit the uses and actions that may be a nuisance to the other owners within the community. 

Use restrictions in commercial communities are also intended to prevent one business owner from becoming a nuisance to the other owners within the community.  Such restrictions also frequently establish specific uses permitted within that community.  For example, some commercial communities are restricted to only medical offices, business offices, or, perhaps, a combination of restaurant and retail uses.

It is important that any such use restrictions on the lots or units be established in the declaration and additional governing documents.  As North Carolina law favors the unrestricted and free use of property, subsequent rules or regulations intended to restrict or prohibit certain uses not specified in the declaration and governing documents will most likely be unenforceable.

Ordinances and Regulations

In addition to the governing North Carolina statutes (mentioned above), local, state, and federal ordinances and regulations (think about local zoning ordinances) must be observed.  In residential communities, all of the lots or units are being used for the same general purposes, so the same ordinances and regulations would apply to all of the owners and their properties.

However, in a commercial community, you may have restaurants, business offices, medical offices, retail stores, and other uses all of which may be subject to different ordinances and regulations.  Most of the burden for complying with those ordinances and regulations will fall on the individual business owners, but the owners association should be aware of the ordinances and regulations applicable to the community to make certain that owners do not commit violations that could harm, or result in a violation enforced against the entire community and association.

Mixed-Use Communities

Some planned communities and condominiums contain both commercial and residential lots and units.  The owners association for a mixed-use community will need to deal with all of the issues important to a commercial community, some of which are described above, and the issues important to a residential community.  One way to ensure that all of the owners’ needs and concerns are considered is to establish in the governing documents that the association board will be comprised of owners of both residential lots or units and commercial lots or units.  The concept of selecting board members from different types of lots or units may also be applied in a solely commercial community to make sure the board is truly representative of the entire community.

All owners associations must perform many of the same tasks, enforce the same rules, fulfill the same obligations, and comply with the same statutes, but the needs and issues in commercial owners associations are unique.  It is important for the board of directors of these associations to understand the complexities of a commercial community so that they can adequately meet the needs of their members.

Sometimes a Reminder is in Order. . .

Christopher G. Hill | Construction Law Musings | November 18, 2019

Recently, I was talking with my friend Matt Hundley about a recent case he had in the Charlottesville, VA Circuit Court.  It was a relatively straightforward (or so he and I would have thought) breach of contract matter involving a fixed price contract between his (and an associate of his Laura Hooe) client James River Stucco and the Montecello Overlook Owners’ Association.  I believe that you will see the reason for the title of the post once you hear the facts and read the opinion.

In James River Stucco, Inc. v. Monticello Overlook Owners’ Ass’n, the Court considered Janes River Stucco’s Motion for Summary Judgment countering two arguments made by the Association.  The first Association argument was that the word “employ” in the contract meant that James River Stucco was required to use its own forces (as opposed to subcontractors) to perform the work.  The second argument was that James River overcharged for the work.  This second argument was made without any allegation of fraud or that the work was not 100% performed.

Needless to say, the Court rejected both arguments.  The Court rejected the first argument stating:

In its plain meaning, “employ” means to hire, use, utilize, or make arrangements for. A plain reading of the contractual provisions cited–“shall employ” and references to “employees”–and relied on by Defendant does not require that the persons performing the labor, arranged by Plaintiff, be actual employees of the company or on the company’s payroll. It did not matter how the plaintiff accomplished the work so long as it was done correctly. The purpose of those provisions was to allocate to Plaintiff responsibility for supplying a sufficient workforce to get the work done, not to impose HR duties or require the company to use only “in house” workers. So I find that use of contracted work does not constitute a breach of the contract or these contractual provisions.

The Court reminds us, and the defendant, that employ in these types of construction contracts does not require use of ones own forces, but simply to use enough resources to get the job done as required by the contract.  The Court also went on to say that because of the fixed price nature of the contract, the Association would have paid the same amount regardless of the method of completion used by James River Stucco so the Defendant could not show any damages from the alleged breach of contract through the use of subcontracted work.

The Court rejected the second out of hand stating that the Defendant had not plead any facts that could lead the Court to conclude that the work was not performed as billed.  The Court pointed out that any alleged poor performance or other issues were more properly defenses to James River’s case in chief and not properly part of a Counterclaim.

In sum, this case is an example of how some of the things that we construction attorneys would think are so obvious are not always as clear as we may think.  We all could use a reminder on occasion.

Deck Police – The New Mandate for HOA’s Takes Safety to the Next Level

Joseph A. Ferrentino | Newmeyer Dillion | November 7, 2019

A recent California law will hold homeowners’ associations accountable for the safety of their decks. SB326 now mandates all homeowners’ associations to have decks inspected at least once every nine years by an architect or structural engineer to determine whether the decks are safe and waterproof. This law (Civil Code section 5551) follows SB721 which was passed in 2018 and requires a similar inspection every six years for other multifamily dwelling units. Failure to comply can result in paying the enforcement costs of local building agencies.

Details on the Mandate:

More specifically, the 2019 law requires inspections of wood “decks, balconies, stairways, and their railings” more than six feet off of the ground and designed for human use. Additionally, the engineer or architect must (1) certify that he or she has inspected for safety and waterproofing, and (2) certify the remaining useful life of the system. Further, the inspector must inspect a random sample of enough units to provide 95% confidence that “the results are reflective of the whole.” In other words, in addition to the inspector, the association will have to hire a statistician.

The nine-year timetable for inspection is no coincidence. After all, the statute of limitations for construction defects is ten years. In fact, associations are required to give notice to their members before filing a suit against a builder. However, under the new law, the association can delay giving notice to its members “if the association has reason to believe that the statute of limitations will expire.” Also, recent case law held that builders could add requirements to CC&R’s to limit a board’s authority to file lawsuits – i.e. adding a supermajority vote by members. Under SB326, any such provisions are now void. Hence, “supermajority” voting provisions are now invalid.

Impact on Construction Litigation

These recent laws are clearly a reaction to the tragic collapse of an apartment balcony in Berkeley in 2015 that resulted in the death of six college students. While it is imperative that decks be structurally safe, the requirements of SB326 will fuel more construction defect litigation.

Insurance Myths: Does “Full Replacement Cost” Insurance Requirement Really Mean an Association has to Cover Everything?

Nancy Polomis | Hellmuth & Johnson | November 1, 2019

I recently had a conversation with an insurance agent who acknowledged he “didn’t deal much with homeowners associations.” His client lived in an association, and had suffered damage within his townhome that the agent thought should be covered under the association’s master insurance policy.  He believed that, if a declaration states that the association’s master policy must provide coverage for “full insurable replacement cost of the property,” the association must maintain what is commonly referred to as “all in” coverage.  “All in” insurance covers not only the building’s exterior and common elements, but also items on the interior of homes such as cabinetry, countertops, built-in appliances and flooring.  It was not the first time an agent has taken such a position.  Unfortunately for their clients, those agents are mistaken.

Where does the requirement for “full replacement coverage” come from?

The declarations of many associations—regardless of whether the associations are subject to the Minnesota Common Interest Ownership Act (“MCIOA”)—include language requiring coverage for “full insurable replacement cost.”  This requirement is mandated by lender guidelines established by federal mortgage lending agencies such as Fannie Mae, the U.S. Department of Housing & Urban Development (HUD) and the U.S. Department of Veterans Affairs (VA).  The requirement applies to all homes with federally-backed mortgages, but confusion arises most often in homes that are located in community associations.

What insurance does MCIOA require?

Some people seem to get tripped up by the language of MCIOA with regard to the level of coverage to be maintained by the association.  Under MCIOA, the master insurance policy maintained by the association may cover certain components on the interior of a townhome or condominium home, including (i) ceiling or wall finishing materials, (ii) finished flooring, (iii) cabinetry, (iv) finished millwork, (v) electrical, heating, ventilating, and air conditioning equipment, and plumbing fixtures serving a single unit, (vi) built-in appliances, or (vii) other improvements.   However, unless the declaration specifically states that the association must cover any or all of those components, the association is not required to maintain insurance that covers those items.  If there is no requirement to cover these items under the declaration, the decision whether to cover them lies with the board of directors.

Federal mortgage lending agencies all acknowledge that an association may not provide adequate coverage to meet the agencies’ requirement to maintain coverage for “full insurable replacement cost.”  If that is the case, those federal agencies require the homeowner’s personal insurance (commonly referred to as an “HO6 policy”) cover the items not covered by the association’s master insurance policy – including such items as flooring, cabinetry, etc.  The master policy and the HO6 policy then work in tandem to provide the full replacement coverage required by Fannie Mae, VA and HUD.

Why wouldn’t an association’s insurance cover everything?

As we are all painfully aware, insurance rates have risen substantially over the last several years.  Not surprisingly, “all in” coverage is significantly more expensive than lesser levels of coverage.  In many cases, the cost for “all in” coverage is simply prohibitive for an association.  Where associations have the flexibility to choose the level of coverage, many are moving to the more affordable “bare walls” coverage, which covers the building, but not the interior finishes of a home, and is sometimes referred to as “studs out” coverage.  For example, if an association opted not to cover any of the items listed above (flooring, cabinetry, etc.), it is likely that the association has “bare walls” coverage.  Having each homeowner cover the interior of his home ensures that the homeowner gets the coverage for his home that he wants, while helping to reduce the insurance costs borne by the association.

How do homeowners know what’s covered by the association’s policy?

If an association has the option to cover certain components within a townhome or condominium, some people have expressed concern as to how homeowners know what is covered under the master policy.

  • First, MCIOA requires that associations provide an annual report to all members that includes, among other things, a “detailed description of the insurance coverage provided by the association including a statement as to which, if any , of the items [referred to above] are insured by the association[.]” (Minn. Stat. §515B.3-106(c)(5).)[1] Therefore, homeowners receive information every year as to what the association’s master policy covers.  Homeowners can then take this information to their own insurance agent to ensure they have adequate coverage, with no gaps or overlaps.
  • Second, when associations make a significant change in coverage, they typically provide multiple notifications to owners prior to the change taking effect.

Homeowners and associations must bear in mind that that the extent of the association’s coverage is determined by the association’s governing documents (typically, the declaration).  Even if the association has been paying for “all in” coverage, if the declaration states that the association is to provide “bare walls” coverage, then the insurer will cover a loss based on the “bare walls” requirement of the declaration.  (If the association’s agent doesn’t ask for a copy of the association’s governing documents as part of the agent’s due diligence when providing a quote for coverage, that should be a red flag for the board of directors.)  If a homeowner insures his home based upon the association maintaining an “all in” policy, when the declaration provides otherwise, there will likely be a gap in coverage.

In addition, homeowners often assume that any repair costs that are not covered by the homeowner’s insurer will be covered under the association’s master policy.  That is not necessarily the case.  For example, if a homeowner’s insurer pays to replace a portion of the homeowner’s damaged wood flooring, the association’s policy may not necessarily cover the cost to replace all the flooring.  As is the case with master insurance coverage, if a homeowner’s agent doesn’t ask for a copy of the declaration and a copy of the master policy (or at least a summary of the coverage), that should be a red flag for the homeowner.

Cut to the chase:  Does “full replacement cost” really mean an association has to cover everything

Not necessarily.  If the declaration of an association governed by MCIOA includes the language giving the association the option – but the obligation – to provide coverage for interior items (or simply refers to the insurance provisions of MCIOA), the association is not obligated to cover those items.  In order to meet the “full replacement cost” requirements under federal lending guidelines, homeowners must ensure that their personal insurance policy covers those items not covered under the association’s master policy so that the combined coverage under both policies provides “full replacement cost” coverage.

If homeowners have questions about what is covered by the association’s policy, they should contact the association’s management company or the board of directors.

The information in this article is provided solely as general information and not as legal advice.  Receipt of this information or its use does not establish an attorney-client relationship.  Readers are urged to speak with a qualified attorney experienced in community association law when making decisions regarding a specific legal issue.

* Special thanks to Grant Herschberger at Marsh & MacLennan Agency for graciously sharing his expertise during the drafting of this article.

[1] The governing documents of many associations that are not otherwise governed by MCIOA also incorporate the annual reporting requirements of MCIOA.

The Accidental Construction Owner: a Checklist of Considerations for HOAs Engaging in Construction

Jason T. Strickland | Ward & Smith | July 26, 2019

Homeowners associations (“HOAs”) do not typically act as construction owners.

HOAs are set up as entities to maintain and manage planned unit communities. The most important and common role of the HOA is to maintain the common elements of the community. However, in that capacity, HOAs will typically be compelled to undertake a construction project. In these circumstances, the HOA plays the role of a commercial construction owner but is doing so without the experience that a commercial construction owner has in managing a construction project. The following is a list of considerations for the HOA that is engaging as a construction owner:

Written Contract

The HOA will typically hire a contractor to perform the construction work. Sometimes the HOA will also hire a designer to develop a design for the work and to inspect construction of the work. In each instance, there should be a written contract put in place between the owner and the contractor (and between the owner and designer, if the latter is involved). The contract should have express terms and be clear and understandable.

Payment

Payment for the work should be set out in the written contract. The two most common types of payment are cost-plus or lump sum. In a cost-plus situation, the contractor will be paid for the materials and labor it provides to the project, plus a markup which is intended to compensate the contractor for its overhead and profit. In a cost-plus situation, the HOA should strongly consider requiring a guaranteed-maximum-price or GMP. A GMP caps the total costs and fees for which the HOA will be responsible — there is a maximum cap above which the HOA does not have to pay.

The second arrangement is a lump sum whereby a fixed price is paid by the HOA to the contractor for the work. This price is negotiated at the outset of the project and set forth in the contract. Unless unforeseen conditions are encountered, or the scope of work is changed for some reason, the owner is required to pay the lump sum, no more or less, to the contractor for completion of the work, regardless of the actual costs. This arrangement is generally more favorable to an HOA but is generally disfavored by contractors.

The HOA should also have the written contract set forth a process for the timing of payments (i.e., when and how payments are made) and the paperwork that must be submitted in order for the contractor to establish its entitlement to payment.

Scope of Work

Written contracts should set forth the scope of work to be performed. There should also be some provision that determines how the work will be accepted, including whether there will be inspections by the owner and/or the designer, and what happens if work is rejected.

Time

The contract should set forth the time in which the contractor is required to complete the work and the remedies available to the HOA if the work is not completed in the time required. Remedies for late completion are typically in the form of liquidated damages, which are a daily rate fixed at the beginning of the project. For each day late that the contractor finishes the project, the contractor will pay to the owner an amount equal to the daily rate. It is important in the contract to not turn the liquidated damages into a penalty. The liquidated damages should be a reasonable approximation or estimate of the actual damages that the HOA will suffer if the project is not completed in the time required.

Liens

In the event of a dispute with a contractor, there likely will be liens asserted against the project. These liens can be asserted not only against the common elements, but also the individual units in the planned unit community. Thus, the HOA’s members, the unit owners in the community, are subjected to being defendants alongside the HOA. This can create problems between the HOA and its members. The HOA should keep its members informed of the construction project. In the event of a dispute or if a dispute looks likely, the HOA should try to get ahead of the problem by informing its unit owners of the problem. Although the assertion of a lien by a contractor or subcontractor cannot be wholly prevented, certain key provisions, if present in the contract, can reduce the likelihood that liens can be successfully asserted against the common elements or the individual units.

Insurance

A written contract between the owner and the contractor (or between the owner and the designer) should set out insurance requirements for the contractor or designer, including specific dollar minimums and types of insurance the contractor is required to maintain.

Sequence

All of the above considerations must be considered in light of the sequence in which negotiations with the contractor are conducted. If the HOA gets too far into negotiations with a specific contractor and becomes wedded to using that contractor, then the HOA has little leverage to negotiate contract terms with the contractor and likely will be forced into a situation where it must sign the contract presented by the contractor as a fait accompli. Therefore, an HOA proceeding as an owner on a construction project should make sure the issues listed above are put forward, considered, addressed, and made part of negotiations at the earliest stage so as to prevent a loss of leverage and avoid being forced into a contract with inappropriate, unfair, or harmful terms.

Conclusion

The HOA should consult with its attorneys, and if necessary, have its attorneys refer them to a competent construction attorney to advise them at the very earliest stages of the construction project. Doing so will allow the HOA to avoid or at least mitigate the risks and losses associated with acting as a commercial owner when the HOA lacks experience doing so.