Show Me the Money! What Associations Need to Know When Considering a Loan
By Melissa M. Garcia, Esq.
I can’t tell you how many times I’ve attended an annual meeting or board meeting where the subject was money. More specifically, the association is in a bind and needs money now. And, while the board could consider a number of options such as annual assessment increases, special assessments, or funding the project with reserves, obtaining a loan is one of the more common ways to deal with a financial crisis today. This, like any other option, must be exercised in a manner consistent with the governing documents and law. Furthermore, associations must be careful to avoid hidden pitfalls with the loan process that oftentimes are not noticed until it’s too late. This article discusses the things you need to know when considering a loan.
Do you have authority to borrow?
First and foremost, the association has to have authority to borrow money. The Colorado Revised Nonprofit Corporation Act (“Nonprofit Code”), which applies to all common interest communities, provides general authority to incur liabilities and borrow money. Additionally, the Colorado Common Interest Ownership Act (CCIOA) provides, in its legislative declaration, that the continuation of the economic prosperity of Colorado is dependent upon the strengthening of associations financially through the facilitation of borrowing, among other things.
Regardless of the empowering language in both the Nonprofit Code and CCIOA with respect to borrowing money, boards of directors still have to review their specific governing documents when considering a loan, as they may impose requirements or limitations on an association’s right to borrow.
For example, the declaration might grant an association the right to borrow, but only upon homeowner and/or mortgagee approval. Or, the declaration might state that loans are permitted, but only for certain types of projects (i.e. repair or replacement vs. capital additions to the community). Boards must review the governing documents in anticipation of obtaining a loan, rather than during the loan process itself, or you may find yourself scrambling at the last minute to try to meet those requirements. And, be sure to review not only your declaration, but your articles of incorporation and bylaws as well.
What about collateral?
In addition to reviewing your governing documents for authority to borrow, the board should also determine what kind of approval, if any, is necessary to secure the loan. For example, your governing documents might require you to obtain homeowner approval in order to mortgage the common elements as security for the loan. Even if your governing documents don’t require this, CCIOA requires associations that were created on or after July 1, 1992 (i.e., post-CCIOAs) to obtain the approval of at least 67% of the total votes in the association.
Most banks, however, do not accept a mortgage on the common elements as security for a loan. Often banks require an association to pledge its assessments (i.e., assign its right to future income) as collateral. The board will need to review its governing documents for this authority.
If your declaration is silent on the power to pledge assessments as collateral, then you still have the right to do so if your association is a pre-CCIOA association (i.e., created prior to July 1, 1992). A pre-CCIOA association may rely on the Nonprofit Code, which grants the association the right to secure its loan obligations by pledge of any of its property or income.
Unfortunately if your association is a post-CCIOA association, CCIOA requires you to have express authority stated in your declaration to assign the right to future income. If this is not stated in your declaration, you will need to amend the declaration to include this right. Amendment of the declaration requires owner approval (anywhere from a majority to 67% owner approval).
Finally, regardless of whether your association is a post-CCIOA or pre-CCIOA association, your governing documents might require homeowner and/or mortgagee approval prior to pledging assessments as collateral for a loan.
How will you pay back the loan?
Once the association gets the loan, how will you pay it back? Again, this is a question that should be considered and answered before entering into the loan itself.
One way to pay back the loan is to increase the budget. CCIOA requires post-CCIOA associations to go through the budget ratification process when proposing a budget increase, regardless of the amount of increase. This process requires the association to submit the proposed increase to the homeowners for an opportunity to veto. If a majority (or any higher percentage stated in the declaration) of the homeowners fails to veto the budget, it is deemed ratified.
Another way to service the loan is to levy a special assessment. Unlike a budget increase, which is incorporated into the regular assessments throughout the year (and, therefore, usually easier on the pocket), a special assessment is usually a large lump sum payment, which the board can then require to be paid in installments. Neither CCIOA nor the Nonprofit Code provides default authority for an association to levy special assessments, so the board must look to its governing documents for authority. Again, obtaining owner and/or mortgagee approval may be necessary prior to levying a special assessment.
A critical factor in getting homeowners to approve any proposed action, whether a special assessment, or a loan, or an amendment to assign income, is the board being able to articulate the need for the action, its benefits, and the numbers involved (i.e., the total amount of special assessment per unit, how many months to pay it off, interest on the loan, the impact of paying off a special assessment or loan early, etc.). Consider that many owners might not have the financial resources to pay for a sizable special assessment. Be prepared for the hard questions and have a well thought-out plan of action.
What other requirements do banks have for loaning to associations?
All banks have certain conditions that must be met before loaning to associations. Banks look at a variety of things, but here are a few potential limitations:
• Unit owner delinquency rate (shouldn’t be greater than 10%);
• Owner-occupancy rates (shouldn’t exceed 40% of the community);
• No one unit owner should have control over 15% of the units;
• Proposed budget increase to service the loan should not exceed 50%.
Be sure to consult with a bank that specializes in community association loans, as the more knowledge they have of how an association works the better and more efficient they will be at steering your board through the process, and answering the many homeowner questions that will be sure to arise.
Have you contacted your attorney?
Last but not least, before you go through the time, energy, and expense of starting the loan process, it would be in the board’s best interest to consult an attorney. In addition to the above, there may be a myriad of other requirements that must be met before applying for a loan. All too often boards wait until the last minute before they contact us, and we have to tell them they can’t move forward with the loan because they failed to obtain owner approval, or they don’t the right to pledge assessments, or some other reason which could have been handled on the front end. The attorney would be able to navigate you skillfully through the conditions for the loan, the loan process, and the closing.
If you are considering a loan, please do not hesitate to contact a HindmanSanchez attorney at 303-432-9999 for more information.