I try to do different blogs for my two blogrolls. I consider one (this one) mostly for homeowner questions and the other (California Condo & HOA law) for everyone else. This particular topic is an important one, and I would not want homeowners to miss out on the information, in case anyone is having some financing difficulties for a condo purchase or sale. So here is the blog posted on the my other blog site:
I guess it’s time to do a blog on fidelity bonds and the questions that commonly arise. I am getting signs from the Universe! I was at an ECHO luncheon the other day for the East Bay Resource Panel (which I “Chair”) and the topic was insurance, insurance,
insurance. The subject of fidelity bond insurance came up. We had quite a discussion on fidelity bonds. The same week, I got a question through the California Condo Guru website on the topic of fidelity bonds. That’s enough to make it a hot topic!
Here’s the question I received:
“I searched the blog in hopes of finding some guidance on fidelity bond requirement on condo association management companies, as it pertains to obtaining financing through the GSAs. I currently represent a seller (bank) in selling a condo for which the buyer has recently been denied a loan due to the HOA management company having inadequate fidelity bond coverage. FNMA guidelines state the management company must have a minimum of 3x assessments for all units. The company does not have this much coverage and refuses to increase the coverage, even if the cost is paid for by the buyer or seller. Not only does this impact the buyer who has now been declined a loan, but all owners within this project.The CC&Rs state that the insurance has to be such that the project meets the GSA qualifications.”
The sender of the question was kind enough to provide me with the 2012 FNMA Guide on Fidelity Bonds in Condos, and the page from the association CC&Rs that has language requiring the fidelity bond protection for the association.
The discussion at the ECHO luncheon was initiated by a couple of managers who raised the point that if the management company has to bond for all funds of all of the associations it/he/she manages, the cost would be astronomical. And one manager mentioned that sufficient insurance may not even be available. And, since the association has to also cover the funds, that seems duplicative, yes? Or No?
The quandary arises for sure when board members and the manager have access to the funds, especially some level of check writing authority. If the association directors are the only signors on the account, then the association’s fidelity coverage should cover losses due to board member misconduct. But what happens if a manager absconds with the association’s money? Whether or not the manager has check writing authority, if he/she/it has the checkbook and prepares checks, receives the statements, and is dishonest, theft can happen. So then the question arises as to whether the association’s fidelity bond will cover the loss?
Fidelity bond coverage is for “employee dishonesty” that results in a loss of funds. The manager in most cases is not an employee of the association. The directors are not employees of the management company and so are not covered by any fidelity bond coverage the manager carries if the theft is by a board member. I do not know the answer to whether fidelity bond coverage providers offer the opportunity for the association to name the management company or manager as an additional insured or vice versa. I have yet to hear that they do. I hope some providers will let me know about that. If that is possible, then good coverage can be obtained (although it will still not necessarily meet the FNMA regs). If not, it seems that the problem for the management companies is a difficult one.
So how does all the FNMA stuff factor into the equation?
Per the “Fannie Mae Single Family / 2012 Selling Guide / Part B, Origination Through Closing / Subpart B7, Insurance / Chapter B7-4, Additional Project Insurance / B7-4-02, Fidelity Insurance (10/30/2009)”, Projects Requiring Fidelity Insurance are “condo or co-op projects consisting of more than 20 units … The homeowners’ association (or co-op corporation) must have blanket fidelity insurance coverage for anyone who either handles or is responsible for funds that it holds or administers, whether or not that individual receives compensation for services. The insurance policy should name the homeowners’ association (or
co-op corporation) as the insured and the premiums should be paid as a common expense by the association (or corporation). A management agent that handles funds for the homeowners’ association (or co-op corporation) should be covered by its own fidelity insurance policy, which must provide the same coverage required of the homeowners’ association (or co-op corporation).”
Note the FNMA Guide specifies that each entity has “it’s own” fidelity insurance policy. The Guide says: “The policy must cover the maximum funds that are in the custody of the homeowners’ association or its management agent at any time while the policy is in force.”
There is an exception, “A lesser amount of coverage is acceptable if the project’s legal documents require the homeowners’ association (or co-op corporation) and any management company to adhere to one or more of the following financial controls:
Separate bank accounts are maintained for the working account and the reserve account, each with appropriate access controls, and the bank in which funds are deposited sends copies of the monthly bank statements directly to the homeowners’ association (or co-op corporation).
The management company maintains separate records and bank accounts for each homeowners’ association (or co-op corporation) that uses its services, and the management company does not have the
authority to draw checks on, or transfer funds from, the homeowners’ association’s (or co-op corporation’s) reserve account.
Two members of the Board of Directors must sign any checks written on the reserve account.”
Most documents that I have seen do say that the association must maintain at least two separate bank accounts but in practice, I am guessing that even in that case, the statements are probably mailed to the manager so they can prepare financials and board packets. Most documents require it but even if they don’t, under California law: “(b) Two signatures are required for withdrawal of monies from reserve accounts. The two shall be board members, or a board member and an officer who is not a member of the board.” (Civil Code Section 1365.5).
And, it is important to note that the FNMA Guide goes on to say that “Even then [meaning if one or more of the above conditions exists], the fidelity insurance coverage must equal at least the sum of three months of assessments on all units in the project.”
The CC&Rs provided to me require that the board maintain fidelity coverage sufficient to cover ¼ of the annual assessments to be collected and all of the reserve funds being held. They also require fidelity bond coverage sufficient to satisfy FNMA.
So what is the liability of the association if it does not have the insurance coverage required by the CC&Rs? What is the potential liability when the CC&Rs make fidelity bonding discretionary, rather than a requirement?
In either case, an association/board could be sued (because anyone can sue anyone). It’s a tough case and the outcome would depend on a lot of things. The person who sues would have to prove not only that the board erred with regard to a requirement in a regulatory document, but also that that error caused damages to the person who sues. Since there are so many factors involved in a real property sale including financing, it seems to me it could be very difficult to prove a case. And the FNMA standards do not regulate what an association must do. Lots of questions are coming up today as to whether an HOA board is required to apply to FHA for a Certificate of Compliance and/or take action to overcome obstacles in getting it, and FNMA does in many reqards have similar standards to those of the FHA. Since the requirements also contain limits on delinquent accounts and a specified percentage of funding in reserves, and since collections are a very big problem for many associations, many boards have determined that applying
would be an exercise in futility. So they do not spend the money to do it.
So as to the question about what is required, and what the liability is, I can only answer “it depends.” I would have to review the regulatory documents for the association as a starting point. And then I would
move on to questions about whether and why or why not the board had considered applying for FHA approval. But I can say again that the FHA and FNMA standards to not dictate what an association might do. There are, after all, other avenues of financing condos.