INCORPORATION of HOA, IS IT GOOD, BAD, OR SHOULD YOU BE INDIFFERENT?

I am working on the Small Homeowners Association Survival Guide and expect to get it done the end of this month, or by mid October (2015) at the outside date. In working on this guide, it has become evident that the topic of incorporation in associations is an important one. Why? Because so many incorporated homeowner associations in California have slipped into suspended status. That effectively means the Board’s legal right to do business is suspended until the status is revived to “active”. So, anyone can challenge the board’s actions in signing contracts, or making other decisions.

 

And some associations, especially in the arena of small homeowner associations, are not even incorporated. There are some very good reasons for incorporating and they are discussed below. The quandary I have discussed with colleagues is whether it is better to incorporate – if there is a chance the status might be suspended due to difficulty or laxity in fulfilling the Secretary of State and Franchise Tax Board requirements (leaving board action open to challenge) or better to not incorporate (leaving the members exposed to personal liability).  Read on.

 

For every association that is incorporated it is important to annually review the status of the corporation with the Secretary of State.

 

To find out if your HOA is incorporated, it will be listed on the website www.sos.ca.gov. To get to the Business Entities section to check status the sequence is Business Programs to Business Entities to Business Search. Put in the name of your corporation. The status of your HOA will come up if you are incorporated. You will see the contact information for the agent for service of process or the “last person standing” at the time the last Secretary of State reporting documents were filed. If the corporation status is suspended, get busy planning to fix that. Making decisions and spending assessments, and undertaking any board action while the status is suspended is very risky. I’m not suggesting all board activity be suspended but I do recommend sticking only to action items that include reviving the status and innocuous decisions or emergency decisions that cannot wait. Why? I want you to be able to justify to a judge if any of your actions is challenged that you only took action that was necessary pending the revival process so as to avoid problems for the association.

 

There is (or will be soon) a pertinent article on my website at www.californiacondoguru.com about revival of a Corporation under the index title of “Corporate Status – Is it Active? It Should Be Checked.” This is the URL for the page you will find it on, but be patient. I just sent it over to my web person to post it on the site.

 

If your association is not listed on the Secretary of State website, you are probably unincorporated. Be sure to spell the name right. If that is the case you should at least understand the pros and cons of incorporating.

 

The most severe consequence of an unincorporated association is the fact that all owners are potentially personally liable for association debts or judgments. If the Association is ever sued for the acts of the Board or any contractors, vendors, management, etc., each and every homeowner is a potential defendant and each individual’s assets are up for “grabs” (attachment) without regard to equally sharing responsibility. As we know in California, any accident or contract “gone bad” could result in a lawsuit and the owner with the most assets is the owner with the highest risk.

 

If incorporated, any legal action would have to be filed against the Association, and the owners would be insulated at least to the extent that no one owner would have any more liability than his or her neighbor. No individual owners could be sued (per Civil Code Section 5805) if the Association carries the minimum amount of liability insurance required by the statute (at least $2 million if 100 or fewer units and at least $3M if more than 100 units). This legislation was borne of a situation where 152 owners in a condominium project were actually sued along with the association in an accident lawsuit. (Ruoff vs. Harbor Creek Community Assn. (1992) 10 Cal.App.4th 1624)
It was a bold move on the part of the plaintiff’s attorney, and was nipped in the bud fairly quickly when the legislature eliminated the possibility by approving the law which became Civil Code Section 5805. Owners cannot be individually included as defendants when an HOA is incorporated, so long as the association is insured to the minimum levels in the statute. This does not mean owners can avoid a special assessment to pay a judgment that exceeds the insurance coverage. It just means that the liability of any individual owner would be limited to a special assessment based on a pro rata ownership share in the association. Thus, the risk is much different than in a situation where the wealthiest person in the Association could become the main biggest target in collection of any judgment.

 

Association board members (in a corporation) also gain some important protections found in the Corporations Code Sections 7231 and 7231.5, as there exists a “liability shield” (called a “safe harbor”) of sorts for good faith exercise of duties. As for the benefit of the Association, there is much guidance and structure available in the Corporations Code for voting, elections, etc. Corporations generally also receive more “respect” in the business community, and most lenders and some insurers prefer (if not require) an Association to be incorporated before lending money to it or providing insurance coverage.

 

I generally recommend incorporation for unincorporated homeowner associations when they come to me to update and restate the governing documents simply because the imbalance that comes to owners in the area of risk/responsibility when it comes to lawsuits and judgments is the clincher.

 

If you have an amendment / restatement project going the voting on the incorporation question could be done at the same time that the governing documents are amended, or it could be done at a different time, before or after voting on the updated documents. I usually recommend that it be done at the same time, so changes in the documents can be incorporated before they are re-recorded. It also saves the Association some money as opposed to handling the process separately. There is some crossover in preparing documents and ballots, and going through the voting processes.

 

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