March 2010
The underlying bases for governance of the Laguna Woods Village housing mutuals are California’s Nonprofit Mutual Benefit Corporation Law (within the Corporations Code) and the Davis-Stirling Common Interest Development Act (within the Civil Code). These laws make common interest developments, which are also known as homeowners associations, different from the operation of local governmental entities such as the cities of Laguna Woods, Mission Viejo, Santa Ana, etc.
A homeowners association is a private community which is usually formed and operated as a nonprofit mutual benefit corporation. Therefore, the laws in the Corporations Code which govern similar corporations also apply to such associations. Additionally, homeowner associations must abide by the requirements of the Davis-Stirling Act, which includes sections pertaining to election procedures, board of directors meetings, distribution of minutes and operating budgets, inspection of records, and alternative dispute resolution.
I believe the failure to recognize that Laguna Woods Village is a corporation and not a governmental entity, is a major factor underlying much of the conflict within our community. Laguna Woods Village is unique in that our operating budgets and population are larger than many city governments; yet unlike council persons in those cities, our board members must comply with their fiduciary duties and responsibilities under the Corporations Code, Civil Code and related laws.
Three fundamental duties which apply to association board members are the Duty of Care, the Duty of Inquiry and the Duty of Loyalty. These duties are unique to corporate directors and are not applicable to city government officials. For example, elected city officials are not bound to observe any minimum standard of due care toward their constituents, short of avoiding participation in clear conflicts of interest, fraud or other corrupt practices. And elected local government officials have no obligation to consider the best interests of the whole community; they can, and often do, represent and champion narrow constituencies and special interests.
What is the Duty of Care? This is the requirement in Corporations Code section 7231 that nonprofit community association directors must abide by the same standard of conduct imposed by the legislature on business corporations under Corporations Code section 309. The Duty of Care in section 7231 states that: “A director shall perform the duties of a director, including duties as a member of any committee of the board…in good faith, in a manner the director believes to be in the best interests of the corporation, and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.” Courts understand that directors must frequently make difficult decisions, and therefore under the Business Judgment Rule judges do not like to “second guess” board decisions which are made in compliance with the Duty of Care.
What is the Duty of Inquiry? This is the requirement that board members obtain an independent analysis or undertake a reasonable investigation of appropriate matters relating to the association. It is not always adequate for the board to use the Business Judgment Rule to excuse the lack of performing an inquiry. A board cannot simply refuse to comply with its Duty of Inquiry when the situation and circumstances warrant an independent investigation. The Duty of Inquiry has to take priority regardless of how politically difficult the situation may be for the directors or the corporate membership.
What is the Duty of Loyalty? This is a requirement that all board members recognize that their obligations are to the association as a whole and not to special interest groups or factions within the community. Compliance with this duty can be difficult for some directors, particularly when they are in the minority on a significant issue. Additionally, when board meetings are televised, each board member’s position on an issue is open for all to see. Although directors (even when they are in the minority) have the right to state their opinions at board meetings during debates on pending corporate issues, in order to comply with the Duty of Loyalty each board member must not undermine decisions of the full board. Unfortunately, if a director does not observe the duty of loyalty, this can create controversy and dissent which can cause harm to the corporation and the community.
It is my hope that this article will help our community members understand the legal basis under which the three housing mutual corporations and GRF must operate. With understanding comes the opportunity for our community to move forward with confidence in the future, with a cooperative spirit, and without wide-spread open conflict. We all wish to enjoy a pleasant retirement and ensure that our investment in the Laguna Woods Village community endures and prospers.
Reference Source:
“Common Interest Community Associations and Their Management Structure”
by Curtis C. Sproul,
Copyright 1993, revised 1998 and 2009
March 2010
Third Mutual Board reviews and plans not only for day-to-day expenditures, but also for future expenditures. Reserves can be considered the savings we set aside for future expenditures and even for disasters which can occur. When little is set aside, it is not the failure of the management company, it is the failure of the board to perform their proper duty. If we look at the financial history of Third Laguna Hills Mutual we see there was a failure to properly provide for the future. I want to focus on how most of the members of this current board have responded to past oversights. With the exception of three new directors, most of the members of this board as well as some members of GRF who formerly served on this board, reviewed policies and practices which we determined were shortsighted. We changed those practices and we have increased dramatically, the reserves held by Third Mutual. The purpose of reserves is to avoid special assessments in the future. When unforeseen expenditures arise, if there are no savings, the board has the legal power to level a special assessment from each member. We don't want to do that, so we prepare by saving as we go.
One practice that enabled us to increase reserve contributions and without increasing your assessment was our earthquake insurance coverage. At the time most of us were elected, we had $10 million maximum earthquake insurance coverage. Moreover there was either $200,000 or 10% deductible for each earthquake damaged building. For that very restricted coverage, we were paying $50,000 per month, which is $600,000 per year. All that money was going straight to the insurance company, and we had never made a claim. Furthermore, the coverage was not sufficient should we experience a major earthquake.
At the end of each year we paid out the $600,000, there was little to show for it. In addition, the premium was set to increase. This board met and changed that practice; we decided to cancel the insurance and to instead place the money in our own account. In essence, we self-insured, kept the money and saved it for the future. Let's take a brief look at how Third Mutual Reserves have grown under the current board.
- At the beginning of 2005 the reserves were just under $5million.
- At the beginning of 2006 the reserves were still close to $5million, and there was even an assessment increase that year of $44.
- At the beginning of 2007, when many of us became directors, the reserves were about $6.5 million. Then, with our change of the earthquake insurance policy, the reserves began to increase more dramatically.
- By the beginning of 2008, the reserves were about $8.5 million.
- By the beginning of 2009 the reserves were close to $12.5million.
- 2010, this year, our reserves are close to $15.5 million. That's almost a 10-and-a-half million increase since 2006.
Please note that reserve increases were made with very little increase in our assessments. These figures are available in the ”red books.” The board is responsible if there are no reserves. The management company cannot be blamed, because it is not their responsibility. The law is very clear that the board has the ultimate responsibility. This board has properly fulfilled its responsibility. We are protecting the community by overseeing proper maintenance and by insuring there are savings available for the future. Let's remember our reserves, or savings are about $10.5 million greater than they were since we became directors.
The board always has the ultimate responsibility. If there are failures, or if there are successes, the board must answer for each. We have worked to maintain costs and at the same time maintain a balance by increasing our reserves, or savings. In addition, members have the right to know where their money is going and how it is being spent.