Published in the ECHO Journal, June 2008
You and the other board members have been nursing the roof along, hoping for maybe two or three more years use. This past week, a member called to report continuing problems with water intrusion. During the summer, both you and the resident noticed a small problem in the flat roof over the affected unit. You are angry; the manager should have seen the same thing you saw on her monthly inspection. You put the roof problem on the agenda, and now you are ready to ask how the manager could have missed such an obvious problem.
Bluntly, you ask “Why didn’t you see the roof problem last summer and do something about it?” The manager pauses, but for just a moment, before responding: “Mr. Smith, I refer you to the management agreement which states the manager shall ‘perform monthly general reviews of the association common areas and facilities from the ground level ….’ Since the board has made no other provisions for professional inspection of the property, it is the board’s responsibility.” Is she right?
Generally, the board has a duty of oversight and decision-making most often based on issues and information provided by the manager and other professionals. Civil Code and the management agreement define the manager’s duties to the board and the association. If the duty is not enumerated in the Civil Code and not contracted in the management agreement, the duty remains either with the board or the association, a rather subtle distinction since the board is charged with the duty to administer the affairs of the association.
When we examine this roof issue, we find three duties; the duties to inspect, to repair, and/or to disclose. There is no legislative mandate requiring professional management or no statutory relief of these duties when the association has a management company. Directors are elected by the membership, in accordance with the association’s bylaw, Civil and Corporation Codes, to govern and preserve the association. Let’s start by examining just what this means.
Section 7231(a) of California Corporation Code states “A director shall perform the duties of a director, including duties as a member of any committee of the board upon which the director may serve, in good faith, in a manner such director believes to be in the best interests of the corporation and its shareholders and with such care, including reasonably inquiry, as an ordinarily prudent person in a like position would use under similar circumstances” (emphasis added). This is probably the best statement of the director’s duty to care-take, and thus to inspect. It is a ‘whatever is prudent’ standard.
This section continues “(b) “In performing the duties of a director, a director shall be entitled to rely on information, opinions, reports or statements, including financial statements and other financial data, in each case prepared or presented by any of the following:.. (2) Counsel, independent accountants or other persons as to matters which the director believes to be within such person’s professional or expert competence.” The certified manager is, by definition, a competent ‘other person’ upon whom you, the director, may rely. Paragraph (c) states “A person who performs the duties of a director in accordance with subdivision (a) and (b) shall have no liability based upon any alleged failure to discharge the person’s obligations as a director . . .”
Civil Code Section 1365.7 expands the director’s indemnity: “(d) Nothing in this section shall be construed to limit the liability of the association for its negligent act or omission or for any negligent act or omission of an officer of director of the association.” The association has liability for the board’s mistakes, and coverage through its D&O policy.
Many directors and professionals assume that Civil Code section 1365.5(e) sets an inspection standard in stating “[A]t least once every three years, the board of directors shall cause to be conducted a reasonably competent and diligent visual inspection . . . as part of a study . . . and the board shall review this study, or cause it to be reviewed, annually. . . .” When read carefully, we note that the three-year frequency applies to the study, and the board is to review the study annually. So, does this study fulfill our duty to inspect? We need to examine the concepts of ‘inspect’ and ‘review’ for an answer.
Under inspection, let’s start with three general categories: conformance (are the draperies the right color), component performance, and reserve study. We are not concerned with appearance; our focus is performance, so we can eliminate conformance. The reserve study is designed to provide a long-term look at expected performance, starting with a description of each component, expected life and remaining life. This document is our ‘trip-wire’ to remind us of funding/replacement deadlines. Our roof issue is really about component performance, which does impact the reserve study.
The performance inspection is a reality check against the reserve study. As caretakers of the asset, the annual review required under section 1365.5 should be both fiscal and physical. When the board prepares the budget for the following year, the yardstick for future replacements is the reserve study. The physical review of the property should be in-depth, with the intent to find structural problems in their infancy when the solution is cheapest. If we see that the balcony is failing and the stucco cracking, we can at least caulk the joint to prevent further water intrusion (and damage) while we formulate a solution and raise the necessary funds. Given that this is budget time, it is the most appropriate time to look at these problems.
There is another aspect of the component performance inspection that is necessary and not generally performed by the reserve preparer. That is an analysis of the current component for serviceability and effectiveness. Most often, this requires an engineer or an appropriate expert who will determine whether to use a different material or application when replacement is needed. This analysis should be performed with sufficient time to recover from the sticker shock of the upgrade and incorporate that cost in both the reserve study and budget.
With the budget, the board will also produce the Assessment and Reserve Funding Disclosure Summary, a disclosure advocated by California Association of Realtors. This document reasonably requires a more detailed disclosure of the funding liability and the funding plan for the next five years. Transparency—nothing hidden—is the goal.
As a practical matter, someone must inspect the property in order to comply with the association’s, not the director’s, duty to prepare and distribute this disclosure summary annually. Under Section 1365(a)(3), these disclosures include:
“(A) Whether the board of directors of the association has determined to defer or not undertake repairs or replacement of any major component with a remaining life of 30 years or less, including a justification for the deferral or decision not to undertake the repair or replacement.
“(B) Whether the board of directors of the association, consistent with the reserve funding plan adopted pursuant to subdivision (e) of Section 1365.5, has determined or anticipates that the levy of one or more special assessments will be required to repair, replace, or restore any major component or to provide adequate reserves therefor. If so, the statement shall also set out the estimated amount, commencement date, and duration of the assessment.”
Inherent in these two paragraphs is the duty to discover necessary repairs or replacements, or unusual wear that would necessitate a special assessment. It is interesting that this duty lies with the association, and not with the board. Most governing documents contain such language as “the association may delegate its powers and duties subject to the limitations” or “to conduct the business and affairs of the association.”
As with the roof leak, it is this failure to inspect and find early solution to building problems that may create significant liability for the association, taking needed funds from the association’s coffer and exacerbating maintenance problems and long-term funding solutions. With a roof leak, not only is the association liable for the roof but also the interior repair. More and more, the area of legislative focus is the reserve liability, since it is here that the board defines the plan to address replacement and major repairs. The question posed at our board meeting is who has this duty, the manager or the director.
Since the board, properly acting for the association has the right to contract (delegate) with a competent professional for service, we need to look at those agreements and see if any contract for inspection services. As with our roofing example, the most logical place to look is the management agreement; and, as with our example, we need to concern ourselves with the specific language of that section of the agreement. Most agreements vary, but it is important to establish a threshold understanding of that duty; there is tremendous liability in this duty, and most management companies understand this. As in our example, undetected building component failures can cause significant damage; no management company willingly assumes this liability without adequate compensation. When management companies compete for a contract, and boards don’t understand this component and its pricing, most bids do not include a comprehensive inspection clause. Look but you probably won’t find it. You will find “walk through” or some other such benign phrase that does not reach an inspection standard. Without some clear statement assigning the duty of inspection to the manager, the board may be responsible, whether or not qualified to conduct such inspections.
As a competent professional, your manager should be able to evaluate the condition of a building. The legislature gave you, the director, indemnity if you rely on professional advice. Did you ever wonder about the language in Civil Code Section 1363.1 (Managing Agents), where the prospective managing agent is to disclose any “. . . relevant licenses such as architectural design, construction, engineering, real estate or accounting . . .” (Sec 1363.1 (a)(2))? When read with Business and Professions Code Section 11502 (Certified Common Interest Development Manager; Criteria), it certainly appears that the legislature intended that the managers would fill this role of professional advisors on general matters. It also means that if the manager does not have this skill or duty to inspect, the manager as a general practice should advise the board, in writing, to hire someone to conduct the ‘diligent visual inspection.’ It is also clear that this inspection should occur annually and, that if the manager reports a problem, the board should hire an engineer or other specifically qualified (not generally qualified) expert to investigate.
In summary, what is clear is the lack of a specific statement in Civil Code or in most governing documents assigning the inspection responsibility to the board. It is also clear that component inspections are not automatically part of the manager’s duties. The responsibility lies with the board. Without particular expertise, it is the board’s duty to delegate the inspection responsibility, ensure that the inspection is thorough and occurs at least annually, and if there is a component failure or problem, to hire the appropriate professional to investigate. In so doing, the board will satisfy both the intent of the Assessment and Reserve Funding Disclosure Summary Form and prudent asset and fiscal management. What more could any association member ask?
David West is the managing shareholder in West Management Company, Inc., an ECHO member, and a shareholder in West Construction and Maintenance Company, Inc. He has been in the CID industry for 22 years and in real estate for 33 years. Mr. West holds a law degree from JFK University.