Not all homeowners associations are successful in managing money effectively and may run out of the resources needed to perform community upkeep. Some run short on money because they fail to make or maintain an appropriate budget or to collect dues in a timely manner. In the business world, a business may be able to declare bankruptcy when their debts become unmanageable but homeowners associations are rarely allowed to declare bankruptcy. The three key reasons are detailed below.
The 3 reasons a homeowners association cannot declare bankruptcy
Lack of creditors: the key purpose of bankruptcy is to remove outstanding debt to creditors. However, a homeowners association rarely has such debts. Homeowners associations are mainly concerned with two things: 1. covering monthly expenses and 2. having money in reserve for future large scale projects or emergencies. Contracts with outside businesses such as landscapers are paid annually or monthly and if left unpaid may be quickly canceled by the contractor before too much debt builds up. Also, banks rarely lend to a homeowners association, greatly reducing the chance of a large loan being past due. The creditor that a homeowners association often owes the most to is itself. Because of this, most financial shortfalls are covered through assets owned by the homeowners association or assessments from its members.
Use of the reserve fund: as noted above, a homeowners association typically has a reserve fund used to make future repairs or upgrades to property owned by the association. Often when expenses exceed revenue, the reserve fund is used to cover this shortfall. While this is far from its intended use it is still a common occurrence. Because the projects that are handled by reserve funds do not occur ever fiscal year this band-aid move to cover a budge shortfall may work out temporarily to prevent a desire to claim bankruptcy. The concern, of course, is that if an emergency repair crops up the funds will not be available to handle the situation. Additionally, if the HOA is unable to recover the funds that it used for the shortfall then there is a permanent loss of a reserve fund.
Owner Liability: lastly, one of the key reasons a homeowners association does not consider bankruptcy is that the structure of such an association does not remove owner liability. Unlike a traditional business or LLC, the debts incurred by a homeowners association are accountable to the property owners. This means that personal property assets become viable solutions to HOA debt. Therefore, when outstanding debt is an ongoing issue parts of the property are likely to be sold. This results in a surge of revenue and less overall expenses due to a reduced property footprint and need to maintain it.
Due to the reasons discussed, bankruptcy is not a realistic solution for homeowners associations that find themselves in debt. The only way to escape financial mismanagement is to review methodology and make up the financial shortfalls through increases in assessments. Part of the responsibility of residential property ownership is covering the debts accrued by the overall community. In extreme cases where resident safety is becoming an issue due to lack of repair or utilities, the partial sale of a property, a government takeover or a complete sale have to be taken into consideration. There are no quick and easy solutions for the financial issues some homeowners associations encounter and only proper planning and management can eliminate them or prevent them completely.
Son-Rise Property Management has been serving the property management needs of Bellingham and Whatcom County since 1996. Contact us today to see how we can help you find a rental property for your family or manage your rental properties.