Ultra Vires: The Revisiting

The association's attorney recently clarified the authority of individual members of the association's board to expend association funds prior to approval of a majority of the members of the board. In response to this clarification, I sent the following email, in response to a previous email that I had sent, to the homeowner who originally inquired as to the status of his/her petition for a veto of the rules.

On the advice of legal counsel, it appears that I was wrong in accusing our board president of an ultra vires act in contacting our attorney and expending association funds without the prior approval of a majority of the board. According to counsel, it is sufficient that the board review and approve expenditures (even after the fact).

I would like to use this opportunity to extend my sincerest apologies to Mr. Crowder for the accusation. My reading and interpretation of our governing documents and the law was incorrect.

For the record, I am sincere in that apology. It was and is still my understanding, as I explained previously, that the expenditure of association funds is the exclusive province of the board of directors. Based on that same research, I further believed that our governing documents and the law precluded any one member (or a minority of the board, for that matter) from expending association funds prior to the approval of a majority of the board. According to counsel, it is this latter belief that is in error. As long as the board conducts reviews and approves of such expenditures, there is no illegality in its or its members actions. I was wrong; I admit it; and I apologized to the affected party for my incorrect accusation.

So, where does this leave what I had said previously:

As such, I will be voting "no" on the approval of the financial statements for the months of March, April, and any other month in which I find such expenses so as not to give credibility to these illegal acts after the fact. Members of the association should be questioning not only why such expenditures are taking place but why other board members are approving them.

Finally, let me be clear that I do not necessarily object to these expenditures but rather the lack of authority with which these expenditures are taking place. The board, in approving expenditures after the fact, would be acting as a "rubber stamp" for one (two, in the case of reserve expenditures) of its board members and would essentially be vesting its fiduciary duties entirely in that member (or members). [...]

In accordance with what I had previously written, I did vote "no" on the approval of March's and April's financial statements. I have mixed feelings about what to do with regard to future votes, however. The method of spending that the board has adopted is not illegal, per the association's attorney. In spite of that, I still feel that it lacks transparency, not only for the remaining board members who are only finding out about expenditures via individual review of the financial statements each month, but also for members of the association who wish to track expenditures and who do not have such ready access to the financial statements. Furthermore, I don't believe it is necessitated by the association's circumstances or in the best interest(s) of the association. With the proper allowances for "emergency" expenditures (which could be accomplished via an "action without meeting" even though probably not legally required), I see no reason that the board cannot at least discuss, if not approve, expenditures prior to their undertaking.

Aside from the lack of transparency, the current procedure has a number of other drawbacks. There is apparently (currently) no limit to the amount of money that can be spent by a board member prior to its (dis)approval by the board. There is no opportunity for discussion about the best use of association funds, e.g. if the cost is truly necessary or if bids should be solicited to find a better price. There is little, if any, opportunity for the board to reverse any expenses of which it disapproves. It is these issues in addition to the lack of transparency that give rise to my ambivalence about how best to vote on the approval of future financial statements.

Voting "no" at the last meeting was easy because I believed that a "yes" vote was aiding an illegal act. Now that that basis is gone, the reason to vote "no" would be because I disagree (in spite of the legal advice) with the method, not the expenditures themselves. (Disagreement with the expenditure(s) themselves would render this ambivalence moot.) There is a good argument to be made, I think, that the method of expenditure is not in the best interest(s) of the association, but a "principled" stand like that is admittedly somewhat pedantic and not likely to be well received. Another option is to vote "yes" when I don't take exception to the expenditures themselves, but this would give tacit approval to the method of expenditure. The final option is to "abstain" from the vote. This would avoid the tacit approval of the method of expenditure but may also open me up to claims of breach of fiduciary duty by refusing to vote on the matter.

Needless to say, I have not yet reached a conclusion.

Unauthorized expenditures

During the past few months, it has come to my attention that our board president and/or other board members have been expending association funds without the approval of the association's board of directors. This first came to my attention back in March when the president admitted that he had consulted an attorney regarding the special meeting that was requested to veto the rules. This action (the consultation with an attorney) was never authorized by the board. I wrote at the time, and still believe, that this constitutes an ultra vires act by the board's president. In light of this evidence, I combed March's financial statements prior to April's open board meeting. If you follow that previous link or review April's meeting minutes, you'll see that the approval of March's financial statements was tabled by the board until "internal board matters could be discussed during executive session". (The board's president was notably and unfortunately absent from April's meeting.) The motion to table the approval was made by me, and the "internal board matters" concerned the issue of association funds being expended without the authority of the board.

In March, I noted the following expenses that were not approved by the board and of which there are no records in the association's meeting minutes:

• $1,614.00 to Artistic Maintenance: $382.00 went to "plants at belflora park" and $1,232.00 went to "CLEAN UP BACK LOT 40" (I believe this refers to the brush behind the homes, to the North of Milano Way.)
• $2,205.60 to QPM: $1,440.00 went to "RMV & RPLC FENCE POSTS" and $765.60 went to "RPR FENCE ABV POCKET PARK". All of this money was charged to our reserve account(s).
• $247.50 to Epsten, Grinnell, & Howell: I'm not at liberty to divulge the purpose of this expenditure; however, no board member has been able to justify its necessity, and it was never approved by the board.
  

Both regular and reserve funds totaling at least $4,067.10 were expended without board approval in the month of March. In April's financial statement, I find the following unapproved expenses:

• $1091.41 to Artistic Maintenance: The entire amount went to "IRRIGATION REPAIR".
• $562.95 to Access Professional Systems (APS): $181.00 went to "ENTRY SYSTEM SVC/RPR" and $381.95 to "QTRLY MAINT SVC". I believe this second charge is probably part of a service contract; however, I don't have the minutes (since they would likely be part of an executive session) or contract to verify that.
• $797.50 to Epsten, Grinnell, & Howell: This is mostly the cost of the aforementioned consultation with legal counsel regarding the rules veto.
• $3,716.95 to QPM: $731.91 for "FENCE RPRS 220&500VENETIA", $1,570.00 for "FENCE RPR BACK 4620MILANO", and $1,494.24 for "FENCE RPRS VENTIA&BELFLRA". This entire amount was taken from the association's reserve account(s).

Unapproved regular and reserve spending for the month of April totals at least $5,866.06, excluding the $381.95 that is likely part of a contract with APS. That means that in March and April, alone, the association has paid out nearly $10,000 in unauthorized expenditures. As I alluded to earlier, I brought the issue of unauthorized expenses up to the other board members during April's executive session. As is evident from April's financial statements, though, nothing has changed.

Park Lane's bylaws, in section 4.13(e), grant the board of directors the authority to "Contract for goods and/or services in accordance with the provisions of the Planned Development Documents". Furthermore, Corporations Code 7211(a)(8) states that "...an act or decision done or made by a majority of the directors present at a meeting duly held at which a quorum is present is the act of the board. The articles or bylaws may not provide that a lesser vote than a majority of the directors present at a meeting is the act of the board". In light of these two statutes, it is my opinion that every one of the previously described expenditures constitutes an ultra vires act on the part(s) of the signer(s) of the checks to the vendors providing the services as they were not approved by the board of directors.

[For reference (and completeness), Corporations Code 7214 states that "any [...] instrument in writing [...] executed or entered into between any corporation and any other person, when signed by any one of the chairman of the board, the president or any vice president and by any one of the secretary, any assistant secretary, the chief financial officer or any assistant treasurer of such corporation, is not invalidated as to the corporation by any lack of authority of the signing officers in the absence of actual knowledge on the part of the other person that the signing officers had no authority to execute the same."

While this would appear to allow two board members (in the proper configuration) to execute a contract on behalf of the association (without approval of the board), what it is actually saying is that if the third party does not know that the two board members are acting beyond their authority, the contract cannot be invalidated due to that lack of authority. Essentially, this statute protects the third party in the absence of knowledge of the ulta vires act. In fact, this statute implies that the authority to execute contracts does not lie solely with the two signers.]

As such, I will be voting "no" on the approval of the financial statements for the months of March, April, and any other month in which I find such expenses so as not to give credibility to these illegal acts after the fact. Members of the association should be questioning not only why such expenditures are taking place but why other board members are approving them.

Finally, let me be clear that I do not necessarily object to these expenditures but rather the lack of authority with which these expenditures are taking place. The board, in approving expenditures after the fact, would be acting as a "rubber stamp" for one (two, in the case of reserve expenditures) of its board members and would essentially be vesting its fiduciary duties entirely in that member (or members). Given that two of our board members have expressed unequivocal support for Park Lane's board president, our board president has a majority to push through whatever items he so desires. One has to ask the question, then, why not follow the legally prescribed methods for spending the association's money?

Do HOA's create moral hazard?

This past week, a letter was circulated by a homeowner (or homeowners) regarding the adoption and pending vote on a veto of Park Lane's rules and regulations. Another homeowner, in opposition to the veto, tried unsuccessfully to reply to the author(s) of the letter and instead forwarded the letter to the board of directors via email. I, personally, did not find the letter very persuasive as most of the arguments in it were ad hominem in nature. However, one of the comments made by the homeowner got me thinking about the nature of the relationship not only between individual members of the association but also between the members and the association, as a bureaucratic entity. Specifically, does the existence of an HOA create moral hazard?

Wikipedia defines moral hazard as occurring "when a party insulated from risk may behave differently than it would behave if it were fully exposed to the risk". This situation generally occurs in finance and insurance when people take risks, the costs of which are borne by others (e.g. an insurance company); however, I think it is equally applicable here. As an aside, the costs associated with these risks can sometimes be referred to as negative externalities which are defined, again by Wikipedia, as "[a cost] incurred by a party who did not agree to the action causing the cost".

Now, consider a simple example of your neighbor parking his car in front of your house or letting his dog defecate in your yard or having a loud party. Your neighbor has created a "negative externality" for you (note that this is not usually or necessarily malicious). You have a number of options to address the issue:

1. Ignore it, and hope it goes away.
   
   • Risk: The problem won't go away.
     
2. Talk to and resolve the problem with the neighbor.
   
   • Risk: You might have to step out of your "comfort zone" and/or your neighbor might be a jerk.
     
3. Call in the authorities (police, code enforcement, humane society, etc.).
   
   • Risk: If your neighbor finds out who made the complaint (possible in the case of a police visit and/or report), he'll be upset at you regardless of whether or not he is a jerk.
     
4. Retaliate with either passive or overt aggression.
   
   • Risk: Escalation may lead to more and bigger issues.
     

(In my opinion, the risks and costs of option 4 far outweigh the benefits, assuming there are any, so I'm going to rule that option out for the purpose of this discussion.)

In the absence of an HOA you bear the risks for all three of the "viable" options. Knowing this, most people will progress through these three options in the order listed, and I would wager that most issues would be resolved amicably without moving past step 2. However, consider the same situation in which an HOA is present. As with the absence of an HOA, you are fully exposed to the risks of the first two options, but in associations in which complaints are kept private (as is the case in Park Lane), you bear none of the risk(s) of pursuing option 3. Armed with this information, it is only logical to assume that people living in HOA's when confronted with issues such as this will jump directly to this option.

But, aren't HOA's supposed to protect property rights and keep people from interfering with each other? The answer is, of course, yes. This is the wrong question to be asking, though. The real problem is that when people are not fully exposed to the risks and costs of their actions, they act differently than they otherwise might (see: moral hazard). In the case of an HOA, this can lead to all sorts of petty complaints like trash cans being left out for too long, home decorations being put up too early, etc. Ultimately this serves to separate individual homeowners from each other and harm the sense of community. I've written about this before; and one of the three readers of this blog has commented on it as well; but, I digress. The problem isn't limited simply to pettiness and over-complaining. These complaints eventually lead to new and more restrictive rules placed on the membership. HOA's often extrapolate from the obscure to the common, and in solving a single, obscure problem, impose general restrictions on everyone regardless of individual situations creating a number of new problems. (All of this reeks of central planning which is, of course, an economic concept but who's shortcomings are equally applicable here.)

The imposition of these rules, I argue, though, has a more insidious and counter-intuitive effect, and that is that people will break the rules simply because they exist. HOA's, in passing rules, assume responsibility for the enforcement of said rules. Normally, a homeowner is obligated to his surrounding neighbors to be "decent" as part of an implied "social contract". When an association explicitly imposes this "decency", the homeowner is now obligated to the HOA (an impersonal, faceless bureaucracy) instead of his immediate neighbors. Suddenly throwing a late night party doesn't inconvenience the neighbors, it breaks association's rules. People are far more likely to transgress against a (perceived) far-away, faceless, emotionless entity than they are the neighbor they have to face each day. Couple this with the decreased sense of community, the knowledge that the inconvenienced neighbor is unlikely to address the situation directly, and the impotence and reticence of HOA's to impose fines; and there is very little incentive to follow the rules.

All of this may sound like an argument for further rules and regulations and more power for HOA's. I think that just the opposite is true, though. That is not to say that problems like late night parties and dogs defecating on lawns should be regular occurrences with which one should have to put up. Rather, with less regulation, the responsibility of homeowners to be decent shifts back to the small, close number of people who are immediately affected by their actions. When neighbors have to deal directly with each other, they begin to empathize with and respect each other as equals instead of railing against a faceless bureaucracy in a far-away place.

Open Board Meeting - 15 April 2010

I apologize, but no in-depth "recap" of April's meeting will be posted. This isn't due to anything that did or didn't happen at the meeting but simply because I didn't have a chance to put up the post in the time immediately following the meeting, and to try to do so now would do a disservice to the (un)official record since too much time has passed for me to now accurately relate what happened.

Here is a not-so-in-depth review of the meeting:

• During the open forum, there was some discussion of (the poor shape of) the association's finances. There seems to be, in my opinion, a disconnect between the reality and the perception of the state of the association's finances among board members and homeowners. This led to a discussion of stopping the mailing of the meeting agenda to all homeowners. The association's property manager stated that it would require a vote to make the change (note that the board's president was absent from the meeting). I questioned why a vote was required to stop the mailing when a vote was not required to start it. This led to a confused look from the property manager and at least one "jeer" from a homeowner (in my direction, not the property manager's). Ultimately, there was a vote to stop the mailing, and it passed unanimously.
  
  
• Approval of the association's finances for the month of March was tabled so that internal board matters could be discussed during executive session.
  
  
• The board approved a few small landscaping items.
  
  
• A proposal for this year's reserve study came before the board for approval. The cost seemed a bit high, and the board asked for more proposals.

The board adjourned to executive session to discuss the aforementioned financial records. Discussion lasted for approximately 15 minutes, after which, the meeting was adjourned.

Quorum requirements for special meeting

[While originally writing this post, I did not have, for reference, the letter that was mailed to the homeowners with the ballots this last month. After re-reading it, it appears that the board president has positioned the handling of this vote and the upcoming special meeting in such a way that the meeting will be for vote counting purposes, only. As such, the entire matter is controlled by Corporations Code 7513, contrary to what I wrote below. This is not what I had intended when I agreed to set a date and time for a special meeting; however, it appears that little can be done about it now.

There is still the issue, as described below, of whether the measure fails or whether the vote is invalid if quorum is not met (which I'm still pursuing). I have been told (third-hand, unfortunately) that legal counsel has advised the board that a vote of this nature does not carry the same "weight" as an annual election; and therefore, if quorum is not met, the measure fails. If you truly care about this matter, please do your best to see to that quorum is met before the 20 May 2010 deadline.]

A little over a month ago, a number of homeowners requested a special meeting to reverse the rule changes adopted by the board of directors at the regular meeting on 21 January 2010. In response to a question from one of our board members about how to proceed on the matter, I sent an email to the board of directors outlining what I believed to be the required course of action. At the most recent regular board meeting and in an email to a number of homeowners, the board president expressed his (opposing) opinion that if the quorum requirement of 51% is not met, then the effort to reverse the rule changes simply fails without a reduction of the quorum requirement as applies with annual elections. What follows is what I found after further researching the relevant laws.

A reversal or "veto" of rule changes by an association's membership is governed by Civil Code 1357.140. According to subsection (a), 5% of the members are required to call a meeting; and according to subsection (b), they must do so within 30 days of the notification of adoption of the rules. Subsection (b) also requires the board to hold a special meeting and give notice of it in accordance with Corporations Code 7511 or alternatively, according to subsection (c), hold a vote of the membership by mail in accordance with Corporations Code 7513. If a meeting is held, then according to subsection (e), said meeting is governed by Corporations Code 7510.

Subsection (d) of Corporations Code 7510 reads, in part:

The votes represented, either in person (or, if proxies are allowed, by proxy), at a meeting called or by written ballot ordered pursuant to subdivision (c), and entitled to be cast on the business to be transacted shall constitute a quorum, notwithstanding any provision of the articles or bylaws or in this part to the contrary. [...]

The latter part of the quoted section turns over requirements for quorum to the association's bylaws which in section 3.03 state, in part:

The presence at any meeting, either in person or proxy, of Members entitled to cast at least fifty-one (51%) percent of the total voting power of the Association shall constitute a quorum for any action except as otherwise provided in the Planned Development Documents. If, however, such quorum shall not be present or represented at any meeting, a majority of the Members entitled to vote thereat shall have the power to adjourn the meeting to date not less than five (5) days nor more than thirty (30) days from the meeting date, at which meeting the quorum requirements shall be one-third (1/3) of the total voting power. [...]

The assertion that the measure would fail if quorum is not met on the first attempt appears to be predicated on subsection (b) of Corporations Code 7513 which states, in part:

Approval by written ballot pursuant to this section shall be valid only when the number of votes cast by ballot within the time period specified equals or exceeds the quorum required to be present at a meeting authorizing the action, [...]

The language here is not clear as to whether the measure "fails" or if approval is simply not valid, in which case the matter is not actually resolved and the association needs to find another or additional means by which to come to a final resolution.

It is my opinion that scheduling a special meeting as the board did at the regular March meeting makes Corporations Code 7513 irrelevant, however. Because a special meeting has been scheduled, Corporations Code 7510 is the controlling law on the matter which, in turn, gives control of the quorum requirements to the association's bylaws which are quoted above.

It is also worth noting (again) that this entire exercise may be academic as the rules may be unenforceable due to the fact that the board did not provide proper notice of their adoption in accordance with Civil Code 1357.130(c).

Agenda mailings

You may have noticed that, for the last two months, you've been receiving the regular meeting agenda in the mail as opposed to having it delivered to your door as part of Tom Crowder's (the board president) newsletter. I was told by Tom after last month's (March) meeting that he was no longer distributing the newsletter (he did not give the reason(s) why) and that that was the reason that the agenda was now being mailed. I explained to him, at that time, that the board was only required to post notice of the meeting and its agenda in the common area and that a mailing was only required to homeowners who had explicitly requested it.

After receiving the agenda in the mail again this month, I sent the following to Tom:

Is there a reason that the agenda was mailed out again this month instead of just placing it on the bulletin board?

After a day of waiting, I received no response, so I sent the following to the entire board (including Tom):

Does anyone know the answer to this? I didn't get a response from Tom.

According to Civil Code 1363.05(f), all that is really required is posting notice at the pool (unless I'm missing something). Considering that this mailing alone probably runs $150-$200, it seems it would be prudent to do that instead.

http://www.davis-stirling.com/MainMenu/Statutes/CivilCode136305/tabid/879/Default.aspx

I have received no response.

[Update: The other directors, at the April meeting, agreed that stopping the mailing was a good idea, and future agendas will be posted at the pool rather than mailed to homeowners.]

Us vs. Them

At March's open board meeting, the open forum portion of the meeting was dominated by discussion of the budget discussion of cuts to the budget overwhelming demand not to cut items from the budget... Well, that and a desire not to raise assessments.

I'm reminded of a post I wrote back when I left the board in 2007. Specifically, I'm referring to the need to find solutions, not more problems. In my opinion, the association has severely mismanaged its reserves and really, its finances in general, over the past few years. Currently, the association's reserves are just over 20% funded; it has "borrowed" approximately $30,000 from its reserves with no plan to pay it back; and its expenses exceed its revenue by almost $15,000 per year. In the face of all of this, homeowners are still demanding that no services be cut and dues not be raised. It's grotesque in its absurdity, and the disconnect would be hilarious if it weren't leading directly to the bankruptcy of this association.

As if this isn't bad enough, anger at the situation is being directed at the current board and the belt-tightening we all now face as if these problems merely appeared out of thin air and were not a direct result of financial mismanagement by previous boards of directors and the lackadaisical attitude the rest of the homeowners took toward the matter.

To paraphrase Walt Kelly: I have seen the problem, and it is us.

So, let me reiterate a couple of points from that previous post:

A homeowners association is exactly what its name implies. It is an association of owners of a given set of homes. All homeowners have an equal right (and in my opinion, responsibility) to participate. The board merely acts to handle the day to day business of the association and see that business gets done in the event that homeowners do not participate (usually the result of apathy, of which there appears to be a great amount). Homeowners who don't speak up should not be surprised when the board acts in a manner inconsistent with what they might have done.

and

The board of directors of an association has a fiduciary duty to the association, not its individual members. Decisions are made in the interests of the association. While the board should make an effort to be as accommodating as possible, eventually unpopular action may become necessary. This can have a disproportionately negative effect on individual homeowners, but that does not automatically make the decision a product of malice.

Let me also make a related point, explicitly. With regard to this problem, prior to now there was no "us", and there was no "them". There was only "we", and by "we", I mean every homeowner in this association. We are responsible for the situation in which we find ourselves. The board of directors may have made the decisions that brought us to this point, but none of the rest of us tried to stop them. We are now responsible for and bear the burden of rectifying this situation. The board of directors consists solely of homeowners within this association, and decisions that it makes to cut services and/or raise dues affect its members just as much as they do other homeowners.

We were the problem, and now we must solve it. There will certainly be disagreements about how to go about finding the solution(s), but the only "us" and "them" distinction that now exists is between those who are working toward the solution and those who are not.