Transition of Association Governance from Developer to Unit Owner Control
Legal Requirements and Checklist
Developer transition is the process by which governance over a condominium unit owners’ association (“condominium association”) is transferred from condominium developer to unit owner control. Below is an overview of the legal requirements in the District of Columbia that govern this transition process as well as a “transition checklist” for unit owner-elected boards of directors that have recently transitioned from developer control.
TRANSITION LAW OVERVIEW
PERIOD OF DEVELOPER CONTROL
A developer initially controls a condominium association because it owns all unsold units in the newly created condominium. As such, the condominium developer has the controlling votes associated with majority ownership and can appoint its own employees as the initial members of the board of directors and thereby control how the association conducts its affairs. This is referred to as the “period of developer control,” during which the condominium developer makes all decisions on behalf of the condominium association.
The developer also creates a condominium association’s governing documents allowing it to dictate, subject to applicable law, the procedures and time periods under which control over the association’s board of directors is ultimately transferred to the unit owners.
In Washington DC, condominium developers are authorized by statute to control the operations of a condominium association and appoint officers and board members during the period of developer control. District of Columbia Condominium Act (“DC Condo Act”) §42-1903.02(a) and (c).
THE TRANSITION MEETING
In the District of Columbia, a transition meeting to allow the unit owners to elect all members of the board is held following the end of the developer control period. DC Condo Act §42-1903.01(b). Generally, the period of developer control will end by statute upon the earlier of the following two events: (1) units representing 75% of the undivided interests in the common elements have been conveyed by the declarant to purchasing unit owner; or (2) three years from the date the first unit is conveyed by the developer to a purchasing unit owner (two years for non-expandable condominiums). DC Condo Act §42-1903.02(a).
OVERLAPPING TERMS OF DEVELOPER-APPOINTED BOARD MEMBERS
Under the DC Condo Act there can be overlapping terms of developer-appointed and unit owner-elected board members during the period of developer control.
Two special meetings must be held in order to allow non-developer unit owners to elect up to 1/3 of the board membership. These elections occur when approximately 25% and 50% of the units at the condominium have been conveyed. These elections can result in overlapping terms of developer-appointed and unit owner-elected board members during the period of developer control. DC Condo Act §42-1903.02(d)(1). Once the period of developer control ends, the entire the board membership is elected by the unit owners. DC Condo Act §42-1903.01(b)
TERMINATION OF CONTRACTS
Certain contracts entered into by the developer on behalf of the condominium association during the period of developer control may be terminated without penalty upon not less than 90 days’ written notice. DC Condo Act §42-1903.02(b)(1). These include association contracts with developer affiliates, management contracts, employment contracts and agreements to lease parking spaces. DC Condo Act §42-1903.02(b)(1).
TRANSITION CHECKLIST
Below is a transition checklist for the initial, unit owner-elected board of directors once it assumes control of a condominium association following the period of developer control.
1. Document/Asset Inventory & Request
Conduct an inventory of the unit owners’ association’s documents and assets. Make a formal written request of the condominium developer to turn over all documents, funds and assets to the extent not already done so. Appendix A below contains a list of items taken from the Maryland Condominium Act that can be used as a guide in determining what if anything needs to be requested from the developer.
2. Contract Review
Review all contracts entered into during the period of developer control. Obtain competitive proposals from vendors for comparison purposes. Contracts that are not in the best interest of the condominium association can be terminated, without liability, under the DC Condo Act by providing 90 days advanced notice.
3. Audit Financial Records
Have an independent auditor examine and audit the association’s financial records during the period of developer control to ensure that all monies were properly collected and accounted for. For example, an auditor can determine whether the correct amount of assessments were collected, whether the association’s reserve accounts were properly funded, or whether there was any inappropriate use of association funds to pay developer obligations. In some cases, an auditor may determine that the condominium developer owes the association a substantial amount of money.
4. Transition and Reserve Studies
Obtain transition and reserve studies in order to identify construction defects and determine whether the developer-created budget and reserve account are adequate to maintain, repair, and replace the condominium common elements over time. For example, if a common element roof is found to be in need of immediate replacement because of construction deficiencies, then a developer-created reserve budget based on a projected roof replacement in 30 years is grossly insufficient.
a. The Transition Study: The purpose of a transition study (also referred to as a “deficiency report” or “warranty analysis”) is to evaluate construction and identify construction defects while warranties are still enforceable so construction defects can be submitted to the developer for warranty repairs. Timely transition studies are essential because defects in newly constructed condominiums may not be apparent when unit owners first take control of the association. Defects in the original construction can remain hidden for years until they manifest themselves in the form of property damage. Left undiscovered and unrepaired, even minor construction deficiencies can result in extensive property damage requiring associations to borrow money and assess unit owners. Moreover, when defects are not identified in a timely manner, warranty rights may be barred by expiration of warranty periods or statute of limitations. Architectural and engineering firms can identify construction defects early on and investigate suspicious conditions before warranty rights expire so timely notice can be given to the developer. Once defects have been identified and then corrected by the developer, the condominium association can establish an accurate reserve budget.
b. The Reserve Study: A reserve study does not seek to evaluate construction. Rather, its purpose is to determine the amount of annual assessments that should be placed into a reserve account to pay for future repair or replacement of the major community components for which the association is responsible, such as roofs, exterior walls, elevators, etc. A normal useful life, or “life expectancy,” is assigned to each of these components (e.g., a 30-year roof), as well as an estimated cost to repair or replace those components at the end of their useful life. Based on these projections, a reserve analyst estimates the amount of money that the condominium association should allocate to its reserve account each year so that the necessary funds will be available for future repairs and replacement. This type of planning avoids a one-time huge assessment for major repair/replacement projects.
5. Retain Legal Counsel
a. General Counsel: Retain general counsel to work with the board members and its management company handling a the wide variety of general legal issues that face a Washington DC condominium association, such as interpreting governing documents, preparing legal opinions, delinquent assessment collection, contract negotiation, dealing with threatened litigation, amending governing documents, etc.
b. Warranty/Construction Defect Legal Counsel: Request a free consultation from an attorney with expertise in condominium construction defect law. Such an attorney can advise the association when applicable warranties and other legal claims expire and how to preserve the association’s legal claims while negotiating proper repairs with the developer. Armed with such information, a transitioning condominium association board of directors can make informed decisions. This legal consultation should be requested as soon as the unit owner-elected board assumes control of the association to ensure that no warranty and other legal rights are allowed to expire.
6. Review Insurance Coverage
Review association insurance coverage obtained during the period of developer control. Make sure coverage complies with governing documents, industry standards, and applicable laws (e.g., property insurance, comprehensive general liability insurance, fidelity insurance, directors & officers/errors & omissions policy). In the event of a lawsuit, having proper coverage will not only provide the association with a legal defense and pay any judgment, but can also provide immunity to directors and officers and cap association liability to the amount of insurance coverage.
7. General Housekeeping Matters
There are a number of housekeeping matters not covered by this checklist involving condominium governance and business that will need to be addressed by the first board to transition from developer control. A condominium association’s property manager and/or attorney typically guides the board in these matters. Some examples include: selecting officers (President, Vice President, Secretary and Treasurer); appointing committees (e.g., architectural review committee); scheduling meetings required by the governing documents; defining maintenance obligations and establishing a maintenance schedule; updating contact information for government agencies, utilities and vendors; amending developer-created governing documents and promulgating new rules and regulations based on the needs and concerns of the unit owner-controlled association; updating resale certifications to ensure they comply with applicable law; etc.
APPENDIX
Documents & Assets To Request from Developer
- Articles of incorporation, recorded declaration, and all recorded covenants, bylaws, plats, and restrictions of the condominium
- All books and records, including financial statements, minutes and completed business transactions
- Policies, rules, and regulations
- The financial records from the date of creation to the date of transfer of control, including budget information regarding estimated and actual expenditures by the condominium and any report relating to the reserves for repairs and replacement of common elements
- All contracts to which the condominium is a party
- The name, address, and telephone number of any contractor or subcontractor employed by the condominium
- Insurance policies in effect and all prior insurance policies
- Any permit or notice of code violation issued to the condominium by the county, local, State, or federal government
- Any warranty in effect
- Drawings, architectural plans, or other suitable documents setting forth the necessary information for location, maintenance, and repair of all condominium facilities
- Individual owner files and records, including assessment account records, correspondence, and notices of any violations
- A roster of current unit owners, including mailing addresses, telephone numbers and unit numbers
- The condominium funds, including operating funds, replacement reserves, investment accounts and working capital
- The tangible property of the condominium
NOTE ABOUT AUTHOR: Nicholas D. Cowie is a partner in the law firm of Cowie Law Group, P.C. and has been representing condominium associations for over 25 years. Mr. Cowie is licensed in Maryland and Washington DC and has extensive experience representing condominiums with developer transition issues including construction defect claims and financial disputes involving developer collection, payment and allocation of condominium assessments and fees.
NOTE ABOUT TERMINOLOGY:
The term “developer” is used in this article to describe the person or entity that creates the condominium association. “Developer” is the terminology often used for this purpose. The District of Columbia Condominium Act, however, refers to a developer as a “declarant” because it is the person or entity that files the condominium declaration necessary to create a condominium.
The term “condominium association” is used in this article to describe the organization or entity that governs the affairs of the condominium in accordance with the condominium bylaws and declaration, and whose members consist of all condominium unit owners. “Condominium association” is the terminology commonly used for this purpose. However, the District of Columbia Condominium Act refers to a condominium association as a “unit owners’ association.”
The term “board of directors” is used to refer to the administrative entity made up of board members that have authority under the condominium bylaws and declaration to act on behalf of the condominium association. The District of Columbia Condominium Act refers to a board of directors as an “executive board.”