Every community association in Michigan undergoes a transition or “turnover” phase whereby the control of the community association changes from developer control to owner control. In Michigan, the transition process for condominiums is governed by the Condominium Act, MCL 559.110, et al. Unfortunately, homeowner associations are not included in the Condominium Act and are solely governed by the terms in the homeowner’s association documents. Therefore, this article focuses on the transition from developer control to non developer co-owner control within a condominium project and practical steps each new Board of Directors should take before, during and after the transition. While the transition process may, at times, be somewhat complicated, the successful transition from developer control to owner control is crucial to the future success of a community association in Michigan.
Era of Developer Control
When a condominium is initially constructed, the developer commits significant resources and capital to construct the project, amenities and infrastructure. During the initial construction phase of the condominium, the developer and its appointees serve as members of the Board of Directors. MCL 559.152(1). The Board must act as fiduciaries to the community association by acting “in good faith and with the degree of diligence, care, and skill that an ordinarily prudent person would exercise under similar circumstances in a like position.” MCL 450.2541.
Unfortunately, there is an inherent conflict of interest when certain decisions may benefit the entire community association, but those decisions have a negative impact on the developer’s bottom line. The developer is primarily concerned with building and selling units as quickly as possible in order to maximize its profits. Due to the recent economic downturn, many developers have further problems with tighter budgets, less liquidity, reduced access to commercial markets, reduced workforces, and related problems that also may impact the quality of the construction work. Given this inherent conflict of interest, the transitioning to nondeveloper co-owner control has a heightened importance for co-owners.
Era of Non Developer Co-Owner Control
In a perfect world, the transition away from the developer takes place gradually and smoothly and any issues are resolved cooperatively and efficiently. Pursuant to MCL 559.110(7), the transitional control date means the “date on which a board of directors for an association of co-owners takes office pursuant to an election in which the votes that may be cast by eligible co-owners unaffiliated with the developer exceed the votes which may be cast by the developer.” MCL 559.152(2) outlines the specific timing requirements for how the transition must take place including specific milestones at 25%, 50%, 75% and 90% of the units conveyed to non developer co-owners. MCL 559.152(2) states:
Not later than 120 days after conveyance of legal or equitable title to non developer co-owners of 25% of the units that may be created, at least 1 director and not less than 25% of the board of directors of the association of co-owners shall be elected by non developer co-owners. Not later than 120 days after conveyance of legal or equitable title to non developer co-owners of 50% of the units that may be created, not less than 33-1/3% of the board of directors shall be elected by non developer co-owners. Not later than 120 days after conveyance of legal or equitable title to non developer co-owners of 75% of the units that may be created, and before conveyance of 90% of such units, the non developer co-owners shall elect all directors on the board, except that the developer shall have the right to designate at least 1 director as long as the developer owns and offers for sale at least 10% of the units in the project or as long as 10% of the units remain that may be created.
While the statute provides for various other requirements, the basic premise is as the project progresses, more and more control is given to the non developer co-owners. In the real world, a gradual and smooth transition is not always possible and problems during this crucial phase can reverberate throughout the community association for years to come.
The co-owners should take control of the Board of Directors as quickly as possible so that the association can focus on the co-owners’ interests instead of the developer’s interests. Below are five essential steps each Board of Directors should immediately take upon transition of control:
- Perform an Initial Audit of the Documents Provided By the Developer. The Board should have all association books and records including, but not limited to, the following: 1) any original, recorded documents such as the Master Deed and Bylaws; 2) any declarations or disclosure statements; 3) the Articles of Incorporation and any amendments; 4) a complete set of the Board’s Meeting Minutes; 5) any and all Rules and Regulations; 6) all accounting information including any audits performed by the developer; 7) any and all escrow accounts or funds; 8) a current operating budget and all previous operating budgets; 9) any and all banking accounts and safety deposit boxes; 10) all state and federal tax returns; 11) any and all insurance policies; 12) any and all contracts entered into by the developer; 13) a complete list of all current owners with addresses and any other contact information; 14) any and all site plans including any as-built drawings; 15) a list of all contractors, manufacturers, subcontractors, suppliers involved with the project and any and all warranty information pertaining to same; 16) any documents by the local municipality pertaining to compliance with state statutes and local ordinances; 17) any and all documents related to any past or pending claims and 18) the tax identification number. If the Board of Directors does not have this information, it should work cooperatively with the developer to obtain all of the above documents/information. If the developer is not cooperative or is slow to respond, it may be a sign of additional underlying problems.
- Retain a Competent Certified Public Accountant. Critically important to a successful condominium association is an initial review of the condominium financials by a certified public accountant or an independent auditor competent in auditing community associations. First, the Board should analyze all income and expenses during the developer’s control. Typically, assessments are kept artificially low and do not adequately fund the condominium for the long term. Second, MCL 559.205 and Administrative Rule 511 require a condominium association to maintain a minimum reserve fund that is equivalent to 10% of the association’s current annual budget on a noncumulative basis. Every condominium should make sure this line item is included and often 10% is inadequate to fund capital improvements. Third, consideration should be given as to whether the developer permitted co-owners to become significantly delinquent in paying association dues including the developer itself, if applicable. The Board of Directors should immediately establish a comprehensive collection policy and uniformly enforce the policy to avoid a claim for selective enforcement.
- Hire a Professional Property Management Company. The newly elected Board of Directors should review whether the existing property management company—hired by the developer—is appropriate for the Association. Pursuant to MCL 559.155, the Board may void the management contract with the developer or affiliates of the developer within 90 days of the transitional control date or with 30 days’ notice at any time thereafter for cause. Typically, the management company remains the same after the transition and there are benefits for continuing to utilize the same property management company, however this should be reviewed on a case-by-case basis.
- Hire a Professional Engineer. The Board of Directors should hire a professional, licensed civil engineer or other qualified professional to analyze and inspect all of the common elements of the project including readily apparent construction defects, but also hidden defects such as 1) collapsing retaining walls resulting from improper installation; 2) cracking in the foundation or drywall caused by concealed foundation issues; 3) electrical wiring that is not properly installed within common element walls; 4) flooding caused by improper installation of the underground storm water drainage system; 5) heaving or cracking of concrete porches, driveways or sidewalks due to poor drainage; 6) leaks, mold and other water issues caused by improperly installed roofing, siding, flashing and/or windows; 7) noise related to insufficient insulation and poor sound protection; 8) pipe bursts that result from a failure to insulate common element pipes; 9) premature road failure resulting from failing to test and/or account for soil conditions, improper use of base course materials or drainage issues and 10) missing or improperly installed trusses, which compromise the structural integrity of the roofing and/or building.
The engineer will prepare a report outlining any construction defects, the cause of the defects, a proposed fix, whether any problems are covered by warranty and the estimated cost to fix the problems. The engineering report will assist the Board and the condominium association’s attorney in evaluating the scope of the problems and determining the best course of action. As part of the engineer’s report, the engineer should perform a reserve study which identifies the current status of the association’s financial health and the project’s physical condition. The reserve study informs the property manager, the Board, the Association at large and prospective purchasers of anticipated major expenses in the future. Based on the information from the reserve study, the Board can create a budget to reflect these anticipated costs thereby helping the association plan for the long term. A condominium association should have a reserve study performed every three to five years to ensure that major problems do not arise. In addition, given that the common elements will eventually need to be repaired and/or replaced, frequent reserve studies also ensure that the association’s contractors have not caused construction defects.
- Retain a Community Association Attorney. Typically, the Board of Directors will consult with a community association attorney prior to the transitional control date. Once the transitional control date takes place, the Board of Directors then hires the attorney on behalf of the Association. MCL 559.276 provides an association with three years from the transitional control date or two years from the date that a claim accrues to pursue a construction defect claim arising out of the development or construction of a condominium. A claim for breach of contract against a contractor for a defect that arises from the repair or replacement of a construction defect, typically has a six year statute of limitations. While the statute of limitations could be extended through various theories, such as fraudulent concealment, among others, an association’s odds of success are greatly increased by vigilance of the Board of Directors. In addition, a developer or contractor often defends a construction defect claim by arguing that the defect was caused by natural wear and tear or improper maintenance by the association. Accordingly, the sooner the association takes action, the better the chance of success.
In addition, the attorney will analyze any additional issues with the developer; determine whether the Master Deeds, Bylaws and Rules and Regulations need to be revised; review the collection policy and determine whether collection actions are necessary against delinquent co-owners; review contracts with vendors and address other transitional control issues which may arise. As a practical matter, the first set of governing documents for the new condominium project were created by the developer, for the developer. Thus, reviewing and revising the condominium documents is an important first step for any new Board.
With the appropriate professional team in place, transitioning from developer control to non developer co-owner control can be a seamless process, even when problems arise. Having an educated Board of Directors with qualified professionals assisting in the transition process, a condominium has a greater likelihood for a smooth transition which is crucial to the future success of the condominium.
The team at Hirzel Law, PLC is composed of award-winning real estate attorneys that can offer quality representation for Michigan clients. Regardless of if you are a commercial real estate developer or individual homeowner, our real estate attorneys can help. We fully understand how unique and complex the challenges that our clients may face, and our real estate attorneys are prepared to help in whatever way necessary. Contact Hirzel Law online or call 248-986-2921 (Farmington) or 231-486-5600 (Traverse City) or 616-319-9964 (Grand Rapids) to learn how our Michigan real estate lawyers can help protect your Michigan real estate investment today.