MCL 559.201 AND MICH ADMIN R 559.511: IS YOUR RESERVE FUND UNDERFUNDED?

Introduction

In Michigan, the laws related to the governance of the formation and operation of condominium projects are found in the Michigan Condominium Act (the “Act”), MCL 559.101, et seq. MCL 559.205 of the Act requires a condominium association to maintain a “reserve fund,” to be set aside for major repair and replacement of the common elements. MCL 559.205 provides:

A reserve fund for major repairs and replacement of common elements shall be maintained by the associations of co-owners. The administrator may by rule establish minimum standards for reserve funds.


(emphasis added).

Michigan Administrative Code R 559.511(1) further provides:

The bylaws shall provide that the association of co-owners shall maintain a reserve fund for major repairs and replacement of common elements in accordance with section 105 of the act. The co-owners association shall maintain a reserve fund which, at a minimum, shall be equal to 10% of the association’s current annual budget on a noncumulative basis.


(emphasis added).

Moreover, in determining the amount of reserve, the condominium administrative rules require the condominium bylaws to contain the following language:

The following statement shall be contained in the bylaws: “The minimum standard required by this section may prove to be inadequate for a particular project. The association of co-owners should carefully analyze their condominium project to determine if a greater amount should be set aside, or if additional reserve funds should be established for other purposes.”


R 559.511(4) (emphasis added).

However, maintaining only the bare minimum amount in the reserve fund could fail to adequately prepare an association for potentially costly expenses for major repair and replacement of common elements.  Relying on the minimum threshold may cause the association to impose a large assessment to offset the expense.  A sudden and dramatic increase in assessments could cause severe financial hardship on the association and the co-owners. Properly funding the reserve is an integral part of administering the affairs of the association.

As stated in MCL 559.511(4), the condominium project should be carefully analyzed in determining an appropriate balance for the reserve fund. The Michigan Court of Appeals has stated that when establishing an annual budget, the board of directors  must consider the, “creation of an adequate ‘reserve fund’ to cover the depreciation and obsolescence of the project’s capital assets, e.g., to replace such capital items as roofs, sidewalks, driveways, etc.”  Newport W Condo Ass’n v Veniar, 134 Mich App 1, 6–7, 350 NW2d 818, 820 (1984)(emphasis added). Accordingly, the age, condition, and type of common elements of the association are factors in determining the proper balance of the reserve fund.

The existence of certain common elements in a condominium could affect how the reserve fund should be maintained. For example, an association that is responsible for the repair or replacement of a common element like a community pool or clubhouse will have different needs than an association that does not have an obligation to repair or replace these types of common elements. Moreover, an older built association is more likely to face imminent repair and replacement of common elements than a newer built association. A helpful tool in probing the adequacy of the reserve fund is by conducting a reserve study. A reserve study considers the physical condition of the common elements as well as the projected expense in repairing and replacing the common elements.

Under the Standards of Practice adopted by the Association of Professional Reserve Analysts (the “APRA”), reserve studies are comprised of a physical analysis and a financial analysis. The physical analysis involves an on-site inspection of the condominium wherein common elements are inventoried and assessed. The assessment is based on the common elements’ physical condition to “estimate the general condition of systems and components and their repair, replacement, or restoration needs beyond that which can be performed as an operating expense.”  APRA, Standards of Practice, Part II, §1. The financial analysis is the evaluation and analysis of the association’s reserve income and expenditures. Id. at Part I(C).  A funding plan based on the financial analysis is issued to assist the association reach its reserve fund goal. The funding plan “recommends an appropriate reserve contribution,” and typically recommends the contribution be made monthly. Id. It is generally recommended that a reserve study be performed every 3 to 5 years. To minimize costs, after an initial on-site inspection has occurred, the association may choose to have an updated reserve study performed without an on-site visit.

Conclusion

While R 559.511(1) requires that each association maintain its reserve fund with a balance at least equal to 10% of the annual budget, this minimum threshold is often insufficient to fund a major repair or replacement of a common element. Failure to maintain a properly funded reserve could result in significant financial hardship for the association and the co-owners alike. As each association is unique, there is no bright line rule as to how much money should be kept in the fund to prepare for such an expense. As stated in R 559.511(4), a careful look should be taken at the individual condominium project. It is necessary to make a comprehensive assessment of an association’s unique obligations and needs when determining the proper balance of its reserve fund.