Condominium Association Funds and Capital Projects: Walsh v Hawthorn Hills Owners of Rochester, Inc.
Introduction
Boards of Directors of community associations are often charged with the responsibility of maintaining the capital assets of the corporation and administering the community itself. This responsibility involves difficult decisions regarding the spending and raising of association funds, especially when it comes to capital improvement projects. Recently the Michigan Court of Appeals issued a decision in Walsh v Hawthorn Hills Owners of Rochester, Inc., No. 361768, 2023 WL 4144757 (Mich. Ct. App. June 22, 2023), in which the Court of Appeals upheld a Board’s use of funds for a community-wide street lighting project, even though the project had not been approved by two-thirds (2/3) of the members of the association. In making its decision, the Court of Appeals appears to have relied, at least in part, on the Board’s significant effort to inform the community of the intended expenditure for several years, and the fact that the Board had included the expense in a proposed annual budget that had been approved by well over 51% of the owners.
In short, the Court of Appeals appears to have applied the business judgment rule to avoid getting involved when there was no clear indication that a violation had taken place and the Board had kept the community well-informed. Boards considering capital improvement projects would be well-advised to consider the steps taken by the Board of Directors in Walsh, supra, in order to withstand scrutiny if their own actions are challenged.
The Business Judgment Rule
The business judgment rule plays an important part in any review of board action. Under the business judgment rule, the financial decisions of a board of directors will not be second-guessed, assuming the decision made was within the scope of the board’s authority and made in good faith. In the context of a condominium association, in MJ Development Co v Inn at Bay Harbor, 2017 WL 726591 (Mich Ct App Feb 23 2017), the Michigan Court of Appeals described the business judgment rule as follows:
The business judgment rule limits the judicial review of decisions made by a condominium’s board . . . to whether the board’s actions are authorized, and whether the actions were taken in good faith and in furtherance of the legitimate interests of the condominium. It can be gleaned form the case law that so long as a condominium board acts for the purposes of the condominium, within the scope of its authority and in good faith, the courts will not substitute their judgment for that of the board’s.
Significantly, the business judgment rule will not protect board action if the action exceeds the authority granted to the board of directors under the association’s governing documents. This area often becomes difficult to evaluate when making financial decisions. A board’s financial authority is often reflected in the boards’ responsibility to project the association’s annual expenses. In this respect, boards are often required to prepare an annual budget to both project annual expenses and raise sufficient funds to pay for those projected annual expenses. For example, many associations will have language in their governing documents similar to the language contained in the Bylaws reviewed by the Michigan Court of Appeals in MJ Development, supra, which stated:
The Association shall establish an annual budget in advance for each fiscal year and such budget shall project all expenses for the forthcoming year which may be required for the proper operation, management and maintenance of the Condominium Project, including a reasonable allowance for contingencies and reserves.
Similarly, and also in the context of a condominium association, in Mayes v Colony Farms Condominium Ass’n, 2002 WL 31319695 (Mich Ct App Oct 15, 2002), the Michigan Court of Appeals considered the spending authority of a Board of Directors governed by condominium bylaws which also imposed the obligation to adopt an annual budget on the Board of Directors:
The Board of Directors shall establish an annual budget in advance for each fiscal year. Such budget shall project all expenses for the forthcoming year which may be required for the operation, management and maintenance of the condominium which shall include a reasonable allowance for contingencies and reserves for replacement of common elements. . . .
Under this type of annual budget requirement, a board of directors must project its expenses and then use that projection as a basis for the imposition of annual assessments. A Board’s ability to spend and raise funds is not without its limits, and most community association governing documents will contain some type of limitation on the Board’s authority. Examples of these types of limitations include limitations on both raising funds and spending funds such as: (a) a cap on the total amount of assessments that can be collected; (b) a cap on any annual increase in assessments: (c) a limit on the categories of allowable expenses; (d) a cap on spending for certain categories of expenses; (e) a limitation on assessments to be imposed outside of the normal annual budgeting process; or (f) a requirement that assessments or expenses which aren’t allowed by right be approved by a certain percentage of the members of the association. In many cases governing documents will contain several of these types of limitations, often creating confusion for boards as they try navigate these limitations and raise and spend the funds necessary to administer their community. These limitations often make it difficult to determine the outer limits of board authority to raise and spend funds, making it potentially difficult to determine when it is appropriate to apply the business judgment rule and when it is not.
Determining What is a Special Assessment
In addition, the limitations on spending described above create a tension between the board’s obligation to maintain in good repair the capital assets of the community and the right of the members of the association to prevent frivolous or unnecessary spending. For condominium associations, with respect to the common elements, expenditures often require co-owner approval if an addition to the common elements either (a) exceeds a certain amount, such as a percentage of the annual budget or a fixed number, or (b) if the expense falls into an identified category of expenses such as new capital improvements. Expenditures that do not require co-owner approval are often labeled as “additional assessments” and expenditures that require co-owner approval are often labeled as “special assessments.” Special assessments might only be approved if a certain percentage of owners agree with the expenditure. Both MJ Development, supra, and Mayes, supra, provide considerable guidance for boards by discussing the authority of a board to impose an additional assessment versus a special assessment.
In MJ Development, supra, the board of directors had the authority to impose additional assessments and special assessments for the following purposes, with the threshold difference between additional assessments and special assessment for new capital improvements being whether the cost of such additions to the common elements exceeded $10,000 annually:
(a) Budget: Regular Assessments…. Should the Association at any time decide, in its sole discretion: (1) that the assessments levied are or may prove to be insufficient (a) to pay the costs of operation and management of the Condominium, (b) to provide replacements of existing Common Elements, (c) to provide additions to the Common Elements not exceeding $10,000 annually for the entire Condominium Project, or (2) that an emergency exists, the Association shall have the authority to increase the general assessment ….
(b) Special Assessments. Special assessments, in addition to those required in subparagraph (a) above, may be made by the Association from time to time and approved by the Co-owners as hereinafter provided to meet other requirements of the Association, including, but not limited to: (1) assessments for additions to the Common Elements of a cost exceeding $10,000 for the entire Condominium Project per year. (emphasis added).
In MJ Development, supra, the issue presented related to board’s authority to impose an assessment for fireplace repairs. In conducting its analysis, the Court of Appeals focused on both the purpose of the assessment and the amount of the expenditure, as specified in the language quoted above:
If the fireplace is a replacement, then the Association was within its power to authorize the associated expenses, regardless of the amount. On the other hand, if the fireplace is an addition, whose costs exceed $10,000, then the Association was required to obtain the co-owner’s approval.
In Mayes, supra, the board operated under similar provisions, quoted below, but the threshold distinction between additional assessments and special assessments depended on the purpose of the assessment as opposed to the amount of the assessment:
Should the Board at any time determine in its sole discretion that the assessments levied are or may be insufficient to pay the proper costs of operation, management and maintenance of the condominium project or, in the event of emergencies, the Board shall have the authority to levy such additional assessment or assessments which it deems necessary.
Special assessments in addition to those described above may be made from time to time to meet other needs or requirements of the association, including, but not limited to assessments for capital improvements, or assessments for the purchase of a unit; provided, however, that special assessments shall not be levied without prior approval of two-thirds (2/3) of all co-owners in number. (emphasis added).
In its review, the Court of Appeals Mayes, supra, focused on the purpose of the assessment in order to implement the purpose of the limitations on spending:
However, it is not the amount of the assessment that is controlling, but whether the proposed repairs and replacements fall within the bylaws’ definition of ‘maintenance.’ As noted, the proposed repairs and replacements at issue do fall within that definition.
Both MJ Development and Mayes describe the appropriate analysis in evaluating the authority of the board of directors to impose an assessment. In essence, it is a contract analysis that is intended to evaluate the limits on board discretion to raise and spend funds. To the extent the attempted spending fits within that allowed by the governing documents, the spending would be allowed. However, if the attempted spending (or attempted assessment) fits within the category prohibited or requiring owner approval, then it would not be allowed or would prohibited, depending on the language used.
Walsh v Hawthorn Hills Owners of Rochester, Inc.
Recently, the Michigan Court of Appeals decided the case of Walsh v Hawthorn Hills Owners of Rochester, Inc., No. 361768, 2023 WL 4144757 (Mich. Ct. App. June 22, 2023), which provided additional guidance to boards of directors in Michigan, suggesting that the Court of Appeals’ consideration of assessments and expenditures would include a practical as well as a legal analysis, consistent with the purpose of the business judgment rule.
In Walsh, supra, Hawthorn Hills Owners Association of Rochester (“Association”) governs the affairs of the Hawthorn Hills Community. In December 2017 the Association notified its members of a proposal to increase the association’s annual dues. One of the purposes of the increase would be to fund the installation of streetlights in the neighborhood. The Association then conducted a vote in May 2018 to increase the Association’s budget and 59% of the Association’s members voted in favor of increasing the Association’s annual dues to $350.00. However, while the increase in assessments had been approved by 59% of the members, the street lighting project itself was not approved.
The Association’s Declaration of Restrictions (“Declaration”) provided for the establishment of a general maintenance fund to be funded by the annual dues paid by members of the Association. The Declaration provided that the maintenance fund was to be used for improving and maintaining the common area and any other property of the Association if determined necessary and advisable by the Association. The Declaration originally set the annual assessment at $75, but provided that the assessment could be increased by a vote in favor of “not less than fifty-one percent” of the Association’s members. Section 4.01 of the Association’s Bylaws allowed the Association to use the funds raised under the annual budget for “all anticipated expenditures of a general and reoccurring nature.” Section 4.02 of the Bylaws, however, stated:
Items of expenditure of the Association which are not general and reoccurring in nature shall not be including the annual budget of the Association, but rather shall be deemed to be items of special assessment, . . . and same shall be subject to the written approval of two-thirds (2/3) of the members of the Association eligible to vote.
In 2020 the Association approved the street lighting project as part of the approval of the annual budget for that fiscal year. However, in 2021 an owner filed a lawsuit against the Association challenging the Board’s expenditure for the street-lighting project on the basis that two-thirds (2/3) owner approval had never been obtained under Section 4.02 of the Bylaws. In essence, the plaintiff took the position that new street lights within the community were not a “general and reoccurring” expense in nature and should not have been included in the annual budget.
The Court of Appeals disagreed with the plaintiff and affirmed the trial court’s decision that the street light project was “general and reoccurring in nature”, thus the Association could use the annual budget to fund the expenditure. In approving the expenditure, the Court of Appeals stated:
We conclude the expenditure for street lighting in a residential neighborhood is a general project because streetlights are a common staple within a community and affect the whole community. The streetlights will presumably be used every night, and thus, are not of a temporary or seasonal nature. Additionally, the upkeep and operation of the streetlights will be a reoccurring expense for defendant.
. . .
There is no evidence that residents were asked to pay any additional fees outside of their annual dues for the street lighting project. Therefore, because the expenditure for the project is general and reoccurring, and because the residents of the community were not asked to contribute additional funds outside of their annual dues to finance the project, we conclude that there is no question of fact regarding whether the street lighting project is not a special assessment.
In its decision, the Court of Appeals appears to have considered it significant that the Association had kept the community well-informed of its intentions commenting on the Board’s efforts as follows:
Moreover, the project was included in the proposal for increasing annual resident dues, which was supported by more than 51% of residents, including plaintiff himself. Residents were first notified of the project in December 2017 and were well-informed of the street lighting project during the vote to increase the annual dues in 2018 and during the 2020 annual association meeting.
Conclusion
The business judgment rule states that courts will not interfere with the decisions of boards of directors when those decisions are made within the authority granted to the board of directors and made in good faith. Under MJ Development, supra, and Mayes, supra, courts are to look to the applicable governing documents to determine the scope of authority for the board’s decision. Under Walsh, supra, the Court of Appeals appears to indicate that courts will be reluctant to set aside a board decision when the board keeps the community well-informed of its decision-making process and there is no clear indication that the action exceeds the authority granted to the board.
Matthew W. Heron is a Member at Hirzel Law, PLC where he concentrates his practice in real estate, community association law, condominium law, real estate litigation, and zoning and land use. Mr. Heron also has extensive experience in a variety of litigation matters, including insurance coverage, non-compete agreements, automotive supplier disputes, and breach of contract. He routinely appears in both federal and state courts throughout Michigan and has argued before the Michigan Court of Appeals and the Court of Appeals for the Sixth Circuit.
