Transparency breeds Legitimacy: 3 Tips for your Condominium Association to Avoid a Lawsuit

Kevin Hirzel_8x10@300Many condominium board members volunteer to serve their condominium association for altruistic purposes. While often well intentioned, it is not uncommon for board members to not have any training that would make them aware of potential pitfalls that commonly entangle a condominium association in litigation. In other instances, co-owners may have self-interested motives for serving on a board that cloud their business judgment. Under either scenario, a condominium association can be subject to a lawsuit if it is not operated properly. As will be discussed below, lack of transparency is one of the most common reasons for co-owner lawsuits against condominium associations. The three most common reasons for a lawsuit against a condominium association related to transparency issues are 1) failing to prepare adequate financial statements 2) failing to respond to requests to inspect the books and records of the condominium association and 3) failing to hold elections.

Failing to prepare adequate financial statements

One of the most common sources of angst for co-owners is not knowing how their assessments are being spent. Accordingly, the first step to keeping co-owners happy is to prepare financial statements on an annual basis and have them audited or reviewed. MCL 559.157 requires a Michigan condominium association with annual revenues in excess of $20,000 to have its financial statements independently audited or reviewed by a certified public accountant on an annual basis. A condominium association may opt out of having a CPA perform an audit or review of the books, records and financial statements if a majority of the co-owners approve not having the CPA perform the audit or review. However, unless such a vote is conducted, a condominium should ensure that an audit or review is performed, and not just a compilation.

Additionally, MCL 559.154(5) of the Michigan Condominium Act and MCL 450.2901 of the Michigan Nonprofit Corporation require a condominium to prepare a financial statement for the preceding fiscal year and distribute the same at least once a year. While MCL 559.154(5) indicates that the contents of the financial statement can be defined by the condominium association, MCL 450.2901 requires the statements to include, at the very least, an income statement, year-end balance sheet and a statement of the source and application of funds. When condominium associations fail to prepare financial statements, and have them audited or reviewed by a CPA, this often creates concern and suspicion amongst the co-owners. Accordingly, complying with the above requirements demonstrates that the condominium association is being operated in a transparent manner and is recommended to avoid a lawsuit.

Failing to respond to requests to inspect books and records

Another common problem for co-owners is not being able to see how their money is spent. In Michigan, MCL 559.157 of the Michigan Condominium Act requires that the “…books, records, contracts, and financial statements concerning the administration and operation of the condominium” be available for examination by the co-owners at convenient times. MCL 450.2487 of the Michigan Nonprofit Corporation Act also allows for a co-owner, either in person, by attorney, or through another agent to inspect the books and records of the condominium association after providing a written demand. The written demand must describe a proper purpose for the inspection and specify the records that the co-owner desires to inspect. If the request is made by an attorney, or agent of the co-owner, the written demand must include a power of attorney or other writing that authorizes the attorney or agent to perform the inspection. In the event that the condominium association does not permit an inspection within five business days after a demand is received, a co-owner may file an action in the circuit court to compel an inspection of the books and records of the association. A condominium association may place reasonable restrictions on an inspection. However, if a court orders an inspection, a court may also order the condominium association to pay the co-owner’s costs, including reasonable attorney’s fees, unless the association can demonstrate that it had a good faith reasonable basis for the denial. Accordingly, it is extremely important for a condominium association and/or is managing agent to provide a timely response to a request for inspection of records. While inspections can be denied in certain circumstances, it is not uncommon for condominium associations that completely ignore requests to inspect the books and records to be sued.

Failing to elect co-owner directors

MCL 559.152 provides a formula for electing directors when control of the condominium association is transitioned from the developer. MCL 559.152 provides in pertinent part:

(2) Not later than 120 days after conveyance of legal or equitable title to nondeveloper 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 nondeveloper co-owners. Not later than 120 days after conveyance of legal or equitable title to nondeveloper 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 nondeveloper co-owners. Not later than 120 days after conveyance of legal or equitable title to nondeveloper co-owners of 75% of the units that may be created, and before conveyance of 90% of such units, the nondeveloper 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.

(3) Notwithstanding the formula provided in subsection (2), 54 months after the first conveyance of legal or equitable title to a nondeveloper co-owner of a unit in the project, if title to not less than 75% of the units that may be created has not been conveyed, the nondeveloper co-owners have the right to elect, as provided in the condominium documents, a number of members of the board of directors of the association of co-owners equal to the percentage of units they hold and the developer has the right to elect, as provided in the condominium documents, a number of members of the board equal to the percentage of units which are owned by the developer and for which all assessments are payable by the developer.

Often times a new condominium association will not elect directors in compliance with the timelines set forth above. Moreover, even after control of the association is transitioned from the developer to a co-owner board, co-owners do not always hold regular elections despite being required to do so. MCL 450.2402 provides as follows:

A corporation shall hold an annual meeting of its shareholders or members, to elect directors and conduct any other business that may come before the meeting, on a date designated in the bylaws, unless the shareholders or members act by written consent under section 407 or by ballot under section 408 or 409…. If the annual meeting is not held on the date designated for the meeting, the board shall cause the meeting to be held as soon after that date as is convenient. If the annual meeting is not held for 90 days after the date designated for the meeting, or if no date is designated for 15 months after formation of the corporation or after its last annual meeting, the circuit court for the county in which the principal place of business or registered office of the corporation is located,…may summarily order that the corporation hold the meeting or the election, or both….

In certain circumstances, whether due to co-owner apathy or a desire to maintain control, boards will not have annual elections or will not have fair elections. Accordingly, having regular and fair elections is another good way to keep the co-owners happy and for condominium associations to avoid a lawsuit.

Conclusion

Preparing proper financial statements, responding to co-owner requests to inspect the books and records and having regular elections is essential for a condominium association to run smoothly. While it is certainly possible for co-owners to abuse the above processes, transparency is typically the best policy as it not only keeps the co-owners happy but also keeps the condominium association’s legal fees down.

Kevin Hirzel is a partner in our Livonia and Clinton Township offices and leads the Community Association Practice Group. He frequently represents Builders, Community Associations, Condominium Associations, Cooperatives, Co-Owners, Developers, Homeowner Associations, Investors, Property Owners and Property Managers throughout the State of Michigan. He may be reached at (734) 261-2400 or khirzel@cmda-law.com.

Please view The Michigan Community Association Law Blog at http://micondolaw.com for additional resources on Michigan Community Association Law.