Now What? Association Use of Construction Defect Settlement Funds

Written by Partner Shane Fleener

Published in CAI RMC Common Interest Magazine September 2016 Issue

 

Congratulations, your Association has completed a construction defect lawsuit and recovered funds through settlement or judgment.  So now what?  The answer seems simple: the Association should use those funds to repair the defects.  While true, the answer is not so black and white.  There are additional factors and considerations that should be taken into account, including accounting and tax issues, the Association’s legal obligations, and repair priority.  Because every case is different, it is impossible to provide one-size fits all outline on how an Association in this position should proceed.  However, this article is intended to provide a general overview of common issues that Associations should consider.

Accounting and Taxes: Obviously, the settlement funds need to be received before any repairs can be made.  It is important that the Association deposit the settlement funds in a separate, and newly created, bank account designated solely for repairs.  The funds should not be commingled with the Association’s general operating account or reserve account and should only be used to make repairs.  By following this simple step, the settlement funds will avoid taxation.  As with any other account, the funds will also gain interest, further benefiting the Association.

Legal Obligation to Make Repairs: I’m often asked if an Association has a legal obligation to spend settlement funds on the defects involved in the lawsuit.  Again, the answer is not black and white.  There is no specific Colorado law mandating that an Association use settlement funds to repair the defects involved in the claim.  However, generally speaking, Association board members owe their members a fiduciary duty.  Further, Colorado’s Common Interest Ownership Act (“CCIOA”), as well as the governing documents for nearly all Associations, place common area repair and maintenance responsibilities upon the Association.  Therefore, Associations should – to the extent possible – use settlement funds to repair the defects.

Making repairs involves many decisions: How should the repairs be made; who should make the repairs; what repairs should be made first vs. last; when should repairs be made . . . the list goes on.  While this might sound intimidating, all of these decisions are subject to the discretion of the Association’s officers and, with the help of your attorney and experts, can be made with confidence and protection under Colorado law.   Board members that were not appointed by the Declarant are not only protected by the business judgment rule, but also CCIOA’s limitations on personal liability and the reality that the owners have agreed to be bound by the decisions of the Association’s board.  Pursuant to CCIOA: “no member of the executive board and no officer shall be liable for actions taken or omissions made in the performance of such member’s duties except for wanton and willful acts or omissions.” C.R.S. § 38-33.3-303(2)(b).

Repair Triage: With legal considerations behind us, the Association must now consider the order and timing of repairs.  In essence, this is a triage prioritization process that should involve communication with your counsel.  Generally speaking, the first items that should be repaired are those presenting life-safety concerns, such as fire suppression defects, structural concerns, mold mitigation, trip hazards, etc.   Defect that present immediate damage concerns, such as active water leaks, should also be at the top of the repair priority list.  After those defects have been addressed, attention can be focused on the other, less-time-sensitive, items.  Exactly what those items are, and the order in which they should be repaired, will vary greatly from case to case.

Now whether you are a board member or a manager you should understand and be able to guide the decision-making process on what to do with your associations money received from a defect case.  Every case and association is and will be different depending on the outcome and the issues in the community.  It is important to utilize your attorney and experts through this process; they are here to help the association every step of the way, from start to finish.

 

Shane has been guiding Associations through the settlement process and aftermath since 2006.