Common Interest Ownership Act
Reserve claims under the Minnesota Common Interest Ownership Act
Laura N. Maupin
July 1, 2010
Since 1994, the Minnesota Common Interest Ownership Act (MCIOA), Minn. Stat. Ch. 515B, has provided statutory governance for planned communities such as condominium and townhouse developments. Before the housing bubble burst, there was explosive growth in the development and construction of these planned communities, and therefore a corresponding rise in residential construction defect litigation involving planned communities. Though residential construction defect litigation traditionally settles early, cheaply and with minimal discovery, planned community cases have increasingly been prolonged and complicated by the addition of the “reserve claim” against the developer / builder.
Under Minn. Stat. § 515B.3-114, the declarant, or the person creating a planned community (usually the developer / builder), is responsible for establishing a budget for operation, including “adequate reserve funds” which are funds set aside for the repair or replacement of elements of the community for which the association bears responsibility. Such common elements in a planned community include items such as roofs, boilers, elevators, swimming pool components, balconies, asphalt surfaces, decks and the like.
Reserve claims generally appear in construction defect litigation commenced by the owners’ association against the developer and builder for perceived problems with the site development and construction of the planned community. The reserve claim is presented as an additional count against the developer, separate and distinct from the construction defect claims. The association claims that the developer breached its duty to the association by setting up an association budget that does not collect adequate reserves, resulting in a projected funding deficit for future common element repairs. In support of its claim, the plaintiff typically hires an accounting firm to conduct a “reserve study,” analyzing major common area repair and replacement expenses over time and the reserve contributions (association dues) that would be necessary to pay for those expenses. When the reserve study demonstrates a reserve deficit, the association argues that because the developer breached its duties by setting up an inadequate budget, it is therefore responsible for paying the association the difference between the dues actually collected over time and the dues that should have been collected to properly fund the reserve. This perceived deficit often accrues over a period of several years, and the value of the alleged difference often amounts to hundreds of thousands of dollars.
These reserve claims are alluring for associations, as they provide a potential source of funding for otherwise expensive construction defect litigation. They are problematic for developers, as insurers have historically taken the position that while there may be coverage for the construction defect counts of the litigation, there is no coverage owed for the reserve claim, and the developer is often a corporate entity with no assets, leading to veil piercing claims against the individuals owning the developing entity. The MCIOA also allows for the award of attorneys’ fees to the “prevailing party” and punitive damages for a “willful failure to comply.” Minn. Stat. § 515B.4-116 (2009). These factors have recently made the reserve claim the tail that wags the construction defect dog in litigation involving planned communities.
Where a reserve claim is made, cases are much more difficult to settle than a typical construction defect claim, both because the association is counting on the reserve claim to fund its attorneys’ fees and because the developer has no assets to fund settlement of the reserve claim. In spite of these problems, these cases have previously settled, often with out-of-pocket contributions by developers worried about a verdict for the full value of the reserve claim and contributions made by insurance carriers concerned about the cost of trial.
Though the statute was enacted in 1994, no reserve claims were ever tried in Minnesota until February of this year, when Historic Ridgewood Condominium Association Inc. v. 522 Ridgewood AG LLC, et al., 27-CV-09-501 (Minn. Dist. Ct. 2010) was tried to a jury in Hennepin County. At the conclusion of trial, the jury awarded the owners’ association a mere 10 percent of the value of the reserve claim presented, a far cry from the bell-ringing verdict that the plaintiffs’ bar anticipated. The parties are currently awaiting a determination as to which party is “prevailing” and whether attorneys’ fees will be awarded to either side.
A few months later, the Minnesota Legislature passed an amendment to 515B.3-114, providing clarification of the method to be used for determining “adequate reserve funds.” It requires the replacement reserves be kept in an account separate from the association’s operating funds, and prohibits the use of or borrowing from replacement reserves to fund the association’s operating expenses. The association is also required to reevaluate the adequacy of its budgeted replacement reserves at least every third year after the recording of the declaration. None of these requirements were present in the prior version of the statute. The amendment did not add a requirement that the declarant conduct a reserve study at the inception of the development. This statutory change helps clarify the developer’s duties in establishing the association budget, though the amendment does not go into effect until the fiscal year commencing on or after Jan. 1, 2012.
The reserve claim is still a problem for developers in planned community cases because of the possibility of exposure without insurance coverage and the threat of attorneys’ fees. But the low-value Hennepin County jury verdict, coupled with the recent statutory amendment providing guidance as to the duty owed in establishing budgets will likely make these claims less attractive to associations, as they can no longer be pitched as a reliable means of funding the construction defect litigation. These two events are almost sure to devalue the reserve claim, docking the tail that has wagged the dog in planned community construction defect litigation.
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