Vol. 77, No. 3, March
Advising Developers in Operating Community Associations
Construction problems and financing shortfalls have always plagued
real estate projects, but with condominiums and similar types of
projects, developers have added liability exposure in their
relationships with owners associations. Legal counseling can help smooth
a developer's transition to an owner-controlled project.
by Lisa M. Pardon
ondominium and homeowner associations, also known as
community associations, have gained in popularity in Wisconsin and in
the country. Nationwide, approximately 6,000 to 8,000 new community
associations are developed each year.1 This
flurry of building activity increases the potential for disputes and
litigation. Construction problems and financing shortfalls have always
plagued real estate projects, but with condominiums and similar types of
projects, developers have additional liability exposure in their
relationships with owners associations.
In addition to constructing buildings, to complete a project, a
developer also must form an owners association to manage and operate the
property.2 Generally, these associations are
formed as nonstock corporations. Initially, the developer appoints the
board of directors.3 Eventually, as units
are sold, owners are elected to the board, replacing the
developer-appointed directors.4 An interim
period, known as the period of developer control, commences with the
developer's formation of the organization and ends with the election of
owners to all board positions.5 Developers
of community associations can find themselves in complex relationships
with the projects they develop that can easily turn contentious. Proper
legal counseling can help developers avoid dissension and legal problems
with these associations and facilitate a smooth transition to an
Until the owners take control, the developer is responsible for and
controls all aspects of the project's operations through the appointed
directors.6 Responsibilities include
property maintenance, covenant enforcement, and financial
management.7 Difficulties can arise because,
during this period of developer control, the developer also is still
developing and marketing the project. The developer thus is charged with
the dual aims of promoting sales of its project and governing the
project on behalf of the present and future owners. Of course, the
developer's ultimate goal is to enjoy a return on its investment, but if
this profit is realized at the expense of depriving the owners of a
fully functioning, financially sound, and well-maintained project, then
the developer can find itself in a lawsuit.
Standard of Care for Developers
Courts in many states differ as to whether developers owe a fiduciary
duty to the owners association. Some states have held that developers
owe a fiduciary duty to the owners association in operating the
project.8 The Restatement Third, Property
(Servitudes) section 6.20 suggests that the developer's duty depends on
the particular role it is playing. In the role of a purveyor of real
property, the developer has no fiduciary duty to potential purchasers,
because the developer-purchaser relationship is an arm's length
transaction. However, when in control of the unit owners association,
the developer has a fiduciary duty of care in operating and managing the
project. The basis of this fiduciary duty is found in corporate law, in
which a developer has been likened to a promoter of a
corporation.9 As a promoter, the developer
must not do anything that hinders the viability of the organization it
has created.10 For example, several courts
have held that developers have breached their fiduciary duties when they
have turned over to the owners control of a project that is in a state
of disrepair with underfunded accounts.11
Not all jurisdictions impose a fiduciary duty upon developers. The
Ohio Supreme Court held in Belvedere Condominium Unit Owners' Ass'n
v. R.E. Roark Cos. that developers were not fiduciaries.12 The court reasoned that in light of the
developer's dual role, the court could not impose such high standards of
care because a fiduciary must subordinate its own interests for the
benefit of another. The court recognized that the developer had a
legitimate right to protect its own interest in promoting its project.
Additionally, the majority reasoned that the Ohio Legislature
accommodated for this inherent conflict by providing consumer
protections in that state's condominium statutes, such as the ability of
the owners association to cancel contracts entered into by the developer
and the phasing out of the developer's control. However, one dissenting
justice argued that the majority's decision permits the developer to
engage in self-dealing with impunity while operating the owners
association and doubted that that was the Legislature's
Wisconsin's Condominium Ownership Act (Wis. Stat. ch. 703) contains
provisions similar to those in Ohio for canceling contracts and leases
entered into by the developer and for phasing out the developer's
control.14 Although owners associations in
Wisconsin have brought several suits against developers for breach of
fiduciary duty, there are no published opinions that hold that a
developer owes a fiduciary duty to an owners association. An argument
could be made that a developer should be held accountable for the
negligent operation of the association during the period of developer
control, because the developer has the exclusive right to appoint and
remove directors from the owners association's board during this
Standard of Care for Developer-appointed
Regardless of whether the developer stands as a fiduciary to the
owners association, the developer's appointed directors do have a common
law fiduciary duty to the association as directors of a
corporation.15 The developer-appointed
directors have a duty of good faith and fair dealing to the association
and may be individually liable for breaching that duty.16 Individual directors also may breach their
fiduciary duties for failing to enforce the association's covenants
against the developer or for failing to disclose developer
misconduct.17 Because of these conflicting
loyalties, attorneys for developers should advise their clients to
obtain directors and officers liability
coverage for their board appointees. This is particularly important
when principals of the developer corporation place themselves on the
association's board of directors - as is often the practice - thereby
removing themselves from the protection of the development entity's
corporate shield. In addition, to avoid future claims of conflict of
interest, the developer's attorney should not act as a director of the
Developers can avoid many potential problems with owners associations
if they are advised and prepared to assume a quasi-fiduciary role in
operating the owners association for the owners' ultimate benefit. When
establishing the owners association, attorneys representing developers
should advise them of their various obligations for operations under
Wis. Stat. chapter 703 (if it is a condominium) and under Wis. Stat.
chapter 181 (if it is a corporation). Chapters 703 and 181 both require
organizations to maintain adequate books and records in accordance with
standard bookkeeping procedures.18 Thus,
the developer-appointed board must maintain separate records for the
owners association and not commingle any association funds with
development funds. The developer-appointed board also should establish
bank accounts, budgets, and records separate from those of the
developer's own organization. The directors should hold board meetings,
give appropriate notice to owners of these meetings, and record all
actions of the board in the minutes. Of course, developers and their
board appointees must abide by the project's governing documents,
namely, the declarations, bylaws, and articles of incorporation.
Developers may be unaware that these covenants apply to them as unit
The Importance of Sound Fiscal
In creating a viable organization, the developer should establish a
sound fiscal basis for the association and set realistic maintenance
fees that meet the association's operational needs. Developers often are
accused of fiscal mismanagement or self-serving fiscal policies. Much of
this can be avoided if the developer is advised to differentiate its
development and marketing expenses from the association's maintenance
and operational expenses. The association's governing documents should
reveal what expenditures can be charged to owners as "common
expenses"20 and how these common expenses
will be assessed against the owners. Authorized common expenses
generally are limited to maintenance, repair, insurance, taxes, and
professional services. Developers must apply maintenance fees to the
common expenses and cannot use the owners' funds to complete
construction of the project or for remedial work for defects covered by
the developer's warranties.
Developers often are accused of "low-balling" maintenance fees,
undercharging owners, and subsidizing operations to keep assessments at
an artificially low level to attract sales. In Wisconsin, developers,
real estate brokers, and condominium purchasers alike have all come to
expect that maintenance fees should hover around $100 per month
regardless of the actual costs of operating and maintaining a
condominium project. Often, the maintenance fees are inadequate to cover
the actual costs of operations. Unit assessments are supposed to be
based on that unit's proportionate share of the annual expenses of the
owners association.21 Under Wis. Stat.
section 703.33, developers must disclose the condominium association's
annual budget to unit purchasers. There is a temptation to manipulate
this budget to achieve the low maintenance fees. The danger in doing
this is that it exposes the developer to claims of fraud and
misrepresentation if the developer fails to disclose the actual costs of
operating the condominium.22 A developer's
misrepresentations of the association's financial state will surface
eventually when the owners take over control of the association's
operation and have possession of the association's accounts and records.
These misrepresentations, besides being illegal, can create an
atmosphere of animosity and distrust, which can lead to other disputes
with the owners. Moreover, the developer probably still will have unsold
units after turning over control to the owners, and if the owners
association is having financial difficulties, then this can affect
future unit sales.
Although not yet required in Wisconsin, condominiums in most states
are required to set aside fund reserves for the future maintenance,
repair, and replacement of the project's common elements, such as roofs,
siding, and painting. Even though Wisconsin does not require reserves,
an adequate reserve fund is essential to the financial health of a
community association. It is a good practice to earmark part of the
owners' assessments for future repairs and maintenance and to spread the
cost of major projects over time to avoid having to burden owners with
large, unforeseen special assessments. Although there is no statutory
obligation to fund a reserve account, there are several cases in other
jurisdictions that hold that developers are in breach of their fiduciary
duty to owners associations if they fail to turn over the property in
good condition and fail to provide enough funds in the association's
accounts to remedy the ill condition.23
Maintenance Fees for the Developer's Own Units
Lisa M. Pardon, U.W.
1999, is an attorney in the Madison office of Brennan, Steil &
Basting S.C., practicing in condominium and homeowners association law.
She serves on the board of directors for the Wisconsin chapter of the
Community Association Institute.
Developers also are unit owners and, like other owners, must comply
with the community association's governing documents unless expressly
exempted.24 This includes paying
maintenance fees.25 Developers may relieve
themselves of this obligation if the unsold units have not been
constructed.26 However, this action may
force associations to operate at a deficit, because the unit owners are
responsible only for a set percentage of the common expenses. If the
number of sold units is less than 100 percent and the developer exempts
its own units, then less than 100 percent of the common expenses can be
collected. When drafting the governing documents, the developer's
attorney may wish to consider how the project's operations will be
funded if the developer's units are exempt from assessments.
Courts have been asked to decide whether a developer can offset its
assessment obligations with expenditures made on the association's
behalf.27 In states other than Wisconsin,
this practice has been permitted as long as the expenditures were
documented and could be permissibly charged as a common expense under
the association's governing documents.28
The better practice is for the developer to make timely maintenance fee
payments and to have expenditures paid from the owners association
funds. Otherwise, the developer runs the risk of incurring late charges
on maintenance fee delinquencies and having a lien being placed on its
unsold units.29 Conversely, the developer
needs to be careful if it overpays its assessment obligations to the
association with the expectation of being repaid. Under Wis. Stat.
section 703.10(2)(f), the procedure for borrowing money must be in the
association's bylaws. The developer may face difficulties in getting
reimbursed if it did not follow the procedures set out in the bylaws.
Borrowing procedures should be considered at the project's drafting
stage if the developer intends to lend the association its initial
Regardless of whether Wisconsin courts find that developers owe a
fiduciary duty to owners associations, developers can avoid many
potential conflicts with owners if, from the moments of it inception,
the owners association is regarded as a separate entity from the
development entity. The developer also should be advised that the sound
operation of the owners association during the period of developer
control is essential to the project's overall success and to reducing
claims by owners. Good operation of the owners association contributes
to the project's reputation as a desirable place to live, which
ultimately benefits the developer in selling the remaining unsold
Lisa M. Pardon, U.W. 1999, is an attorney in the Madison office of
Brennan, Steil & Basting S.C., practicing in condominium and
homeowners association law. She serves on the board of directors for the
Wisconsin chapter of the Community Association Institute.
2Wis. Stat. §
3Wis. Stat. §
4Wis. Stat. §
5Wis. Stat. §
6Wis. Stat. § 703.15.
8See Hampton Ridge
Homeowners Ass'n v. Marrett Property Ltd., 265 Ga. 655, 460 S.E.2d
790 (1995); Raven's Cove Townhomes Inc. v. Knuppe Dev. Co., 114
Cal. App. 3d 783, 171 Cal. Rptr. 334 (1981); Maercker Point Villas
Condo. Ass'n v. Szymski, 275 Ill. App. 3d 418, 655 N.E.2d 1192,
9See Duncan v.
Brookview House Inc., 262 S.C. 449, 205 S.E.2d 707 (1974);
Rafalowski v. Old Country Road Inc., 719 A.2d 84, 45 Conn.
Supp. 341 (1997).
10See Maercker Point
Villas, 275 Ill. App. 3d 418.
see also Concerned Dunes West Residents Inc. v.
Georgia-Pacific Corp., 349 S.C. 251, 257, 562 S.E.2d 633, 637
1267 Ohio St. 3d 274, 617 N.E.2d
13Id. at 292, 617 N.E.2d
14Wis. Stat. §§ 703.35,
15See, e.g., Rose v.
Schantz, 56 Wis. 2d 222, 201 N.W.2d 593 (1972).
16Raven's Cove, 114 Cal.
App. 3d 783.
17Pebble Cove Homeowners'
Ass'n v. Shoratlantic Dev. Co., 191 A.D.2d 544, 595 N.Y.S.2d 92
18Wis. Stat. §§ 703.20,
Osterndorf, 87 Wis. 2d 525, 275 N.W.2d 154 (1979).
20Wis. Stat. §
21Wis. Stat. §
Shepard/Legan/Aldrian Ltd., 350 N.W.2d 741 (Wis. Ct. App. 1984)
23Concerned Dunes, 349
S.C. 251; Goddard v. Fairways Dev. Gen. Partners, 310 S.C. 408,
426 S.E.2d 828 (Ct. App. 1993).
24LeFebvre, 87 Wis. 2d
25Aluminum Indus. Corp. v.
Camelot Trails Condo. Corp., 194 Wis. 2d 574, 535 N.W.2d 74 (Ct.
27See LaFreniere v.
Fitzgerald, 669 S.W.2d 117 (Tex. 1984); Battery Homeowners
Ass'n v. Lincoln Fin. Resources Inc., 309 S.C. 247, 422 S.E.2d 93
29Wis. Stat. § 703.1