Transition 7-6-17

Understanding the Process of Transition from Declarant to Homeowner Control

The transition process from declarant to homeowner control can be a stressful time for an association. However, having a better understanding of the overall process can help alleviate some of the stress and allow for a successful transition. There are responsibilities the board has and should be aware of so that the transition process can run more smoothly and effectively.

First, it’s important to understand what a transition entails. According to attorney Steven L. Sugarman, of Steven L. Sugarman & Associates of the greater Philadelphia area, “a transition constitutes the turnover of control of the board of directors of a common-interest ownership community.” Sugarman explained that the board of directors changes its composition from being run by appointees of the declarant to being run by homeowners who are elected by the members of the community association. 

However, the concept is often misunderstood, he said. “Unfortunately, it is often viewed simply as a formal passing of a baton from declarant to homeowners. Instead, I think that the success of a community can be enhanced if developers and unit owners view it as more of a growth process or as an evolution, not just a turnover of control, but the process of the declarant completing the improvements within the community and ensuring that the units and the common elements have been completed or repaired properly in accordance with the original plans and specifications,” Sugarman said.

He also added that various committees and sub-committees should be formed during this time period. “All of this should happen early on as opposed to the back-end of the process when the statutes mandate the turnover,” noted Sugarman. Doing so, he said, will not only benefit the community association and its members, but also the declarant.

According to Sugarman, the board of directors, whether run by homeowners or declarant appointees, is governed by a fiduciary responsibility to act in the best interest of the association. “Therein lies certain complications,” he said, “because the board members appointed by the declarant have to act in the best interest of the association, not in the best interest of the declarant. Even though they may often be employees of, affiliated with or otherwise aligned with the declarant, when they sit on that board of directors of the community association, they owe an express duty of loyalty and a fiduciary obligation to the association, not the declarant. There can be certain inherent conflicts that have to be overcome, by law, once the board members don their hats and become members of the board of directors of the association. They must view themselves as fiduciaries to that entity, and not to the developer-entity,” he said.

Sugarman advised that during the turnover phase, it is prudent for the newly-constituted board to retain third-party professionals to assist in evaluating the condition of the community. He explained that the condition of the common elements should be evaluated as part of the new board’s due diligence and that the board should note any construction deficiencies which may need to be remedied by the declarant. In addition, the board should also evaluate the financial condition of the community to determine if there are sufficient funds in the reserve accounts and whether common expense assessments have been properly established and collected by the original, declarant-controlled board.  

Therefore, Sugarman said, the association should consider retaining an engineering firm to address the engineering concerns, a transition auditor to assess the financial affairs and legal counsel to assist in the evaluation of all of those aspects so that the board can properly fulfill its fiduciary obligations.

Additionally, a number of other professionals should be retained by the new board of directors. For example, the board ought to confer with an insurance agent as part of its due diligence to make sure that proper insurance coverages are in effect, said Sugarman. Typically, the declarant-controlled board will have already obtained certain insurance, but it’s important for the homeowner-controlled board to ensure that proper Commercial General Liability (CGL) and Directors and Officers (D&O) coverages are in place. 

“Under Pennsylvania statutes, it is especially important that the association maintains adequate insurance,” said Sugarman. He explained that under the Uniformed Planned Community Act and the Uniform Condominium Act in Pennsylvania, any judgment entered against an association which is not satisfied by sufficient insurance proceeds serves as an automatic lien on every unit within the community.

As far as how long the transition process typically takes, Sugarman said it can vary between several months to several years depending on the financial and construction-related conditions of the association and the approaches taken by the parties.  “It’s variable because so much depends on what roots the developer may have already put in place, which is why I’m a big advocate of starting this process early on and seeing it nurtured and developed over time,” he noted.

According to Sugarman, most of the turnovers take place based on the statutory mandate, which in Pennsylvania is usually after 75 percent of the units are sold.  Shortly after that percentage of sales is reached, the declarant-controlled board must hold an election meeting for the purpose of establishing the homeowner-controlled board. The newly elected board then engages in the condition evaluation and required due diligence. If the declarant has properly handled all of the affairs of the association, the transition process will take less time than if the declarant has not done so or if construction deficiencies have been found. 

“More often than not, the transition is viewed as a date certain that’s mandated by state statute for the control to be transferred from the declarant to the homeowners. Too frequently, and as a general rule, that transition only occurs at the very last date that’s required,” said Sugarman. 

However, there is nothing that prohibits the process from beginning before the mandated date arrives, he noted. Sugarman said he believes that the turnover of control to the homeowners before the statutory mandated date is reached is in the best interests of the association and can also help the declarant avoid conflicts of interest. This would permit the community members to begin governing their association as well as permit the developer to continue to build, market and sell homes. “Having control vested in the homeowners earlier on in the process preserves and protects the interests of both parties,” noted Sugarman. 

It also enables the association to identify certain issues, whether construction-related or financial, while the developer is still building homes and has an interest in taking steps to remediate them rather than these problems being addressed after the developer is no longer working on the site, Sugarman added. “It breeds a better environment in which the parties can engage in a fruitful discussion, rather than limiting any discourse to the far back-end of the development process,” he said. 

Once the transition process is complete, it is typically finalized through the negotiation of a transition settlement agreement that runs between the association and the declarant, noted Sugarman. “The best way to effectuate the divorce between the association and the declarant would be to enter into a written agreement which memorializes the terms and conditions of any settlement, as it creates a certain finality to the process,” he said. However, Sugarman explained that there is no legal requirement for the parties to enter into such an agreement, but it is a prudent practice to do so and clearly defines the consummation of the transition process.  

Additionally, there is no legal requirement that the unit owners be formally notified of the completion of the transition process. “However, it is certainly good practice for an association board to be transparent and disclose to the unit owners what’s going, especially regarding the resolution of any disputes with the developer/declarant incident to the transition,” said Sugarman. He suggested that the association should consider hosting an informational meeting, where the community members can be apprised of what the board is doing or has done with regard to the transition process, and at which the board and any third-party professionals who provided assistance throughout the process could be available to answer questions from the members.  These kinds of meetings, explained Sugarman, go a long way toward keeping the members informed and achieving a successful transition process.

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