Overview

Reserve funds sit in a separate account for a reason. Homeowners pay into that account every month through their regular assessments (or through special assessments aimed at funding reserves), and the money accumulates over years to cover the expensive work that arrives on a predictable schedule, like roofs, pavement, elevators, pipes, and other common area components. While most HOAs (or at least their managers) are aware of at least some of the strict requirements governing HOA reserve accounts, some bad HOAs aren’t. Those HOAs have no idea that the Davis-Stirling Act contains a flat prohibition on spending reserve money outside a defined list of items.

This Fact Sheet identifies the money the reserve restrictions attach to, breaks down each permitted use, and explains the requirement that ties reserve spending back to the components the reserve fund exists to cover. It also identifies the expenses that some HOAs try to charge against reserves that the Davis-Stirling Act doesn’t allow, including the routine operating costs that account for most improper reserve spending in California HOAs.

Homeowners who know what belongs in the reserve account and what can lawfully come out of it can read a financial statement, spot a problem, and act to correct things before the problem grows. That skill matters because reserve depletion rarely announces itself immediately, and instead often shows up years later in the form of a massive special assessment that nobody saw coming (but should’ve).

Key Points

Reserve spending rules come from two places in the Davis-Stirling Act. One defines what money counts as reserve funds. The other limits what HOAs can do with that money once it does. Homeowners who read a financial statement without knowing both provisions can’t tell the difference between an HOA spending reserves correctly and an HOA quietly draining the account for expenses that belong in the operating budget.

• Reserve funds are the monies that an HOA sets aside for future work on the major components it has to maintain. Civil Code 4177 defines reserve accounts to include monies the HOA has identified for use to defray the future repair or replacement of, or additions to, those major components. That definition covers regular assessment contributions the HOA allocates to reserves, special assessments levied to build reserves, and interest the account earns while the money sits there. It also covers a second category that homeowners rarely think about. Money an HOA receives from a construction defect settlement or damage award for injuries to real or personal property qualifies as reserve funds by operation of law, and Civil Code 4177 requires the HOA to itemize those funds separately from everything else in the account.
  • HOAs can’t argue their way out of the restrictions by claiming they never designated the money. Civil Code 4177 defines reserve accounts by reference to money that HOAs designate for future component work, and HOAs occasionally read that language as an escape hatch for deposits they never affirmatively labeled. Interest earnings draw this argument most often. Some HOAs treat the interest earned in their reserve accounts as “free” money that can be transferred or spent with no restrictions. That is not the case. Interest accrues on money the HOA already identified (i.e., inside the reserve accounts that HOAs establish for reserve-related purposes).
  • Directors who approve improper reserve spending face personal exposure. HOA directors owe fiduciary duties to the membership, and reserve funds carry a use restriction directors are charged with knowing. Directors who vote to charge operating costs, general legal fees, or non-component work against reserves therefore open themselves up to potential personal liability. Reserve spending decisions are supposed to appear in board minutes, and when they do, those minutes will identify which directors voted which way. [For when homeowners can reach HOA directors individually, read my Fact Sheets: “Can You Hold HOA Board Members Personally Liable in California?” and “Can I Sue My HOA Board Members Personally in California?”]
• Civil Code 5510 permits reserve spending on four activities. Civil Code 5510 allows HOAs to expend reserve funds on the repair, restoration, replacement, or maintenance of major components that the HOA is obligated to maintain. It also allows spending on litigation involving any of those four activities. Repair and replacement carry their ordinary meanings. Restoration reaches work that returns a component to its prior condition after damage or deterioration, and maintenance reaches the upkeep that extends a component’s useful life. Nothing outside those four activities and the litigation category qualifies, and Civil Code 5510 states the restriction as a prohibition rather than as guidance.
  • The litigation category reaches component disputes only. Civil Code 5510 permits reserve spending on litigation involving the repair, restoration, replacement, or maintenance of qualifying major components, which covers construction defect actions and disputes with contractors over that work. It doesn’t reach general legal expenses, such as those related to assessment collection suits, enforcement actions against homeowners, records disputes, election challenges, and defense of homeowner claims. Those must all come from the operating budget.
  • Spending reserve funds on litigation triggers notice and quarterly accounting duties. Civil Code 5520 requires HOAs that decide to use reserve funds for litigation, or to temporarily transfer reserve money to pay for litigation, to provide general notice of that decision to the entire membership. The notice has to state that an accounting of the litigation expenses is available. Civil Code 5520 then requires HOAs to prepare that accounting at least quarterly and to make it available for member inspection at the HOA’s “office.” Governing documents can impose stricter standards, but they can’t relax these.
• Reserve spending has to trace back to the components the fund was established to cover. Civil Code 5510 requires that the components be ones the HOA is obligated to repair, restore, replace, or maintain and for which the HOA established the reserve fund. Both requirements are in play. An HOA can’t charge reserves for work on a component that the CC&Rs assign to individual owners, for example, because the HOA carries no obligation to maintain such a component. HOAs also can’t charge reserves for components that never appeared in their reserve studies because such funds weren’t  established for those components. Every reserve expenditure should correspond to a line item in the reserve study.
  • Civil Code 4177 and Civil Code 5510 don’t match on additions. Civil Code 4177 defines reserve accounts to include money held for additions to major components. Civil Code 5510 permits expenditure for repair, restoration, replacement, and maintenance, and omits additions entirely. Civil Code 4178 does the same thing when it defines reserve account requirements by reference to repairing, replacing, and restoring major components. While HOAs can hold reserve money earmarked for additions, they have no lawful way to spend that money on those additions. Those projects have to come from operating funds or from special assessments levied to pay for them, and reserve studies listing planned additions don’t change that. [Other than amending the Davis-Stirling Act, I have no solution for HOAs wishing to resolve this dilemma.]
• Operating expenses can’t come out of reserves. Landscaping contracts, management fees, insurance premiums, utilities, administrative costs, bookkeeping, and general legal bills involve no work on a major component, and thus puts every one of them outside the four permitted activities discussed above. The size of the reserve balance and the condition of the operating budget change nothing. HOAs that need reserve money to cover operating costs have one lawful route, and it requires advance notice to members, a written finding in the minutes, and repayment. [For the full procedure an HOA has to follow before it moves reserve money into the operating fund, read my Fact Sheet, “Can My California HOA Borrow From Reserves?”]
  • Small repairs to major components belong to the operating budget. Reserve funds cover major components, and the reserve study identifies which components qualify by assigning each one a remaining useful life and a replacement cost. Patching a section of stucco, replacing a sprinkler head, fixing a gate latch, or repainting one railing doesn’t reach a component the study tracks, even though the HOA maintains stucco, irrigation, gates, and railings. In other words, recurring upkeep that the annual budget absorbs isn’t reserve-account worthy work.
• Homeowners should care about improper reserve spending because it will eventually result in at least one special assessment. Civil Code 5550 requires reserve studies to calculate annual contributions HOAs need after subtracting total reserve funds on hand. Money that an HOA spends outside Civil Code 5510 reduces the funds on hand, which raises the contributions called for by the reserve study. HOAs close that gap by raising regular assessments or levying special assessments, and homeowners paying that bill years later rarely connect it to the expenditures that created the shortfall. [If your HOA has hit you with a special assessment and you want to know whether it’s lawful and how to fight it, read my Fact Sheet, “California HOA Special Assessments: What They Are, When They’re Legal, and How Homeowners Can Challenge Them.”]
• If your HOA is spending reserve funds outside what Civil Code 5510 permits, call the HOA attorneys at MBK Chapman. Improper reserve spending exposes individual directors to personal claims for breach of fiduciary duty and exposes the HOA to litigation to restore the missing funds. If your HOA has spent reserve funds for improper purposes, call the most respected homeowner-side HOA firm in California—the HOA attorneys at MBK Chapman. Our attorneys are highly trained to review your reserve records, identify the expenditures that violate the Davis-Stirling Act, and force your HOA to put the money back.

Civil Code 5510 works as a prohibition rather than as a list of suggestions. HOAs can spend reserve money on repairing, restoring, replacing, and maintaining the major components their reserve funds were built to cover, and on litigation over that same work. Everything else falls outside the statute, no matter how legitimate the expense looks or how badly the operating budget needs the money.

FAQs

About Michael Kushner

Michael Kushner is a California attorney with over 30 years of experience representing homeowners in disputes with their HOAs. He is widely regarded as California’s leading homeowner-side HOA attorney, and has built one of the state’s most prominent law practices dedicated to holding HOAs accountable under the Davis-Stirling Act and California law.

In addition to his law firm’s work, Michael is a recognized lecturer, author, and the host of the hit HOA HELL podcast, where he provides homeowners living in HOA-governed communities with clear, practical strategies for dealing with bad HOAs. He’s also the author of the best-selling book, HOA HELL | California Homeowners’ Definitive Guide to Beating Bad HOAs, which has become a go-to resource for both homeowners seeking real-world solutions to their HOA disputes, as well as those good HOA board members who are interested in doing a good job.

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