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Misappropriation of HOA Funds

by | HOAs, Real Estate

OVERVIEW

Managing an HOA’s finances is among the most important duties that HOA members (i.e., homeowners) entrust to their board of directors. Such management responsibilities include everything from collecting and distributing funds for common expenses (e.g., property maintenance and repairs), to ensuring that the HOA is setting aside funds for future maintenance and repairs (i.e., reserve funds).

Sometimes, however, one or more board members may misappropriate HOA funds, and when that happens, it can have serious consequences for the association and its members.

WHAT IS MISAPPROPRIATION?

Misappropriation of HOA funds refers to the unauthorized use of HOA funds by its board of directors, officers, or employees. This can take various forms, including embezzlement (fraudulent theft of funds by someone in a position of trust or responsibility over those funds), or simply misusing funds for unauthorized expenses. In some cases, misappropriation of HOA funds can also occur due to lack of proper financial controls, poor record-keeping, or a failure to follow the association’s governing documents.

Misappropriation can take a variety of forms, including:

  • Withdrawing cash from the bank for personal use.
  • Paying vendors for work not performed and then splitting the money, or conspiring with vendors to increase their invoices in exchange for a kickback.
  • Using HOA debit/credit cards for personal expenses.
  • Submitting falsified reimbursement requests.
  • Keeping cash payments instead of depositing them into an HOA account.

MISAPPROPRIATION OF HOA FUNDS HAS SERIOUS CONSEQUENCES

Misappropriation of HOA funds can (and does) have serious consequences for the association and its members, including the following:

  • Misappropriation of HOA funds can result in significant financial losses, which can have a lasting impact on the HOA’s financial stability. This can lead to higher assessments, imposition of special assessments, delayed repairs and maintenance, or even bankruptcy in severe cases.
  • Misappropriation of HOA funds can erode the trust owners have in their HOA, making it difficult for the association to function effectively. This can lead to low participation and involvement, which can further damage the association’s finances and stability.
  • If the HOA’s board of directors, officers, or employees are found to have misappropriated HOA funds, they may face individual legal liabilities, including fines, imprisonment, or both. The HOA itself may also be held liable for any damages resulting from the misappropriation of funds.

There are a variety of steps that a well-managed HOA can take to prevent misappropriation of funds (or at the very least, make it much easier to spot early on). The easiest one also happens to be required under the Davis-Stirling Act.

For example, Civil Code section 5500 requires an HOA’s board of directors to review the association’s financial records at least once a month. In fact, the board is obligated on a monthly basis to review all of the following:

  • A current reconciliation of all of the HOA’s operating accounts (including a review of the bank statement(s)).
  • A current reconciliation of all of the HOA’s reserve accounts (including a review of the bank statement(s)).
  • A comparison between the current year’s operating revenues and expenses and the current year’s budget.
  • An income and expense statement for all accounts (e.g., operating and reserve).
  • The check registers for all HOA checking accounts.
  • Delinquent assessment receivable report.

Compliance with Civil Code section 5500 should not only make it relatively easy to spot improper financial practices early on, but hopefully the fact that the requirements exist can discourage would-be embezzlers from going forward with their plans knowing that the chances of discovery will be high.

There are, however, a variety of other practices that an HOA should implement to prevent financial misappropriation, including:

  • Maintaining accurate and comprehensive financial records. This includes keeping detailed records of all financial transactions, such as assessments, expenses, and bank statements.
  • Implementing adequate financial controls—such as regular audits or review (like the ones required by Civ. Code, § 5500).
  • Hiring a professional manager. Such managers do provide a level of independent oversight of the association’s finances. A professional manager can also ensure that the HOA follows best practices for financial management. Of course, hiring such a manager is not a substitute for the directors’ doing their job because sometimes it’s the professional managers who commit the misappropriation.
  • Segregating certain duties is also effective. For example, if the treasurer is the only individual authorized to sign association checks, then perhaps someone else should be in charge of holding and making out the checks. Some HOAs require that all checks be signed by the treasurer and one other director. Doing so decreases the opportunities for check fraud.
  • Implementing policies (i.e., rules) to prevent some of the more common forms of misappropriation, such as getting rid of director debit/credit cards or prohibiting checks from ever being made out to cash.
  • Providing training for all new board members regarding what is and isn’t appropriate when it comes to spending the HOA’s money. For example, providing the HOA’s treasurer with a bit of training on financial management, record-keeping, and risk management is always a good idea.

WHAT CAN HOA MEMBERS DO IF THEY SUSPECT THAT MISAPPROPRIATION OF HOA FUNDS HAS OCCURRED?

If an HOA member suspects that a director, employee, or manager has misappropriated HOA funds, he or she should take several steps to deal with the problem, including the following:

  • Gathering as much evidence as possible, including the HOA’s financial records, bank statements, invoices, and other relevant documentation. HOA members are entitled to such documents by law. (See Civ. Code, § 5200.)
  • Reporting his or her findings (in writing) to the board and demand an open investigation. This can be done during an open board meeting (followed by a written recap), or via email prior to a board meeting (preferred).
  • Notify other homeowners (again, in writing), and ask other to work with you to help address the issue, or if necessary, hire an attorney to force an investigation if the board is reluctant to do their jobs.

If a member’s suspicions are confirmed—i.e., if evidence exists proving that someone misappropriated HOA funds, rather than bear the burden of the loss with an assessment, HOA members can insist that their HOA tender the claim to the HOA’s insurance company. As it turns out, Civil Code section 5806 actually requires HOAs in California to carry “crime insurance, employee dishonesty coverage. . .and fidelity bond coverage” for the association’s directors, officers, and employees including the employees of any management company employed by the HOA. The statute also requires that such coverage be “in an amount that is equal to or more than the combined amount of the reserves of the association and total assessments for three months.”

CONCLUDING THOUGHTS

Misappropriation of HOA funds can have serious consequences for California HOAs and their members. By taking steps to prevent misappropriation and addressing it promptly if it occurs, HOAs can protect their finances, maintain the trust of their members, and preserve the stability of their associations.

Homeowners play an important role in ensuring financial fidelity by holding their board members accountable, and when necessary, taking action to address suspected misappropriation.