January 2010

Keep an eye on how you use the "miscellaneous" line item in your HOA budget, recommends Jeff Vinzani, an attorney at Nexsen Pruet LLC in Charleston, S.C., who represents homeowners associations. If you're not careful, you could waste precious homeowner association funds and possibly violate your fiduciary duty to act in the best interest of the HOA.

Here are tips for making sure that budget line item doesn't get turned into a slush fund.

The Problem in a Nutshell

"I've served on two homeowners association boards, and I represent homeowners associations," explains Vinzani. "I've learned that you have to be careful how much money you put in that miscellaneous budget item. Normally it's in place for a rainy day. But if it's unused by the end of the year, it should be carried over to the next year. Instead, some boards use it as a slush fund and toward the end of a fiscal year use it for a big party rather than allowing it to carry over to the next year."

Vinzani says playing loose with miscellaneous funds is dangerous. "I've seen boards say, 'We've got $2,000. Let's have a party.' I don't think that's fair because not everybody goes to association parties. I also think it's breaching the board's duty to the homeowners because it's not a social line item but a miscellaneous line item. This budget category needs to have a list of possible uses so the board and the management company have some guidance on how to proceed in spending the funds."

It's true that there's a fine line between legitimate expenses and abuse of association funds, says Lisa A. Magill, a shareholder and association attorney at Becker & Poliakoff PA in Fort Lauderdale, Fla. "Directors don't have unlimited authority regarding the use of funds belonging to a community association," she explains. "Each corporation is governed by state law and the governing documents. You must use funds belonging to the association for legitimate association expenditures. Throwing a big party or event for the residents doesn't necessarily seem like an abuse of the association's funds, but it may be beyond the powers and duties of the corporation."

Though he recognizes the potential for abuse of a miscellaneous line item, Robert White, managing director of KW Property Management & Consulting in Miami, which oversees about 125 associations totaling 30,000-35,000 units, hasn't seen it yet. "All associations have some contingency or miscellaneous expenses, but in none I've seen are people doing hanky panky with it," he says. "Do I think it creates an opportunity for that? In buildings with in-house management, that would be an area the board should really look closely at because an opportunity for fraud exists. The onsite manager may be going out to lunch and putting it on the association's tab or going to Home Depot for his home and putting the cost in that line item."

Is It Even Needed?

You may not even need a miscellaneous line item in your budget. "Having a miscellaneous line item isn't necessarily a bad practice, but it's unnecessary," says Magill. "Your board, along with management, should be able to estimate the expenses associated with each budget category, and evaluating the expenses from the previous year is always a good place to start."

But White does see a purpose. "We call it a contingency line item," he explains. "In every association, especially in older ones where maintenance can pop up, you're working to get the budget as close to actual as possible. But we usually build that line item in there for a couple of reasons. One, in older properties, you always have an expense that pops up that wasn't accounted for in the budget. Two, recently associations have had big problems with bad debts. We've always had a line item for bad debt, but lately we've been coming in way above that. There are things like that that you can't plan for and can't hit perfectly for which you need to have a little money in there."

If an association doesn't use the full amount budgeted during the year, White recommends his clients reduce the amount for the next year. "If the contingency amount was $100,000 and you had $60,000 of items you didn't budget for, you'd reduce your contingency budget the next year by that extra $40,000. As long as you take that approach, I don't think a so-called slush fund will accumulate."