millions at risk above FDIC insured limit

We are in a developer controlled HOA and a week before the FDIC raised the insured rate from $100K to $250K, the developer placed millions of the association's funds at risk in a weak bank in exchange for a loan to the developer. The developer says the declaration gives it the right to manage the funds though such risky management seems contrary to their fiduciary responsibilities as controlling directors of the HOA. The developer says it can't take out the money now since it would loose the loan which could run for a year or more. Next month, the members will start paying 2009 dues well over a million. How can we avoid throwing new money into another risky situation when the developer has the control?

Thank you, Joe. I think your idea is excellent but the bank doesn't offer CDARS. But it would have been the perfect solution since gives us interest, allows large balances at loaning bank and is secure since funds distributed among multiple banks who in turn swap equivalent CD's and each is within the FDIC limit.

I'm going to assume that the association funds are not being used as collateral for his loan. I'm assuming it was a "gentlemen's agreement" that in return for the deposit of the association funds, the developer would find it easier to get a loan, however, I would use your right to see all association documents to confirm that no written agreement exists that would put the association funds in jeopardy if the developer defaulted. If there is anything that indicates that your funds could be tapped if the developer misses a payment or defaults, take a copy of it to the local district attorney or state AG. No board can commit association funds to cover a loan that is not for the association's benefit or wasn't voted on by the owners.

Having said that, there is the issue of the developer's statement that he can't remove the funds for a year - that may indicate a tie-in.

That leaves your major concern as the bank failing.

I'm assuming your an HOA in Virginia: http://leg1.state.va.us/cgi-bin/legp504.exe?000+cod+TOC55000000026000000000000

§ 55-514.2. Deposit of funds; fidelity bond.

A. All funds deposited with a managing agent shall be handled in a fiduciary capacity and shall be kept in a fiduciary trust account in a federally insured financial institution separate from other assets of the managing agent. The funds shall be the property of the association and shall be segregated for each account in the records of the managing agent in a manner that permits the funds to be identified on an individual association basis.

B. Any association collecting assessments for common expenses shall obtain and maintain a blanket fidelity bond or employee dishonesty insurance policy insuring the association against losses resulting from theft or dishonesty committed by the officers, directors, or persons employed by the association, or committed by any managing agent or employees of the managing agent. Such bond or insurance policy shall provide coverage in an amount equal to the lesser of $1 million or the amount of the reserve balances of the association plus one-fourth of the aggregate annual assessment income of such association. The minimum coverage amount shall be $10,000. The board of directors or managing agent may obtain such bond or insurance on behalf of the association.

(2007, cc. 696, 712; 2008, cc. 851, 871.)

It looks like your best hope is convincing him that his actions could be considered a breach of fiduciary responsibility under the state POA law.

Joe

Before we take the DA/AG route, it seemed prudent to use the same VA POA laws internally to see if the developer will compromise and protect our funds. Below is a draft of a letter I propose to send to the developer and members in the community. Any critiques would be greatly appreciated. Thanks, Bob
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Subject: continuing risk for 2009 assessment dues?

Will our 2009 assessment dues be FDIC protected or will they also be placed at risk at the same bank? The loan that the developer got in exchange for risking our funds only needs a minimum of $1 million held at that bank. The road reserve fund exceeds that. So why should the new 2009 assessment dues be placed in jeopardy? To risk our money further seems in violation of the fiduciary responsibilities required under the declaration we all signed.

Though the declaration gives the developer the authority to manage our accounts, that same declaration also binds the declarant and the association directors to abide by the VA POA laws (see below) which include its fiduciary obligations to the association. That law also states that a bond (in our case $1 million) must be posted to help protect association funds. If the association directors/officers have not posted the bond and they continue to place our funds at risk, then don't those actions constitute a fundamental breach of their fiduciary responsibilities and thus permit association members to withhold compliance of the contract until the requirements under law are met? Clearly, this is an issue for the association attorney and should be answered.

But how can we know what the association attorney is saying, if the developer only allows its staff access to the association attorney and uses "Attorney Privileged" as the reason for not releasing what the association attorney has written in its reply to the legal issues raised? If the members of the association who pay the attorney's fees can't get legal advice from their own attorney, then how else are we to protect our funds from loss other than withholding them if such is permitted under law?

VA POA law link:

http://leg1.state.va.us/cgi-bin/legp504.exe?000+cod+TOC55000000026000000000000

§ 55-514.2. Deposit of funds; fidelity bond.

A. All funds deposited with a managing agent shall be handled in a fiduciary capacity and shall be kept in a fiduciary trust account in a federally insured financial institution separate from other assets of the managing agent. The funds shall be the property of the association and shall be segregated for each account in the records of the managing agent in a manner that permits the funds to be identified on an individual association basis.

B. Any association collecting assessments for common expenses shall obtain and maintain a blanket fidelity bond or employee dishonesty insurance policy insuring the association against losses resulting from theft or dishonesty committed by the officers, directors, or persons employed by the association, or committed by any managing agent or employees of the managing agent. Such bond or insurance policy shall provide coverage in an amount equal to the lesser of $1 million or the amount of the reserve balances of the association plus one-fourth of the aggregate annual assessment income of such association. The minimum coverage amount shall be $10,000. The board of directors or managing agent may obtain such bond or insurance on behalf of the association.

Thank you KirkW1 for your insightful argument "using association funds to guarantee a loan to yourself". The implications from your comments, raises legal issues about a guarantee versus collateral. Though the developer has not used our money as collateral for the loan, the net effect from a guarantee perspective may be the same.

Our money is an essential condition for getting/retaining the loan. That's why we cannot get our money out of a failing bank. So the cost to us if bank fails is the same as the cost to us if the developer defaulted on the loan and our money were held as collateral. So if illegal to use association money as collateral for a loan to the developer then why not equally illegal to use association money as a guarantee to get and retain a loan for the developer. In both cases developer used/lost money that was not his to get a financial benefit for him while he controls the association and has fiduciary responsibility to the association. (The declaration gives him the right to manage our funds responsibly without self dealing at our expense.) Since functionally equivalent to stealing our money, this argument would provide the legal basis for a criminal complaint to the commonwealth attorney, Virginia's equivalent of the DA in most places.

But we prefer not to hire attorney's just yet since not economically justified.

The highest priority is saving the money and the FDIC does have a program for unlimited protection for noninterest bearing transaction accounts if the bank is participating though our bank isn't at this time.
See http://www.fdic.gov/news/news/press/2008/pr08100.html for more details. Since the bank may loose other depositors by not participating, thus they will probably decide to go that route and my best guess is that the funds will be protected sometime within the next 6 weeks assuming no major financial catastrophes. Still there are some real risks but we see no better alternative.

Going the legal route such as injunctions would be costly and without the structure to compel sharing of costs by the association members (developer still in control) not worth it for a few individuals since attorney costs for us would be greater than the pro rata costs of losing all the millions but amortized across the entire membership. Also any effective legal action would most likely take longer than the 6 weeks time we expect the bank to start participating in the unlimited FDIC protection plan.

Finally, in the event all the money is lost then it would be easier to get most members to fund the legal action for recovery since then the pro rata legal costs will be much less than the losses absorbed by each member and the case is much more compelling so a cleaner legal battle. There are many assets held by developer that we could go after.

I misspoke. It is not a guarantee. The bank required that the association place up to 2 million of their funds as a condition to get the loan and retain the loan. If developer defaults our money is still safe but if bank fails we could loose all of it above the $250K FDIC limit. Since the developer controls the association we have no way to get the money moved to a safe investment.

If we lost $2 million then the cost per member would be under $3K. If 5 paid legal fees of $30K then $6K per person. But if funds protected in 6 weeks regardless of legal action then loose the $6k. If funds lost then must convince rest of community to pay the $30K so far plus extra costs to recover funds. If $50K additional plus $30K so far then total of $80K across all members is just over $100 each so good investment for members to save themselves about $3K but not good investment for early attempt for legal protection.

I don't think you have a realistic idea of the expense involved. I don't think it would cost any where in the neighborhood of the $150,000 you mention. I would be shocked if it went to the $30,000 you believe each would have to pay.

I would certainly speak with a lawyer about it. There may be one who will take the case on contingency fee.

KirkW1, again I misspoke. I should have said: "If 5 shared legal fees of $30K then $6K per person". versus what I first said: "If 5 paid legal fees of $30K then $6K per person". I got the $30K estimate by talking to an attorney. In fact I talked to 4 different attorneys about different issues from breach of fiduciary responsibility, antitrust, securities law, Virginia nonstock corporation law,... But right here I'm discussing fiduciary responsibility over risking association money in exchange for a developer benefit.

Thanksgiving Surprise?

The developer's loan was renegotiated and the documents released yesterday, 11/26/08. Unfortunately, only terms favorable to the developer were changed e.g. extensions on payments due. The section binding association assets for developer's purpose remains, leaving us at risk. Below is the text from the loan agreement that puts our funds at risk in this weak bank.

"Borrowers agree that the deposit accounts of the (name deleted) Community Association (including but not limited to, the streets and the annual dues account) will be maintained at Lender during the life of the loan described herein. Borrowers acknowledge that these accounts will have a balance of between One Million and 00/100 Dollars ($1,000,000.00) - Two Million and 00/100 Dollars ($2,000,000.00)."

No such good luck for the holiday.

Happy Thanksgiving

I agree with you, KirkW1, but want to make sure every last effort was made before turning to the local, state and federal authorities. Here's a letter I sent out today. I deleted specific names for privacy.

In the December newsletter it said that a BOD meeting was held on Friday, Nov. 21, yet there was no announcement made to the community. Also, both the November and December newsletter calendars show BOD meetings for December 1, at 6pm yet no such meeting was held and there was no notification sent to the community association as is required by law. Similarly, last summer when there was a finance committee meeting to replace the finance chair who had resigned over fund safety, no community announcement for that meeting was made, so the community was not aware of the controversy over disclosure of the association financial accounts and their safety. I objected to the meeting not be held according to the law and was over ruled by a board member.

Given that our funds were put at risk at a weak bank, in an exchange for a loan for the developer and that association members at the annual meeting have expressed concern that most of our funds are still uninsured by the FDIC, then it is more urgent than ever that the law be followed so the proper protections for the community be followed. For example, if the BOD had been properly announced so we could attend, I would have asked the BOD to vote that the association funds be protected since it is their fiduciary responsibility to the association to protect our financial interests even when they are in conflict with the interests of the developer. The fact that the developer controls the association board does not put the developer above the law.

The developer suggested in an email and at the annual meeting that risking our funds in exchange for a developer loan was in the best interests of the community association but there was no explanation of why.

The loan agreement says at section 6, (c), page 5 at (SEC link) and I quote,

"Borrowers agree that the deposit accounts of the (name deleted) Community Association (including but not limited to, the streets and the annual dues account) will be maintained at Lender during the life of the loan described herein. Borrowers acknowledge that these accounts will have a balance of between One Million and 00/100 Dollars ($1,000,000.00) - Two Million and 00/100 Dollars ($2,000,000.00)."

I think the community is owed an explanation of what is going on, as this is totally at variance with the normal concerns expressed by your office for the welfare and protection of this community. Even the damage to the community commons by vandals of several thousand dollars cannot begin to compare to the loss of several million dollars that is in jeopardy at a bank the FDIC refused to save with TARP funds because "it could not survive" on its own. In both cases of vandalism and breach of fiduciary responsibility, laws seem to have been broken, but the magnitude of what is happening now is considerably larger.

For those who hope that we will get lucky, they should note that there is no assurance that (an acquiring bank) will complete the acquisition of (the weak bank) nor that our funds will be FDIC protected post (acquisition) as it may take a year or more to integrate all the operations. Given the surprises in the financial markets so far, it seems gross negligence to continue to let our funds remain at risk despite all the warnings that have been given by community members.

The community is owed an explanation of why the BOD has not taken action to protect our funds and not announcing BOD meetings as required by law.

The 2009 dues will be collected by January 1, 2009. Will those funds be put at risk as well?

Thank you,

Bob - I can't believe you are trying to do all this yourself!

With these amounts of money involved, a financial lawyer should be brought in ASAP.

Are your neighbors as upset as you?

Have you asked the developer to tell you how he determined the legality of his using associaton funds as collatoral for his loan?

Susan - I just realized an error in my letter to the AG. The fidelity bond should be $1 million and not $10 million. See my note 11/20/08 above.

Below is the last letter to the president of the association who is also the developer. I think it captures the frustration of nothing happening. The usual run-around to requests as has been going on since the summer when I first raised the issue of the fidelity bond and safety of accounts convinced me that I had to go the AG route.
Specific names have been deleted.
Bob
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12-3-08
To: (name deleted but he is president of the association and also the developer)

This is an open letter to you and the community and will be posted on the web site at (name deleted of web site I set up for this purpose) in the members-only section. It is open to the community since they should be made aware of the added financial risks associated with the 2009 assessments to be mailed out next week and why those risks (no FDIC insurance in failing bank) benefit the association.

Yesterday, you replied to my inquiry regarding the safety of our 2009 dues, and why the association benefits from these risks, that any response may take awhile due to the (association secretary also developer employee) being incapacitated for several weeks and the (association's) counsel's response would most likely involve her and therefore be delayed "for a time". However, time is running out now and (secretary's) office will be mailing the 2009 assessment bills next week.

Perhaps you could direct someone acting on (secretary's) behalf to include in the mailing for the 2009 assessments a letter disclosing the risks of the funds collected in keeping with your fiduciary responsibility as officer and director of the (association). Since the association needs the funds to function, alternative options should be offered without the risks of uninsured deposits in a weak bank.

We still do not know if the proper bonds as required by law have been posted nor whether they would help recover any loss of our dues. Therefore, the risk of loss seems real with few options for recovery.

As an association under the control of the developer, we cannot sue for lost funds since the developer controls the decision to file a law suit against itself on the association's behalf. Also, the association needs the funds for services to us so we would be punishing ourselves if the services couldn't be rendered due to lack of funds. All directors and officers of the association are indemnified by the association so even if we did sue we would be suing ourselves. The indemnification insurance has a large deductible which we would pay and it doesn't cover more than $2 million. Just the reserves are almost $1.5 million and the 2009 dues would just about double that.

As an association we do not know other legal options that may be available since we do not have access to the association's legal counsel except through the developer and so far we haven't received any responses for months even though we pay all the legal bills for the association.

We cannot communicate easily with the rest of the community since requests for email addresses of the members have been denied by the (association) as well as the database of physical addresses. Stuffing mail boxes is illegal and use of the "newspaper" box below though legal outside (gates of association) is forbidden by the (association) according to page 7 of the December 2008 newsletter. Free organized meetings in the club house is only for approved groups which the developer controlled board approves. Though VA POA law (see http://leg1.state.va.us/cgi-bin/legp504.exe?000+cod+55-510.2 ) says that "The board of directors shall establish a reasonable, effective, and free method, appropriate to the size and nature of the association, for lot owners to communicate among themselves and with the board of directors regarding any matter concerning the association," this has not been implemented here.

BTW, during the cold war days, many of us spent careers championing the free market system as superior to command economies with restrictions on freedoms and yet some of us find ourselves rewarded in retirement with some of the feelings of the constraints on freedoms that we so abhorred. When we signed the declaration as a member of this community, we rightfully assumed that the laws that protect us would be followed and independent access to legal advice as a community would be available. Hopefully, you will understand these feelings and act in the best interests of the community.

Thank you,

Bob

Robert, you are right and being human, we all do make mistakes like quoting that the fidelity bond is $10 Million when it is $1 million. I have already tried to form a group within the association to raise the funds to get the legal help needed. When I asked around, I learned that it had already been done before but later abandoned so doubtful it would be successful again. Just the same, I tried again and none really want to do the work of organizing and sticking their necks out and I don't have enough time to do all that work either. All want the benefits but few will do the work.

I then reached out to another community in another state who has already transitioned from the same developer and they had also formed their own internal group collecting funds to hire the engineering and legal resources to investigate their infrastructure before transition but the developer then stepped in to avoid this and compromised enough that made the separate group unnecessary. That core group organized a new board at transition and then sued the developer for millions. The case is still in court.

I believe that many here are resigned to loose all the millions since the cost per member is in the $2K - $3K range though there are far more who would organize and fight back since they cannot afford that loss. Since we cannot easily reach the whole community as already explained, our last chance is to try to pressure the developer to let the whole community know what has happened to their money and will happen to the new funds - or change the conditions of the loan so we are protected under the FDIC.

That is why I sent those letters out since I bcc enough members here and they in turn have forwarded it around so that a much larger percent is aware of what is happening. Because of the re-transmissions there is no way to estimate how many are now in the loop. I may now use this network to organize to raise funds if the core inner group thinks it will work.

As for contacting lawyers, I have already done that and their conclusion is to risk loosing the money, since any day the bank could decide to participate in the FDIC program. If the bank doesn't and things unwind at the bank and we loose the money then that will cost us less per individual in core group than taking on the legal help.

My attitude at this point, is that we tried and did our best so if the money is lost the rest of the community that had no idea of what was happening becomes outraged blaming us for not letting them know then they will see how many different attempts were made. This can then be used to change Virginia POA laws so one or a few individuals can contact a state level commission and they can investigate. In fact such a law was passed (in response to millions being stolen at other associations) and became effective July 1, 2008. However, that commission that is to receive such complaints has not been set up yet. Just the same, I did contact that office but none have replied yet and probably won't until the commission is up and running.

Bob

Bob,

As I see it, the problem isn't with the ability to file a suit. If the money is lost any party having to make it up can sue the Board for breach of fiduciary duty in losing the funds. But the problem is that you may not have a means of recovery. What are the chances your developer can cover the loss? (nill)

It also occurs to me now (sorry for being slow on this) that in some fashion the association is lending the money to the developer. But the association would be better served if it actually did just that. The reason the bank is requiring the money is because the bank must have a certain amount of deposits to make the loans. And the deposit of your funds allows the bank to make more loans. In some sense you are adding tot eh stability of the bank. But as you noted this as at your peril.

If you made the loan directly, then you would only be risking the amount of the loan itself. In addition, you could require security of some real property which could eventually lead to a recovery of funds. (I say eventually because we all know what the market is right now.) I personally consider the investment risk of undeveloped property to be close to the risk of needing the money in the next few years. While it could take some time, the reality is that we will eventually come out of the slump.

Kirk

Mary,

The fact that the association attorney works for the developer run BOD explains why the BOD never replies to our request of why putting our funds at risk in a failing bank benefits the association. If legally, they don't have to justify what they did with the funds, then we will never know. In fact, we would never have known about the loan if the assets of the development were not owned by shareholders and the SEC has disclosure requirements protecting their investments. But when millions were stolen by managers of associations here in Virginia, and hidden from scrutiny from members, the legislature passed new POA laws to allow individual members to tip off government officials so such losses can be avoided. They just haven't implemented these laws yet. Nor do we know if our developer has followed the new fidelity bond requirements.

The cumulative investment of the shareholders has been $64 million and only part of that has funded our development since there are 2 other communities in other states. We are lucky for the SEC disclosure requirements though association member stakeholders here have much more at risk e.g. almost half a billion in homes at valuations two years ago.

Unlike most developers, ours is really a contracting company that uses public funds from shareholders and loans to develop raw land into the infrastructure needed for third party builders to build homes. According to the SEC documents, the funds are used for developing new raw land with roads and other infrastructure and then they sell the lots to buyers and builders to place homes on them. They do not build homes nor are funds used to run the association as we are self sustaining according to the developer.

I cannot disclose the name of the bank because of privacy concerns for our association though the bank's condition is public record and is widely discussed in many news articles. The AG was sent all that information. This is a very factual based case. No need to rely on what I say. Same within this community as they can read the same SEC documents.

Bob

Bob,

For all the good reasons you stated above that you don't want to damage the reputation of your association and cause property value to fall, I think you need to balance this with the reality that you all can stand to lose a lot of money and maybe have obligated your selves for liability if this developer goes bust. You posted here because you have some pretty strong doubts about how things are going to turn out. IMHO, that train has left the station and you all are pretty much locked into the whole process. Now you all would like to know how deep you are in this mess, it appears the developer or his lawyer or anyone else is not going to tell you all in a language that you can understand. Now if this is close to being right, I can't see what you can lose. How much are your property values going to increase if developer goes belly up? How much will they increase if suddenly he changes his spots and puts some more cash into this problem, enough to bail the bank out? Now if you consider that a viable risk, where's the problem? It is, of course, you all don't know how thing are going to happen, why, when or by whom. For the amount of interest you all have invested, you deserve better and if the media can get you that assurance, I would consider it, along with political pressure.

I also am aware of the real fact, that what I am stating can be a hard sell and maybe impossible to accomplish, many folks are hesitant to accept the truth and don't want it shoved in their faces. They prefer to stand and watch from the sidelines and that usually results, at some point if things turn sour, in these same people lambasting everyone for not telling them.

Mary,

I woke up in the middle of the night with this question which I had to write down before I forgot it and I need to give you enough info to set the context. Sorry for the length.

You said that, "You should be aware that the assn's attorney is NOT the attorney of the members -- he is NOT " ,..."

If the association attorney is not the attorney of the members then does that mean the members as a class do not have legal representation? If the association is not made up of 100% of its members then what constitutes the association?

Suppose the bank fails and we loose our funds and therefore 100% of the members have lost their dues, who should represent their cause? If the answer is that they don't have representation and therefore they will need separate counsel, does that mean the association needs separate counsel? If the association needs separate counsel under the case of loosing their funds, then do they need separate counsel before the event to help them avoid the loss?

In our situation we have 7 directors on the BOD, 4 are from the developer and 3 are elected by the community from their membership. The resident directors seem to vote straight down the line with the developer under the argument that the developer has the final say any ways so we might as well go along to get along. They argue that at transition, that is the time to get separate counsel but until that time my argument for our own separate counsel is not needed since the association attorney that reports to the BOD is the attorney representing the association even when there appears to be conflicts of interest between the developer and the interests of the community as is the case now. All directors, both developer and resident have equal fiduciary responsibility to the association.

However, the resident board members, unlike the developer board members, do not have direct access to the association attorney but must go through the developer for all their questions as well as answers. Same applies to financial records. That is why it seems none of them were aware of our funds being placed at risk in a failing bank in exchange for a loan for the developer. I uncovered that by reviewing SEC documents for the company that owns the assets and commons here. (That company is not the developer, rather the developer contracts with the owner company to develop the land.)

At the November BOD meeting I submitted in writing some questions to the BOD and was told that I would receive a written answer from the association attorney. One of the questions is below. (specific names deleted)

"Director's fiduciary responsibility issues:

If both (developer) appointed and resident directors of the (name deleted) Community Association have equal fiduciary responsibilities, then shouldn't they have equal access to legal, financial and other
information that are critical to executing those responsibilities?,..."

The response came back some days later as the "Attorney Privilege" argument of why they would not be answering my questions.

So my question now is, does the association need its own attorney to represent the interests of 100% of its members? Or is the existing association attorney our representative and if so why can't the interests of the association get answers from that attorney? If the attorney only reports to the BOD then why does he only communicate with some BOD members (developers) but not resident?

Bob,

A couple more articles for your reference:

http://www.neighborhoodlink.com/article/Legal/Who_Does_Our_Attorney_Represent

http://www.meeb.com/current_alert2.htm

Joe

Bob,
You say more words than I do, and that is difficult.

You really really need a sounding board for this message. I am not so sure we are the best one. Run this by your wife, friend, even a member of the Board you can trust for an honest opinion. I think I know our owners (I may be wrong) but I would never expect my bunch to digest all you have here. Have you ever held (you) a town meeting? Just a get together of neighbors and you open the floor for their comments. Give them a three minute talk and LIST by number your Power Points. One sentence each. Or maybe that is the format you need for this letter you want comments on. You have got to figure out a way to get the emotion out and the specific concerns in. You don't have to tell them of your doubts and cast blame, they are smart enough to devine that. You also need someone (several) to stand up in front of the folks with you. Do not be the Lone Ranger riding in to save the ranchers from the cattle rustlers.