Reserve Funds and Reserve Fund Studies
Can I Pay for This From the Reserve Fund?
From the Winter 2021 issue of CCI Toronto Condovoice Magazine, Volume 26, Issue Number 2
The board of directors of an Ontario condominium has the authority to pay for work using reserve funds without the consent of the unit owners. This feature of the Ontario Condominium Act recognizes that reserve fund expenditures are generally necessary for the upkeep of the common elements and should therefore not be subject to the whim of the owners. But, as we know, with great power comes great responsibility. It is important that boards only use reserve funds for expenditures which are reserve fund eligible.
There are several sections of the legislation and regulations that help clarify what constitutes a reserve-eligible expenditure.
Section 93 requires that reserve funds be used only for the major repair or replacement of the common elements and assets of the corporation. Section 97 addresses the Corporation’s ability to make additions, alterations or improvements to the common elements or changes to the assets of the Corporation and sets out the procedure to be followed by the Corporation.
This sounds simple but is actually quite complex due to complex nuances in the language of the legislation.
Section 97 (1) says that if the corporation has the duty to repair after damage or to maintain the common elements (which includes the requirement to replace after normal wear and tear) and does so using materials “that are as reasonably close in quality to the original as is appropriate in accordance with current construction standards” then the work is deemed not to be an addition, alteration, improvement to the common elements or a change to the assets of the corporation (an “AAI”).
Section 97 (1) provides clarity when a like-for-like replacement is not possible. For example, if you were repairing a plaster and lathe wall and did so using drywall, that would be considered current construction standard. Or if you were replacing an atmospheric boiler, with a mid-efficiency boiler, that would also be considered current construction standard. Both can be paid from reserve provided they relate to the common elements.
This is where things start to get a bit confusing. Section 97(2) indicates that the board may make an AAI without notice to the owners if the AAI is being made to comply with legislation, if, in the opinion of the board, the AAI is necessary to ensure safety and security, or if the cost, in any month is no more than the greater of $1,000 or 1% of the annual budgeted common expenses for the current fiscal year. It is important to note that this section tells a board that they can make an AAI without notifying the owners, but the work remains an AAI. As such, it is not clear that an AAI constitutes a major repair or replacement that may be paid for from the reserve fund. Many in the industry misinterpret this section, deciding that if notification of the owners and/or consent of the owners is not required, then the project is reserve eligible. However, AAIs are not allowed to be paid for from reserve, per section 93, which is limited to major repair and replacement.
The rest of section 97 explains the requirements to notify the owners or obtain the consent of the owners for any AAI that are not captured by 97 (2). If the estimated cost of the AAI is greater than 10% of the annual budgeted common expenses for the current fiscal year, then consent by a vote of the owners who own 66 and 2/3% of the units in the corporation must be obtained. If is the estimated cost is less than 10%, but not captured by 97(2), then the owners must be notified of the intended AAI and be given the opportunity to requisition a meeting of the owners to vote on the proposed AAI.
So, if a corporation decides to add a tennis court, when there was none originally, this is clearly an AAI, and will almost always fall into the category of section 97 that requires notice to the owners giving them the right to requisition a meeting or obtaining the consent of 66 and 2/3% of the owners (depending on the cost relative to the annual budgeted common expenses). Even if approved, the cost cannot be charged to reserve.
There is case law where a corporation has charged work to a reserve fund that an owner or group of owners did not think was reserve-eligible. The general principal from the courts is that section 97 (1) of the Act allows the Corporation to make reasonable modernizations to the common elements, in addition to complying with current construction standards. Nevertheless, these disputes can result in lengthy litigation and onerous legal costs. Even if the decision is eventually found to be correct by the courts, the related costs, in terms of legal costs, time and aggravation, are well worth seeking to avoid. It is best, when there is any doubt, to seek a legal opinion from the Corporation’s solicitors.
Let’s look at areas where questions arise:
Replacement that includes an AAI
What about a replacement where the replacement is better than the existing but is not current construction standard? For example, if a board decided to replace an asphalt-shingled roof with a sheet metal roof? In this case the roof is a replacement, but the material chosen would not necessarily be considered current construction standard given that most new condos with sloped roofs have asphalt shingles. What dollar value should be used when considering the requirements of section 97? The total cost of the project? Or the incremental cost of the metal roof over the shingled roof?
The Act does not provide clarification on this point, but there is case law that relates to a corporation making changes to a service provided to the owners pursuant to section 97 in which the court found that it is the incremental cost of the making the change in service that must be considered for purposes of section 97. This is consistent with industry consensus that the incremental cost of an AAI over the cost to repair or replace the existing item with like-for-like, should be used when interpreting section 97, and that the incremental cost (perhaps over and above the amount the reserve fund study predicted for the asphalt shingles, or perhaps, tendered as an option) should be paid from the operating budget/surplus or a special assessment.
Repair after damage
What about repair to the building after an insurable event like a flood? What can a corporation elect to charge to the reserve fund?
Repair after damage caused by an insured peril is, in the authors’ view, not intended by the Act to be paid for from reserve, but rather through insurance, so this is an issue that requires more attention than it has been facing. In the authors’ opinion, the insured portion of the cost of repair after damage should not be a reserve fund charge, but there is nothing in the Act to prohibit using reserve funds for repair or replacement after damage. This is the basis upon which some corporations elect to charge the deductible or full cost of the repair to the reserve fund.
Historically, with insurance deductibles in the range of $10,000, charging the deductible to reserve seldom had a material impact to the reserve fund, so was typically not flagged by auditors or reserve fund planners. But these days, deductibles of $50,000 to $500,000 are becoming more common. In the worst cases, there are several insurable events each year. Costs of this size can seriously deplete a reserve fund, leaving insufficient funds to cover planned major repairs and replacements and shifting financial burden onto future owners.
Further, many corporations are choosing to self-insure, even if a claim exceeds the deductible, to avoid driving up their insurance premiums or risking not being able to obtain insurance. This further erodes the reserve fund.
The methodology currently used to determine reserve fund contributions does not include planning for costs related to insurable events, whether the cost of the repair or the deductible portion.
Corporations should consider setting a policy regarding whether or not they will charge these costs to the reserve fund. Ideally, corporations should pay these costs either from an operating surplus, a fund set aside for such costs, or a special assessment. Creating a special fund that holds one- or two-times deductible seems a prudent course of action, particularly for a corporation burdened with a very high deductible.
If a corporation wishes to charge these costs to the reserve fund, it should seek legal advice and also notify the reserve fund study provider so they can include a periodic allowance intended to cover the cost. Depending on the corporation’s history, this might be one deductible every one year, or one every five years. Alternately, a minimum balance greater than one times the deductible could be used; noting that this would need to be set high enough to cover the deductible risk over the three years between studies plus other risks to the reserve fund such as budget overruns or unexpected work.
As the reserve fund is limited to the common elements, costs related to the standard unit repair should never be charge to reserve. This may require the corporation to obtain detailed invoices from contractors splitting out repair to the units from repairs to the common elements.
Installation of EV Charging Equipment
Corporations have a duty to allow for the installation of EV charging equipment upon the request of a unit owner, and have the right to install EV chargers on the common elements, in accordance with section 24.2 to 24.7 of O.Reg. 48. Typically, a unit owner who wants to install an EV charger pays for its installation, including the cabling to a dedicated electrical distribution panel installed by the Corporation. So, can the cost of the new dedicated electrical distributions panels and modifications to the main switchgear, and the cost of the EV charger and cabling if being installed by the Corporation on the common elements, be charged to the reserve fund?
There are two schools of though on electric vehicle charging.
The first interpretation is that this is clearly an addition, alteration or improvement to the building and therefore not a major repair or replacement (because this charging equipment did not exist previously). As such this cost should not be charged to reserve.
The second interpretation is that the corporation has a duty to install the charging equipment, and that charging equipment is now current construction standard in new buildings, which pursuant to section 97 (1) there may be some justification for using reserve funds. However, it is not in fact a current construction standard as even today the vast majority of parking units are constructed without electric vehicle charging capabilities. In the authors’ opinions, this interpretation also neglects to consider whether or not the expenditure is a major repair or replacement, which it is not.
If a corporation wishes to use reserve funds to install electric vehicle charging equipment, they would be wise to obtain a legal opinion from the corporation’s counsel prior to proceeding.
Once the electric vehicle charging equipment is installed by the corporation, the corporation can use reserve funds for its future major repair and replacement.
Installation of Additional Security Cameras
Adding additional cameras to an existing CCTV system is captured under section 97 (2) because it would be being done to improve safety and security. Therefore, it does not require the consent or notification of the owners. Next question is, can it be paid for from reserve?
Once again, there are two opinions on this matter. The first is that this is an addition, alteration or improvement and should not be paid for from reserve. The second is that cameras would only be being added to the system because it has been found to be deficient and it could therefore be argued that the CCTV system is being “repaired”.
While the second opinion may be more palatable to the board, because it allows them to access reserve funds, this is again depleting the fund for an unplanned cost. It is the authors’ view that the initial installation of additional cameras is an operating expense. However, replacing existing black and white security cameras with infrared colour security cameras, would likely be considered current construction standard and therefore reserve-eligible. If a corporation wants to use reserve funds to install new security equipment, it should obtain a legal opinion. In addition, whenever expenditures are made from a reserve fund that were not anticipated in the reserve fund study, consideration should be given as to the potential impact on the reserve fund and whether or not the expenditure would deplete the fund to such a degree that it could jeopardize funding other planned work.
Compliance with legislation
AAIs made by the Corporation to the common elements to comply with any legislation or regulations, are AAIs that can be made without prior notice to the owners pursuant to section 97. This would typically include, but is not limited to, work to comply with changes to the Fire Code, or taking steps to comply with the Ontario Human Rights Code, for example to make a portion of the common elements accessible to persons with disabilities.
However, there is no authorization under the Act to use reserve funds for these expenditures. The initial expenditure would be considered an operating expense, but future related major repairs and replacements can be paid form the reserve fund.
Many Ontario Condominiums already struggle to adequately fund their reserve funds. Care should be taken to minimize using reserve funds to cover costs that are not reserve-eligible and have not been planned. Some costs fall into a grey area and boards must decide if they can be charged to the reserve fund. If there is any doubt, corporations should seek a legal opinion before charging the expense to the reserve fund. Where the expenditure is material to the fund, they should also seek an opinion from their reserve fund study provider, ideally, before incurring the expense. Knowing if the expenditure can be paid from the reserve fund may inform the board’s decision with respect to the work, including the extent of the work, phasing of the work and how it will pay for the work. For example, there may be a need for an increase in common expenses and/or a special assessment if the work must be paid from operating. In addition, while there is a cost to obtaining a legal opinion, it is far less than the potential costs likely to be incurred if a unit owner elects to litigate regarding the suitability of the expenditure from the reserve fund.
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