Converter Reserve Accounts: To Fund or Not to Fund? - The Question Florida Condominium Converters Must Answer
When a developer in Florida converts a building to a residential condominium, the developer is statutorily obligated to protect the owners from future deterioration of the property. A developer has three options to choose from when determining how to satisfy this statutory duty. According to Section 718.618 of the Florida Statutes (hereinafter referred to as the statute), a developer may elect to fund converter reserves, assume certain warranty obligations, or post a surety bond.
Funding Converter Reserves
To fund converter reserves, a developer must pay the condominium association a portion of the estimated replacement cost of any air conditioning systems that serve more than one unit, the plumbing and the roofs within the condominium project. The portion that the developer is obligated to pay is based on formulas provided in the statutes. Generally, in order to determine the required funding for the air conditioning reserve account, the developer multiplies the current replacement cost of the system by a fraction that has a denominator of 10 and a numerator of the lesser of the age of the system in years or 9. To determine the required funding for the plumbing reserve account, the developer multiplies the current replacement cost of the plumbing by a fraction that has a denominator of 40 and a numerator of the lesser of the age of the system in years or 36. To determine the required funding for the roof reserve account, the developer multiplies the current replacement cost of all of the roofs within the condominium by a fraction that is determined based on the type of roof. For a built-up roof without insulation, the denominator is 5, and the numerator is the lesser of the age of the roof in years or 4. For a built-up roof with insulation, the denominator is 5, and the numerator is the lesser of the age of the roof in years or 4. For a cement tile roof, the denominator is 50, and the numerator is the lesser of the age of the roof in years or 45. For an asphalt shingle roof, the denominator is 15, and the numerator is the lesser of the age of the roof in years or 14. For a wood shingle roof, the denominator is 10, and the numerator is the lesser of the age of the roof in years or 9. For all other roofs, the denominator is 20, and the numerator is the lesser of the age of the roof in years or 18. Thus, the younger the roof, air conditioning and plumbing systems, the less a developer is required to pay, which should play a large role in the developer’s decision whether to fund converter reserves.
To apply the formulas, the developer must first determine the age of the component. The age of the component is measured in years and is the later of: (1) the date the system or structure was replaced or renewed; or (2) the date when the system or structure was installed. If the developer decides to use the replacement/renewal date, then the developer must provide the Division of Florida Land Sales, Condominiums and Mobile Homes with a certificate bearing an architect’s or engineer’s seal, verifying the date of the replacement or renewal, and that it met the building code in effect at that time.
Once the developer has determined the total amount of each reserve account based on the above formulas, then, upon the sale of each unit, the developer must make a deposit of an amount equal to at least the total amount required for each reserve account multiplied by the percentage of the common elements allocable to that particular unit into the reserve account,. For example, if the developer is obligated to fund $500,000 in converter reserves, and there are 100 units in the project and each unit owner’s percentage share of the common elements is 1 percent, then, at each unit closing, the developer must pay $5,000 into the association’s converter reserve accounts. Thus, the developer funds the converter reserves on a pro rata basis upon the sale of each unit. In addition, a developer may choose to fund more than that percentage, and later deposits will be reduced by the amount of the excess funding. Moreover, if an association spends money from the reserve accounts prior to the sale of all of the units, the developer must deposit an amount equal to at least the portion of the expenses that would have been allocated to the unsold unit(s) if the unit(s) had been sold. Although not commonly exercised, the statute also gives developers the right to fund additional reserve accounts.
To properly fund the converter reserve accounts in accordance with the statute, there are other requirements that the developer must comply with in addition to the requirements regarding the amounts to be paid into the converter reserves. The developer must open the reserve accounts in the name of the association at a trust company, savings and loan association, or bank located in Florida. The statute also restricts the use of the converter reserves. Prior to the unit owners (other than the developer) assuming control of the association, the association may only spend converter funds on the repair or replacement of the items for which the funds were deposited. After the unit owners (other than the developer) assume control of the association, the converter reserves may be spent for other purposes if three-quarters of the voting interests of the association vote in favor of the expenditure.
If a developer chooses to fund converter reserves, in addition to actually funding the accounts listed above, a developer must also establish capital reserve accounts for deferred maintenance and capital expenditures. In other words, the developer cannot elect to waive the collection of capital reserves by unit owners, which it otherwise would have the right to do under Florida statutory law. The statute requires that capital reserve accounts be established for at least the following items: roof, building painting, pavement resurfacing, and any item for which replacement costs or deferred maintenance are greater than $10,000.
Thus, according to the statute, “[a] developer makes no implied warranties when existing improvements are converted to ownership as a residential condominium and reserve accounts are funded in accordance with this section.” However, if converter reserves are not funded strictly in compliance with the statute (which includes establishing capital reserve accounts), the developer runs the risk of being found to have actually granted the statutory warranties since the developer did not comply with the statute in order to opt out of the warranties. There is currently no case law which states whether the failure to properly fund the converter reserves will result in the statutory warranties applying or whether the court would allow the developer to retroactively come into compliance with the converter reserve requirements. Thus, a developer choosing to fund converter reserves must be certain to comply with all elements of the statute. Otherwise, the developer may not only lose the money already paid into the converter reserve accounts, but may also be responsible for the implied warranties discussed below. This is undoubtedly a risk a developer does not want to assume.
Granting Statutory Implied Warranties
If a developer chooses not to fund converter reserves, the developer is deemed to have granted to the purchaser of each unit and to each successor owner: (1) an implied warranty of merchantability and fitness for the intended uses or purposes of the roof and structural components of the improvements; (2) fireproofing and fire protection systems; and (3) mechanical, electrical, and plumbing elements serving the improvements, excluding mechanical elements that serve only one unit. The warranty period runs from: (1) three years from the date of the notice of intended conversion; (2) three years from the date of the recording of the declaration of the condominium; or (3) one year after the date that the owners, other than the developer, gain control of the association, whichever period ends last, but in no event more than five years from the date of the notice of intended conversion.
The statute of limitations for bringing a lawsuit for a breach of a statutory warranty based upon a defect which arose during the warranty period (except a breach relating to a latent defect) is four years. This timeline runs from the later of the date the unit owner takes actual possession of the unit or the date of the issuance of the certificate of occupancy. For a latent defect, which is a defect that is not obvious when the unit owner purchases the unit, the statute of limitations does not begin to run on the unit owner’s claim for a breach of a statutory warranty as to that defect until the unit owner knew or should have known about the defect with the exercise of reasonable diligence. Note, however, under the Florida Statutes, the maximum time period within which a plaintiff can bring a lawsuit for a breach of warranty claim for any defect is 10 years from the date of the issuance of the certificate of occupancy.
The warranties set forth above are conditioned upon routine maintenance being performed by the unit owners and the association, unless the maintenance is an obligation of the developer or a developer-controlled association. This “failure to perform routine maintenance” defense is almost always raised by developers in construction defect lawsuits. Although it can certainly be a valid defense, the developer must be able to establish that when the developer controlled the association, the maintenance was either (1) properly performed or was not required and (2) that the failure to maintain is related to the problem that is the subject of the lawsuit. A developer does have the option of purchasing an insured warranty program to cover its warranty obligations as long as the warranty program satisfies the requirements set forth in the statute. To date, there has not been significant usage of the insured warranty program, presumably because categories of pricing and scope of insurance coverage are not identical to the developer’s warranty obligations.
An important issue to note is that the improvements which are required to have converter reserve accounts and the improvements covered by the statutory warranties are not identical. Specifically, in addition to the improvements for which the developer would need to fund converter reserve accounts, the statutory warranties cover structural components of the improvements, fireproofing and fire improvements, and electrical and mechanical elements of the improvements. Thus, a question arises as to whether a developer, after funding converter reserves, is deemed to be making implied warranties as to those three components since the components are not covered by the converter reserves. However, because the statute expressly states that when a developer funds converter reserves, the developer does not make any implied warranties, it is unlikely that a court would find that the developer made any implied warranties under the statute if the converter reserves were properly funded.
Posting a Surety Bond
If a developer elects not to fund converter reserves but does not want to grant the statutory warranties, a developer may choose to post a surety bond. The acquisition of a surety bond satisfies the statute if: (1) the developer first notifies the buyer; (2) the surety bond is issued by a company licensed to do business in Florida; (3) the bond is readily available on the open market; (4) the amount of the bond is equal to the total amount of all reserve accounts; and (5) the bond is payable to the association. This option is not frequently selected because of the cost and terms required by the surety to cover the bond.
Making the Choice
Although funding converter reserves may insulate a developer from the statutory warranties, the developer is not insulated from common law causes of action, including negligence, misrepresentation and fraud. When deciding whether to fund converter reserves, a developer must carefully weigh all of the potential areas of liability (both common law and statutory), evaluate the age and condition of the improvements at the time of conversion, and determine the cost of funding converter reserves. Even after funding converter reserves, a developer may still be sued by the unit owners on common law grounds and on statutory grounds relating to the failure to comply with converter reserve funding requirements. A developer must also keep in mind that if the developer funds converter reserves, the association is entitled to retain that money, even if no construction defect issues ever arise. Thus remains the question whether to fund converter reserves and release the developer from some, but not necessarily all, liability or not to fund and take the chance that no construction defects will arise during the statutory warranty period.
We would like to acknowledge the assistance of Garland Reid, a summer associate in Holland & Knight’s Jacksonville office, for her contributions to this article.