How to X-ray an HOA #6 – Lawsuits, Judgments and Insurance

Pending lawsuits must be disclosed on Minnesota’s Resale Disclosure Certificate when the HOA is a party to it.  If you are considering a home where the association is in litigation, it is imperative to know what’s at stake.  Is someone suing the HOA over a $2,000 invoice or is the association suing the builder for a multi-million dollar construction defect?  Banks generally don’t want to lend money for houses with pending lawsuits and may insist on a higher interest rate to do so.  If you are determined to buy in that complex, first consult an attorney for advice.  I also recommend that you read the court records, if possible.   Then use the litigation to negotiate a lower price.  

Judgments.  Prospective buyers should also understand the basic story behind any court judgments against the association.  What caused the original dispute?  Did the HOA Board make imprudent decisions or fail to follow the procedures in the Governing Documents?  Does either party seem unreasonably litigious?   Occasionally, a disgruntled homeowner will sue their HOA repeatedly and that tension can poison the entire neighborhood. 

Also, find out when and how the HOA plans to satisfy the judgment.  Will there be a special assessment or will the Board use existing funds?  If the judgment became final more than a year ago, why hasn’t it already been paid?  Unpaid judgments usually indicate an HOA that is struggling financially or lacks proper business procedures or both.

Insurance.   All associations should maintain commercial general liability insurance covering the community property.  The HOA should also have a blanket hazard insurance policy covering 100% of the current replacement cost of the common elements.   That blanket policy may include interior coverage for individual units but if it does not, owners must obtain their own “walls-in” insurance policy (also known as an HO–6 policy).  While many HOAs include the cost of the blanket insurance policy in the annual dues, others issue a separate bill for this insurance expense.  The Resale Disclosure Certificate should tell you which situation applies in your target neighborhood.  

Both buyers and sellers should be aware of new FHA, Fannie Mae and Freddie Mac rules requiring developments with 20 or more units to maintain a fidelity insurance policy or bond.  This protects the association’s funds against theft and other dishonest acts.   Sellers should verify that their HOA meets this requirement before their home goes on the market.  Without it, potential buyers will not qualify for mortgages backed by these institutions, leaving the seller with a tiny pool of eligible purchasers.   

Even without the mandate from these federal agencies, prudent HOA Boards routinely carry fidelity insurance.  Furthermore, the HOA should also carry “Directors and Officers” liability insurance, if available at a reasonable cost.  This policy covers litigation expenses and losses incurred from alleged breaches of fiduciary duty.  

Sellers in developments with pending lawsuits, unpaid judgments or inadequate insurance will have a hard time retaining the interest of buyers.  Those who are lucky enough to get an offer after disclosing these matters should recognize that holding out for top dollar would not be a wise strategy.

In Part 7, we will discuss HOA management and community amenities.

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