Illinois Condo Developers have a Fiduciary Duty to Create a Reserve Fund after recording the Declaration

One of the most significant challenges facing board members taking over a newly built condominium, townhomes, or single-family homes is that the community association is often turned over from the developer with minimal funds. Developers often set unrealistically low initial assessments to make homes or condominium units more appealing to buyers, creating the false impression that assessments will remain low. This strategy may boost short-term sales but leaves a community association financially unprepared once the developer exits. As a result, reserve funds are frequently underfunded, putting long-term maintenance and the association’s financial stability at risk. However, as will be discussed in this article, developers and their appointees on a community association board have a statutory and fiduciary obligation to ensure that a community association is turned over to the owners with a reasonable reserve fund in place that also accounts for any construction defects that the developer may have caused.

Reserve Fund Requirements for Illinois Community Associations

765 ILCS 605/9(c)(2) requires a condominium association to establish a reasonable reserve fund for capital expenses, maintenance, repair, and replacement of the common elements. In determining the amount to be set aside in the reserve fund, the board must consider the following:

The repair and replacement cost, and the estimated useful life, of the property which the association is obligated to maintain, including but not limited to structural and mechanical components, surfaces of the buildings and common elements, and energy systems and equipment.
The current and anticipated return on investment of association funds.
Any independent professional reserve study that the association may obtain.
The financial impact on unit owners, and the market value of the condominium units, of any assessment increase needed to fund reserves.
The ability of the association to obtain financing or refinancing.

The Illinois Common Interest Community Association Act (“CICAA”), specifically 765 ILCS 160/1-5 defines “reserves” as “….those sums paid by members which are separately maintained by the common interest community association for purposes specified by the declaration and bylaws of the common interest community association.” 765 ILCS 160/1-5 further defines “common expenses” as the “proposed or actual expenses affecting the property, including reserves, if any, lawfully assessed by the common interest community association.” As such, the requirements that a board must analyze in creating a reserve fund are less stringent for homeowners associations that are subject to CICCA than condominium associations.

However, after taking control of a community association from the developer or declarant, it is best practice to set reserves based on the recommendations in a reserve study, as many developers do not utilize reserve studies in determining assessments. An initial reserve study involves an on-site inspection and analysis of the existing reserve fund to prioritize maintenance and repairs over a future period, often 30 years. The reserve study will then forecast the useful life of the common elements and the future cost of repair or replacement of the common elements. If you need help finding a reserve study professional, the Community Associations Institute maintains a directory of credentialed reserve study professionals.

Illinois Community Association Developers a Fiduciary Duty to create a Reserve Fund with “Reasonable” Reserves

In Glickman v. Teglia, 388 Ill. App. 3d 141, 146, 902 N.E.2d 1256, 1260, 327 Ill. Dec. 870, 874, 2009 WL 424756 (1st Dist. 2009), the Illinois Court of Appeals held that the developer appointees had a statutory duty to maintain the common elements, which was described as follows:

“Until election of the initial board of managers that is comprised of a majority of unit owners other than the developer * * *, the same rights, titles, powers, privileges, trusts, duties and obligations vested in or imposed upon the board of managers by this Act and in the declaration and bylaws shall be held and performed by the developer.” 765 ILCS 605/18.2(a).

Looking at the plain language of section 18.2(a), this provision operates to impose the responsibilities of the board of managers on the developer, not the responsibilities of the association itself. To determine the responsibilities of the board of managers, we look to section 18.4 of the Act. This section provides:

“ §18.4. Powers and Duties of Board of Managers. The board of managers shall exercise for the association all powers, duties and authority vested in the association by law or the condominium instruments * * *. The powers and duties of the board of managers shall include, but shall not be limited to, the following:

(a) To provide for the operation, care, upkeep, maintenance, replacement and improvement of the common elements. * * *

* * *

(d) To collect assessments from unit owners.

(e) To provide for the employment and dismissal of the personnel necessary or advisable for the maintenance and operation of the common elements.

(f) To obtain adequate and appropriate kinds of insurance.

* * *

In the performance of their duties, the officers and members of the board, whether appointed by the developer or elected by the unit owners, shall exercise the care required of a fiduciary of the unit owners.” 765 ILCS 605/18.4.

As part of that fiduciary duty, Illinois courts have consistently held that a developer, and the developer’s appointees that serve on the initial board of a community association must adequately fund reserves.

In Maercker Point Villas Condo. Ass’n v. Szymski, 275 Ill. App. 3d 481, 482–83, 655 N.E.2d 1192, 1193, 211 Ill. Dec. 809, 810, 1995 WL 559560 (2d Dist. 1995), a condominium association sued the developer and a developer-appointed director for failing to fund the reserve fund adequately. In that case, the declaration stated that “the Board shall establish and maintain a reasonable reserve for contingencies and replacements.” The declaration also required the board to maintain, repair, and replace common elements. The developer transferred control to the owner with only $7000 in the association’s bank account to maintain a 48–unit condominium building and a garage building with space for over 30 cars. The Court held:

The facts here establish that $7,000 is an unreasonably small amount of money in relation to the needs of the association. Defendant should have known that plaintiff’s obligations could not be met without his contribution of reasonable reserve funds. Furthermore, as a fiduciary, defendant had the duty not to hinder “the ability of the corporation to continue the business for which it was developed.” (Smith–Shrader, 136 Ill.App.3d at 577, 91 Ill.Dec. 1, 483 N.E.2d 283.) By leaving plaintiff underfunded, defendant violated his fiduciary duty to plaintiff.

Maercker Point Villas Condo. Ass’n v. Szymski, 275 Ill. App. 3d 481, 485, 655 N.E.2d 1192, 1194, 211 Ill. Dec. 809, 811, 1995 WL 559560 (2d Dist. 1995). The condominium association was awarded $70,965.56 in damages following a bench trial.

In Bd. of Managers of Weathersfield Condo. Ass’n v. Schaumburg Ltd. P’ship, 307 Ill. App. 3d 614, 617, 717 N.E.2d 429, 432, 240 Ill. Dec. 336, 339, 1999 WL 504322 (1st Dist. 1999), as modified on denial of reh’g (Sept. 30, 1999), the condominium association was turned over by the developer with $26,546,17 in its reserve fund, and at that time the roof already need to be replaced, and the parking lot needed repairs, all of which would have cost the association $500,000. In holding that the condominium association’s claims could proceed against the developer, the Court noted the following:

… as board members, defendants knew that from 1980 through November 6, 1993, the capital improvements of the Association, including the roofs and parking areas, were reaching the end of their useful life and by 1993 needed to be replaced and that defendants failed to maintain adequate reserves for the repair of the common areas. Defendants LaSalle, Schaumburg, and Inland should have known that plaintiffs’ obligations could not be met without an adequate contribution of reserve funds.
Id. at 620-21.

The Illinois Condominium Property Act and the Common Interest Community Association Act do not mandate a minimum amount of funds that must be set aside in a reserve fund. Rather, 765 ILCS 605/9 only requires the board to maintain “reasonable reserves.” In some cases, the declaration or bylaws will identify a specific reserve amount that the association must maintain, but in most cases, the governing documents indicate that a “reasonable” reserve fund must be maintained to track the requirements of 765 ILCS 605/9. In such a case, a reserve study helps determine what constitutes a “reasonable” reserve fund, as the Court relied on expert testimony based on a reserve study to determine the amount of a “reasonable” reserve fund in Maercker Point Villas Condo. Ass’n v. Szymski.

Developers of Illinois Condominium Associations Duty to Fund the Reserve Fund when the Declaration is Recorded

Developers and developer-appointed directors may argue that the obligation to fund reserves only commences after units are sold or at the time of turnover. However, the Illinois Courts have been clear that the duty to fund reserves begins when the declaration is recorded. Specifically, the Illinois Court of Appeals has held as follows:

Defendants argue that defendants’ duty to fund reserves began only after the first unit was sold. The court in Maercker held that, pursuant to the historical and practical notes of the Act (765 ILCS Ann. 605/9, Historical & Practical Notes, at 45 (Smith–Hurd 1993)), the duty to fund reserves begins when the declaration was recorded. Maercker, 275 Ill.App.3d at 486, 211 Ill.Dec. 809, 655 N.E.2d 1192. We agree and hold that doing so does not place an undue burden on defendants.

Bd. of Managers of Weathersfield Condo. Ass’n v. Schaumburg Ltd. P’ship, 307 Ill. App. 3d 614, 623, 717 N.E.2d 429, 436, 240 Ill. Dec. 336, 343, 1999 WL 504322 (1st Dist. 1999), as modified on denial of reh’g (Sept. 30, 1999). As such, condominium associations should analyze whether the developer created a reasonable reserve fund for the entire time it controlled the association’s board of directors.

The Initial Reserve Fund Must Account for Common Element Construction Defects caused by the Developer or Declarant

In determining what constitutes a “reasonable” reserve fund, Illinois courts have held that the developer-appointed directors must also consider whether common elements have any construction defects. In Henderson Square Condo. Ass’n v. LAB Townhomes, L.L.C., 2014 IL App (1st) 130764, ¶ 134, 16 N.E.3d 197, 226, 384 Ill. Dec. 101, 130, 2014 WL 3709423, aff’d sub nom.opinion modified on denial of reh’g (Jan. 28, 2016) Henderson Square Condo. Ass’n v. LAB Townhomes, LLC, 2015 IL 118139, ¶ 134, 46 N.E.3d 706, 399 Ill. Dec. 387, 2015 WL 6742339, the Court stated:

…defendants were bound by a fiduciary duty to budget for reasonable reserves. 765 ILCS 605/9(c)(2). What is reasonable is determined, in part, by “the repair and replacement cost, and the estimated useful life, of the property which the association is obligated to maintain, including but not limited to structural and mechanical components, surfaces of the buildings and common elements, and energy systems and equipment.” 765 ILCS 605/9(c)(2). Plaintiffs have alleged that defendants knew, at the time of transfer, that the repair and replacement costs would be high as a result of substandard construction. Therefore, defendants had a duty to charge assessments at a level high enough to fund adequate reserves for the repair and replacement of defects caused by substandard construction and materials. Furthermore, defendants’ argument that one of the unit-owner-controlled boards could have charged higher assessments to fund greater reserves ignores plaintiffs’ allegation that the defects were not known to plaintiffs, and could not have been known to plaintiffs until they discovered the substandard construction and materials. If plaintiffs did not know that the building would require extensive and expensive repairs and replacements resulting from the inferior construction and materials, it would not have been reasonable to charge higher assessments to cover for such unknown repairs and replacements.

As such, the Illinois courts have held that independent of a developer’s obligation to turnover the common elements in a good and workmanlike manner, under the implied warranty of habitability, they also must ensure that the reserve fund accounts for any construction defects that the developer does not repair.

Conclusion

Illinois community associations must hold developers and declarants responsible for creating a reasonable reserve fund. If developers are not held accountable for funding a reasonable reserve, the financial burden shifts to the owners, often resulting in unexpected assessment increases or deferred maintenance that diminishes property values. Illinois law imposes clear fiduciary and statutory duties on developers and their appointees to establish and maintain adequate reserves, including for known construction defects. Community associations should conduct reserve studies immediately after developer turnover and pursue claims where necessary because every dollar a developer fails to contribute is a cost that owners will be forced to pay. If your condominium or common interest community association is unsure whether the developer has created a reasonable reserve fund, Hirzel Law is here to help!

Kevin Hirzel is the Managing Member of Hirzel Law, PLC, where he focuses his practice on community association law, condominium law, homeowners association law, real estate law, and Fair Housing Act compliance. He is a Fellow in the prestigious College of Community Association Lawyers (CCAL), an honor held by fewer than 200 attorneys nationwide. Mr. Hirzel serves on the CCAL National Board of Governors and was previously a member of the Community Associations Institute (CAI) Board of Trustees. Best Lawyers, Leading Lawyers, and Super Lawyers have recognized Mr. Hirzel. He is also the author of Hirzel’s Handbook: How to Operate an Illinois Condo or HOA, available on Amazon.com. Mr. Hirzel has been featured in major media outlets such as CBS, CNBC, Fox News, Fox Business News, NPR, Newsmax, and The Wall Street Journal. His insights have also been showcased on programs like The Dan Abrams Show (SiriusXM Radio), Dr. Drew Midday Live (KABC Radio), and the Law & Crime Network. A sought-after speaker, Mr. Hirzel frequently lectures at state and national conferences, sharing his deep knowledge of community association law. Hirzel Law, PLC, represents common interest community associations, condominium associations, homeowners associations, and townhome associations in Illinois. Hirzel Law, PLC has offices in Chicago, Downers Grove, and Skokie. Kevin Hirzel can be reached at (312) 552-7669 or kevin@hirzellaw.com.