Condo boards can and should earn interest on reserve funds
Q: We have a dilemma on our condominium board of directors. Some of our board members believe that the association reserve funds cannot earn interest because we are a nonprofit entity. On the other hand, we have board members (myself included) that think we can not only earn interest, but we should invest our reserve funds in more aggressive investment products other than basic CDs and earn interest that can be added to our reserves. Can you please comment on this?
A: There are a couple legal issues involved in your questions. First, the board of a condominium is required to establish reasonable reserves. Typically, those reserves are to be used for capital expenditures, long-term maintenance, repair or replacement of the common elements or other items outlined in your particular association’s governing documents. Legally, under Section 9(c)(2) of the Illinois Condominium Property Act, when determining a reasonable reserve amount, one of the five items a board is to take into consideration is “the current and anticipated return on investment of association funds.” Therefore, the Condominium Act clearly anticipated that the association could invest reserve funds in interest bearing products. For many condominium associations, such an investment would be an interest-bearing, government insured bank account, CD or Money Market. Importantly, the association's status as a not-for-profit corporation is not impacted by the condominium association merely earning interest on their reserve fund investments. Moreover, keeping association reserve funds in an account that does not earn interest or create a return on investment might actually be considered a breach of the board’s fiduciary duty; although probably not to the extent as if an association invests funds in a product that places reserve fund principal at significant risk of loss.
Which brings us to the other legal issue you raise: how aggressively can a board invest the association’s reserve funds. This is a common question with which condominium boards struggle. First, it is important to note that the board members are fiduciaries of the unit owners/association, under the Condominium Property Act. However, the ICPA does not expressly address how the board can invest reserve funds. That said, there are other Illinois statutes that provide some direction for condominium boards. For example, the “prudent investor rule” has been adopted as an Illinois statute (760 ILCS 5/1). It governs trustees and fiduciaries, and, is at a minimum, applicable to association boards by analogy as they have a fiduciary duty with respect to the investment of association reserve funds.
Similar to the Condominium Act, that statute does not provide specific investment parameters. It merely requires that fiduciaries must act “prudently” when it comes to investments. However, that statute requires that an investment strategy must consider both the “reasonable production of income” and “safety of capital.” When it comes to investing condominium association reserve funds, protection of capital or principal is critical. As such, a condominium board’s decision to invest the association's reserve funds (or any funds) in an investment product which may result in the loss of capital would certainly be subject to criticism and potential claims of breach of fiduciary duty in the event of significant losses. Accordingly, the conservative approach dictates that the principal is not at unnecessary risk when considering the investment of the association’s reserve funds.
Taking all that into account, there may be investment products that could yield a better return than your board is getting now but that would still not put the principal funds at risk. That would be something your board should discuss with their professional management team and a licensed investment professional.
• Matthew Moodhe is an attorney with Kovitz Shifrin Nesbit in the Chicago suburbs. Send questions for the column to him at condotalk@ksnlaw.com. The firm provides legal service to condominium, townhouse, homeowner associations and housing cooperatives. This column is not a substitute for consultation with legal counsel.