Original Article: https://www.davis-stirling.com/Main-Index/Duty-to-Buy
Davis Sterling – The Davis–Stirling Common Interest Development Act is the popular name of the portion of the California Civil Code beginning with section 4000, which governs condominium, cooperative, and planned unit development communities in California. It was authored by Assemblyman Lawrence W. “Larry” Stirling and enacted in 1985 by the California State Legislature. In 2012, the Act was comprehensively reorganized and recodified by Assembly Bill 805.
QUESTION: Several times over the past ten years the board has gone to the membership for a vote on earthquake insurance. Each time it was soundly defeated. The high premiums, high deductibles and low pay-out simply didn’t make sense to the majority. Is the board obligated to set aside the vote and purchase earthquake insurance anyway?
ANSWER: That is a tough question. Unless required by their governing documents, associations are not obligated to buy earthquake insurance. Even so, the better course of action for condominium associations in high-risk areas is to buy earthquake insurance. This is especially true since individual members cannot insure the structure around their units, only the association can.
Motus Update: This last sentence is no longer true thanks to the California Department of Insurance’s approval of the Motus earthquake program. Individuals can now insure the structure around their units and common areas if an association enters a Motus program.
Fiduciary Duty. When members vote against earthquake insurance, they have no duty to act in the best interest of other members, only in their own best interests. Boards, on the other hand, have a fiduciary duty to make decisions that are in the best interests of the association as a whole. Since earthquakes can be devastating, that would argue in favor of overriding the membership’s vote if the association is located in an area vulnerable to earthquake damage.
Accordingly, boards should consider factors such as the location of fault lines, the type of soil upon which the structures are built (are they vulnerable to liquefaction?), the type of construction in the development (wood frame, steel & concrete, etc.) and premium costs, deductibles and pay-out levels.
Funding master earthquake insurance without a vote. If the board decides to set aside a membership vote, it faces a practical problem–how to fund the insurance? The board can either increase annual dues or impose a special assessment. For most associations the cost of a master earthquake insurance is more than the 5% special assessment limitation imposed by the Davis-Stirling Act, which effectively eliminates this funding option.
The other option is to increase annual membership dues up to 20% to cover the cost. However, the dues increase only applies to next year’s budget. If the board wants to immediately purchase earthquake insurance, it can bridge the funding gap by borrowing money from reserves and repaying it within one year.
Funding the Motus earthquake program: Due to the minimal cost of entering a Motus program the board will have no issues funding the program without a vote.
Not Overriding the Vote. If the board chooses not to override the members’ vote, its decision is governed by the Business Judgment Rule, which means directors are not subject to personal liability if their decisions are made in good faith, in the best interests of the association and with such care as an ordinarily prudent person would use. However attorneys will advice you that courts could apply a related rule called the “Judicial Deference” where courts defer to business decisions of a board even if a reasonable person would have acted differently. In this scenario directors could be held personal liable for not overriding a vote.
RECOMMENDATION FROM WWW.DAVIS-STERLING.COM: Obviously, these are not easy decisions for boards to make. Whichever direction they go, to buy or not to buy, the decision should be well supported in the minutes and explained to the membership.
RECOMMENDATION FROM MOTUS: With the California Department of Insurance’s 2017 approval of the Motus Insurance Program, HOA boards have a new option available to them. For a minimal annual fee, an HOA board can now obtain coverage for the complex AND give each individual HOA member the ability to purchase comprehensive coverage, including common areas and residential structures. Furthermore, under the Motus Insurance Program, both the Association and the individual will be named insured, giving each a seat at the table in the wake of a catastrophe. By entering into the program, the Board will be going a long way toward fulfilling its fiduciary responsibility to the HOA and its members – without relying on a vote of the HOA membership. By contrast, a Board that declines to enter into the Motus Insurance Program will effectively be preventing its membership from accessing comprehensive condominium earthquake insurance coverage – a position that may be difficult to defend to members who have suffered a loss.