The Theory of Reserve Fund Planning – A Primer
Section 94 of Ontario’s Condominium Act (the Act) describes the obligation of every condominium corporation to prepare and implement a new reserve fund plan following each reserve fund study. And the Act says that the reserve fund plan is to be prepared so as to result in a fund that is adequate “within a prescribed period of time and in accordance with the prescribed requirements”. What exactly does this mean?
The Act and Regulations do not yet contain any definition of the term “adequate”. This is expected to come in anticipated additional amendments to the Act and Regulations. For now, there is room for debate about the meaning of the term “adequate”.
In our opinion, a reserve fund is “adequate” when the annual contributions are sufficient to meet the predicted long-term requirements of the fund. This means that – based upon the latest available information – there is no expected need to increase the annual contributions beyond inflation or to make any extra lump-sum contribution to the fund at any time in future. [When the reserve fund is “adequate”, I think of the fund as being “on track”.]
When the reserve fund is adequate, this means that the current prediction is that future owners will spend no more than current owners for major repairs and replacements (after one adjusts for estimated inflation).
When the reserve fund is adequate, this also means that there is no need to include a warning in the status certificates that the reserve fund “may be off track”.
When the reserve fund is inadequate, this means that, at some time in future,
- annual contributions may need to increase beyond inflation; and/or
- a lump sum contribution may be required.
When the reserve fund is inadequate, it is also usually necessary to include a warning in the status certificates until the reserve fund is “back on track”.
Hopefully, all of this will be confirmed, one way or another, by upcoming anticipated amendments to the Act and Regulations.
Again, condominium corporations must plan (following each reserve fund study) for the fund to arrive at a “state of adequacy” by a certain deadline indicated in the Regulations. These requirements are “in flux” in the sense that changes to these Regulations are also anticipated soon. We recommend that each condominium corporation take advice from their reserve fund analyst and/or legal counsel as to how the time frames apply to them.
What if your annual reserve fund contributions are more than adequate? When the annual reserve fund contributions are more than adequate, the result is that the balance in the fund will grow excessively large. This happens when the annual contributions are at a level that is higher than necessary, given the balance in the fund. When this happens, I often say that the annual contributions are “higher than natural” for the condominium.
In my experience, contributions that are higher than natural most often occur when unexpected events have “unnaturally reduced the reserve fund”. In such cases, the most natural solution may be to make a lump sum contribution to the fund, in order to re-establish a “natural balance” (given the age and type of property). If the condominium corporation instead decides to increase the annual contributions, this may result in contributions that are “more than adequate” (i.e. higher than the natural contribution level for the particular property).
Having annual contributions that are more than adequate is in my view perfectly legal, but there are some disadvantages:
The disadvantages of having annual contributions that are “more than adequate”
- The higher than natural contributions will often mean higher condominium fees – with resulting potential impact upon market values of the units.
- The higher than natural contributions may mean that some owners (whether present or future owners) may end up paying more into the reserve fund than would otherwise be the case (i.e. if the contributions were at a natural level for the condominium).
Some condominium corporations are content to have reserve fund contributions that are “more than adequate” ….particularly given the fact that adjustments (including any appropriate reductions in the contributions) can of course be made in future reserve fund plans (after future reserve fund studies). However, other options are as follows:
- You could plan for a lump sum contribution (to place the fund balance at a natural level). Again, it is our view that you can only plan for a lump sum contribution to occur before the “adequacy deadline” mentioned above. [Note however that you can consider borrowing (with approval by by-law) to achieve the lump sum contribution. This has the effect of spreading the cost to owners over the term and/or amortization period of the loan. It would also often be necessary to mention the loan in your status certificates.]
- Your reserve fund plan could call for a future reduction to the annual contributions (remembering always that the planned future contributions can never be reduced below what is “adequate”).
In summary, if your reserve fund contributions happen to be more than adequate – in other words are unnaturally high given the age and type of property – there may be a few options available to you. In each case, it will be up to the Board (assisted by management and the reserve fund analyst) to consider the options.
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