When is enough, enough? The adequacy of reserve funds

January 21, 2021 | Justin McLarty

The Auditor General of Ontario’s recent report, “Value-for-Money Audit: Condominium Oversight in Ontario” (the “AG’s Report”) outlines a number of issues facing condominium corporations and owners. One of these issues is the adequacy of reserve funds, with the AG’s Report noting that a whopping 69% of condo’s registered in the years 1980 and 2000 did not have sufficient reserve funds.

While this is a small sampling of older condominiums, the AG’s Report also noted issues with newer buildings as a result of “fixed rate” reserve fund contributions during the first year. Many of the issues being faced, in our view, are a result of the lack of clarity with respect to what level of funding is “adequate.”

Section 94(8) of the Condominium Act, 1998 (the “Act”) provides that a corporation’s reserve fund plan is to be prepared to provide for a fund that is adequate “within a prescribed period of time and in accordance with the prescribed requirements.”

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While it is expected that the Regulations under the Act will provide for a definition of “adequate,” neither the Act nor the Regulations have ever defined what constitutes an adequate level of funding. There will be no one size fits all solution, given the different needs and characteristics of the thousands of condominium corporations across Ontario. Providing greater certainty with respect to the meaning of adequate would go a long way.

A commonly accepted definition in the industry is that a reserve fund is “adequate” when regular contributions will reasonably ensure that sufficient funds will be available for long-term repair and replacement of the common elements. In other words, there should be no need to increase the annual contributions by more than inflation or to levy a special assessment for repair and replacement projects.

Without a legislative definition, however, whether a reserve fund is adequate within the meaning of the Act is usually a question left for engineers and legal counsel to answer to the best of their abilities. This lack of certainty on what constitutes an adequate level of funding allows for undesirable flexibility in some cases, as future expenses and projects can be shifted over a reserve fund study’s 30 year time span.

Unfunded reserves are not necessarily a result of bad governance, management or professional advice (although all three will certainly result in an inadequate reserve fund). Unexpected events, like the early failure of a building component or damage that is either not covered by insurance, or for which an insurance claim would result in both a substantial deductible and a skyrocketing premium, can throw years of prudent financial planning off track.

Unforeseen events highlight the importance of remembering that a reserve fund study is a planning tool, not a crystal ball to predict future expenditures. With that said, until the expected Regulations under the Act come into force, we suggest that the following steps be taken to reduce the risk that a corporation’s reserve fund is not adequate:

  1. Use a reputable engineer that is familiar with condominiums and the industry. A good engineer will understand the lifecycle of a building and have experience working with property managers and boards to provide an accurate assessment of expected funding needs.
  2. Ensure that the reserve fund study is completed on time every three years. Delaying a new study often results in little more than a shorter time span to make up for any shortfall, leading to the need for higher contributions over a compressed time span.
  3. Listen to the corporation’s engineer and avoid the temptation to push projects and increased funding needs further down the road. Delaying increased contributions for political reasons (for example, being able to claim that common expense contribution increases have been kept at or below the rate of inflation) will only result in a current shortfall becoming a larger issue with each passing year.

Disclaimer

This publication is provided as an information service and may include items reported from other sources. We do not warrant its accuracy. This information is not meant as legal opinion or advice.

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