April 4, 2004

The appellate court of Illinois decided three cases recently which expand the liability of the developers and directors of condominium and townhome associations to the association. It is likely that future appellate decisions will expand the liability of developers and directors of other types of property owner associations.

Illinois statutes require condominium developers to make contributions to reserve accounts for unsold units as required of other unit owners. There is no similar statute regarding townhome developers.

In 1995, an Illinois appellate court held that the developer owed a fiduciary duty to the condominium association not to do or not do anything that would interfere with the ability of the association to operate. This included a duty to provide proper reserves to replace the common elements, even though the condominium statute at the time did not require this.

In a 1999 case against a developer of a townhome development, the same issue was raised—the failure of the developer to provide and fund reserve accounts. The court relied upon the previous decision regarding condominium associations and ruled that the townhome developer owed a fiduciary duty to the association to fund reserve accounts. However, because the recorded declaration of covenants expressly provided a limitation on the developer’s obligations to fund reserve accounts, the court ruled that this duty could be modified. The court held that a developer of a townhome association can limit its obligation to fund reserve accounts if it gives prospective purchasers notice of such limitation. The prospective purchasers can elect not to buy a unit with such limitations. The court also indicated that the limitation must be reasonable.

In another 1999 case involving the same issue in a condominium situation, the court ruled that not only could the developer be liable but that the individual board members could also be held personally liable for failure to require appropriate reserve accounts.

These decisions do not hold that developers and directors are automatically liable. They only require that those persons act fairly, equitably and reasonably under the circumstances.

Developers, in their recorded declarations and in the contracts they provide to purchasers, should include provisions defining their obligation to fund reserve accounts. They should also include (or the associations should include) provisions for the association to indemnify innocent members of the board of directors. Consideration should also be given to providing directors and officers with liability insurance.

Prospective owners, when purchasing a condominium, townhome or other property governed by an association, should inquire into the status of reserves and whether reserves will be required in the future. This should be investigated prior to entering into a contract to purchase the property.

Purchasers frequently investigate the condition of the property they plan to purchase but give no consideration to the condition of the common property owned by the association or all the owners.