Addressing Association Manager Conflict of Interest

In late 2006, I wrote an article that unintentionally created a minor maelstrom of backlash from several association management companies in Oregon and Washington. Although published in 2006 in the Community Associations Journal and Regenesis Report the topic is as relevant today as it was almost two years ago. Many management companies continue to serve two masters (homeowners and developer/declarants) without taking proactive steps to minimize the perceived, and sometimes actual, conflict of interest as demonstrated below.

Property management companies retained by developer clients often have to walk a tight-rope as they balance the interests of their two clients: the developer and the homeowner association. In the perfect world, this dichotomy of client interests would not be at issue because the developer and homeowner association would share parallel interests. But practically speaking, inherent conflicts arise between developers and homeowners regularly, which place the property manager squarely in the middle of an undesirable situation.

A.        Conflict in the Making

A developer will hire a property manager to take the association through the transition from developer/ declarant control to homeowner control with an intention for the property manager to stay on as the association’s management company. At the time the management company is hired, it is clear the client is the developer. But soon thereafter, the manager has to begin working with the homeowner association members and must consider the interests of the homeowners.

In large projects or master plan communities, a property management company may be retained many months prior to establishment of a homeowner’s association in order to manage the physical property and assist in creation of the association. As the development sells out and homeowners begin populating the association, additional duties are initiated, including management of operating and reserve financial accounts, coordination of association meetings, administration of vendor contracts, oversight of physical maintenance, et cetera. At the point of formal transition from developer or declarant control to homeowner control, the pendulum shifts and the property manager works almost exclusively for the association.

But just as during initial retention by the developer, the property manager should begin to consider the interests of the ensuing homeowners, following transition, the manager may find it difficult to ignore the interests of the developer—the party that initially hired him or her. This dual master relationship creates a less than enviable challenge for the property manager.

B.         Actual Examples of Actual Conflicts

At or shortly after transition, an association becomes aware of potential construction defects within its condominium. The developer is notified and offers to repair problems. This scenario presents an immediate conflict of interest between the homeowners and the developer. It is in the interest of even the most honest developer to minimize the repair, as once the project is sold and turned over to the homeowners, the project shifts from a profit center to a cash drain. Thus, there are very few developers who would conduct an exhaustive investigation to determine the extent of the problems, choosing instead to effectuate the most minimal repair possible. This interest clashes head-on with the interest of the homeowners, who should conduct an independent, comprehensive investigation to determine the exact nature and scope of the problems or defects. The property manager is placed directly in the cross-hairs between the two competing interests. If the manager sides with the developer and recommends that the association accept the developer’s offer to repair the problem, then it is possible that he or she is compromising the interests of the homeowners. Conversely, if the manager recommends that an independent investigation be conducted, then the manager will surely aggravate the developer.

Another example of developer-homeowner conflict involves financial accounting. Frequently, at time of transition, there are operating or reserve account questions. Although Washington law requires an audit and Oregon law requires a financial audit be conducted, for a substantial percentage of associations residual financial questions remain, such as whether and how much the developer contributed to homeowner dues during the time they owned units, maintenance costs that might have been attributable to the developer involving expenses related to finishing the project, or other administrative reimbursable expenses. More often than not, these types of questions are not answered, and seldom raised, during an audit or financial review.

Another condominium association was less than a year from transition when it discovered possible construction defects. The association obtained legal representation and was attempting to work with the developer and his attorney to resolve the problems short of litigation. Unbeknownst to the association’s attorney, and done behind counsel’s back, the developer met with the property manager and told her that he had two new properties that were coming on line within the next year and he was looking for a management company. In the same breath, the developer asked if the manager could arrange a meeting with the current association’s board of directors so he could pitch a repair plan “without the need to get the attorneys involved.”

C.        How to Avoid the Conflict Conundrum

There are certain conflicts of interest that are inherent in the business world. Some professions, such as physicians and business facilitators, handle these conflicts through implementation of strict guidelines and rules. Other professions, such as the legal, accounting and real estate brokerage industries, are heavily regulated by state statutes or administrative codes. There are no such laws or guidelines in the property management industry—yet. Therefore, property management companies might consider self-regulating themselves until such time as more formal rules or policies are enacted. The following guidelines are suggested for those property management companies who are hired by developers or declarants and then continue to serve as the homeowner association management company.

The most obvious and cleanest way to avoid this conflict is simply to avoid acting as both the developer/declarant manger and ensuing association manager. A property management company could either specialize in pre-transition properties on behalf of a developer/declarant, or post-transition properties on behalf of an association, but not both. Once control of the association shifted to the homeowners, the developer’s management company’s services would be terminated. The obvious drawback to this option is revenue. There are not many management companies that voluntarily choose to work only for developers or only for already established associations.

The next best alternative would be for the property management company to state up front when hired by the developer that the manager would work for the developer up through time of transition, but once the control of the association shifted to the homeowners, the manager would act solely on behalf of the interests of the homeowners. This arrangement should be clearly defined and articulated in the services agreement with the developer/declarant. A possible drawback to this option is that there may be developers or declarants who would not be amenable to this arrangement, and would not accept the fact that the property manager’s allegiance would shift to the homeowners (even though the developer/declarant would no longer be paying the property manager post-transition). It likely would only take one example of the property manager siding with a homeowner association against the developer post-transition for the developer to abstain from using that property management company for future projects.

The last option (and apparently most common in today’s industry) would be for the property management company to try to balance the interests of both clients simultaneously throughout the period of management. Although discouraged, when a property management company proceeds in this manner, it is highly suggested that the manager inform both the declarant/developer and homeowner association in writing of such dual representation and potential conflict of interest. It would be further recommended that the manager obtain written consent from both parties.

If acting for both the developer/declarant and association, the property manager should also make it a practice to rely on independent consultants, rather than try to resolve the dispute or potential conflict internally. This custom would minimize the likelihood of perceived or actual wrong doing or unintentional favoring of one client over the other. For example, if a legal question arises, the manager should recommend that the association seek independent legal advice, and not advice obtained by the property manager and passed on to the association. Or, if construction or defect issues are suspected, then the manager should refer the association to an independent inspector with expertise in the field. If financial questions arise, it would be wise to conduct a review or, under severe circumstances, an audit of the association’s financials by an independent, certified CPA.

D.        Conclusion

Property management companies are placed in difficult situations every time they are hired by developers or declarants and carry on as the association’s manager. A substantial number of management companies’ business plans include such a portfolio of properties. For those companies who do not desire to become entangled in the conflict of interest quagmire, than they should ideally refrain from dual representation. For those companies who pursue such clients, they should take proactive steps to minimize the potential for conflict and to ensure they provide sufficient notice and even receive written consent from their clients. All property managers should refer questions or issues to independent, qualified consultants who should be hired by, and report directly to, the association board of directors, rather than pass information through the manager.

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