Chapter 5 FORMATION OF COMMON INTEREST COMMUNITIES

• Jurisdiction: North Carolina

5 FORMATION OF COMMON INTEREST COMMUNITIES

§ 5.01. In General

The formation of an association starts in the planning stages with the local jurisdiction approving the development and the developer shaping an association to meet the needs of the development. The second phase of the association involves the preparation and recordation of a number of documents, including a declaration, articles of incorporation and the bylaws for the association. Of these documents, the declaration is the most important for both a condominium and a planned community.¹ It is the document that subjects the land to how it will be used decades after the developer has completed the development. During these initial phases, a developer needs to consult with the subdivision regulations of the particular county or municipality in which the development will be constructed.² It is still recommended that the developer obtain a subordination of its lender's interest in the land, if any, to the declaration to ensure the declaration remains in-tact should the developer lose all or a portion of the development to foreclosure.³

The last two phases of an association are the transition phase where the developer cedes power to an independent board of directors and then, finally, the ongoing management and operation of the association after the developer is gone.⁴ This last phase is where most of the association will exist. Therefore, it is crucial that the developer get the original set of governing documents for the association right. Sloppily written and hastily assembled legal documents will cause problems in association operations for years after the developer completes development leaving lasting impacts on homeowners that live in the community.

§ 5.02. Creation of Condominiums

§ 5.02.01. Declaration

The declaration is by far the most important legal document in the formation of a condominium. It is the foundational document that deals with assessments, use restrictions, voting rights, easements, control over (and ownership of) the common elements. It is the first document an owner, manager or attorney must consult in answering any question about the association. Most fundamentally, the declaration contains a description of the property that is subjected to the declaration.⁵ The description of the property subjected to the declaration is usually embedded in the declaration itself or as an exhibit to the declaration. Due to the fact that the Condominium Act requires the declaration to refer "by number" to the file where the plats and plans are recorded, the declaration is recorded immediately after the approved plats and plans for the condominium are recorded with the register of deeds, which is after the building is constructed.⁶

Unlike the PCA, which does not dictate what has to be in the declaration, the Condominium Act requires a number of basic components to the declaration.⁷ The declaration must contain detailed information on "leasehold condominiums." ⁸ Since the common elements are not owned in fee simple by the condominium association, the declaration must also allocate a fraction or percentage of undivided interests in the common elements, interests in the common expenses of the association and a portion of the votes in the association to each unit and state the formulas used to establish those allocations.⁹ These allocations are typically done by an exhibit to the declaration showing the fractional ownership of the condominium common elements. Importantly, while the fractional ownership of the common elements may differ between the units, the assessments which unit owners pay do not have to be based on those percentages necessarily. The only requirement in the Condominium Act is that the common expense liability be allocated to all units as one if stated as a fraction and 100% if stated as a percentage.¹⁰

If the developer expects to maintain a sales office, management offices, or models in units or on common elements then the declaration must provide the rights of a declarant with regard to the number, size and location of these offices.¹¹ The declaration should contain the number of units which will initially be within the condominium and the boundaries of such units. The unit boundaries defined in the declaration may, but need not be consistent with the defined unit boundaries in the Condominium Act.¹² Under the Condominium Act, if any flue, duct, wire, conduit, bearing wall, bearing column, or any other fixture lies partially within and partially outside the designated boundaries of a unit, portions serving only that unit is a limited common element allocated exclusively to that unit, and portions serving more than one unit or any portion of the common elements is a part of the common elements.¹³ In other words, regardless of the location of these parts of the building, if it serves only the unit, then it is a limited common element. For example, if a portion of a water pipe or duct work lies outside the boundaries of a unit, the portion outside the unit that only serves the unit is a limited common element, even though it is outside the physical boundaries of the unit itself.¹⁴

The Condominium Act requires the declaration to specify which unit or units limited common elements are allocated.¹⁵ Common examples of limited common elements are patios, porches or decks affixed to the unit. Limited common elements can also include the "guts" of the building such as internal conduit and wiring. In such instances, it may be difficult to allocate which unit a duct or conduit belongs. Therefore, the declaration need not have a specific provision in it identifying how limited common elements such as duct, wire, conduit (the guts) are allocated to a unit, nor how the decks, porches, balconies, patios, are allocated to a particular unit.¹⁶

The declaration should also provide a period of declarant control of the condominium association even though the Condominium Act contains a specific time period within which the declarant must turn over declarant control irrespective of the declaration.¹⁷ The declaration should specify that the declarant may appoint and remove the officers and members of the executive board during this time. Under the Condominium Act, this declarant control period has to terminate no later than the earlier of: (a) 120 days after conveyance of 75% of the units (including units which may be created pursuant to special declarant rights) to unit owners other than a declarant; (b) two years after all declarants have ceased to offer units for sale in the ordinary course of business; or (c) two years after any development right to add new units was last exercised.¹⁸ Of course, the declarant can surrender his right to control the association earlier; however, in no event can it last longer than any of the above trigger points under the Condominium Act.¹⁹

Other fundamental provisions that should be in the declaration include provisions on how assessments are calculated and raised, the voting requirements for special assessments, easement right of owners over common elements for the declarant and association, the types and amounts of insurance that must be obtained, the procedure for the reconstruction of the condominium, any provisions with respect to notices to mortgagees, and common use restrictions and the procedures for amending the declaration. The declaration can, and usually does, contain many more provisions that are generally enforceable unless their application is limited by other legislation or they are contrary to the Condominium Act where the Condominium Act does not authorize deviation.

§ 5.02.02. Office Condominiums

Office condominiums are structured the same way as residential condominiums charted under the Condominium Act. Usually, with office condominiums more emphasis is placed on rental restrictions in recognition that leasing of office space is far more common in office condominiums than it is with residential condominiums. Declarations for office condominiums usually prohibit residential use.²⁰

Since purchasers of commercial and industrial condominiums are perceived to be more sophisticated than purchasers of residential condominiums, the consumer protection provisions in the Condominium Act do not apply to office condominiums.²¹ This includes the provisions requiring delivery of a public offering statement and express and implied warranties set forth in Article 4 of the Condominium Act. Consequently, it is imperative that purchasers of office condominiums take extra precautions such as obtaining all appropriate financial documents of the condominium association (budgets and income and expense statements), as well as having the building thoroughly inspected by a competent building inspector before purchasing if the seller is disclaiming implied warranties.

§ 5.02.03. Leasehold Condominiums

A leasehold condominium is when the owner "owns" the interior space of the condominium, however, the underlying land on which the condominium building sits is subject to a long term ground lease — often for as long as 99 years.²² Since the land on which the condominium sits is not owned by all the owners, but rather leased, leasehold condominiums are financed differently and valued differently.²³ Under the Condominium Act, any lease which may effectively terminate the condominium, must be recorded.²⁴ The lessor (owner of the land) must sign the declaration for a leasehold condominium.²⁵ Among other things, the declaration has to set forth the date on which the lease will expire.²⁶ As long as each unit owner pays his proportionate "share" of rent, the lease cannot be terminated.²⁷ The unique nature of the leasehold condominium has made it subject to litigation in other states.²⁸

§ 5.02.04. Conversion Projects

When apartments are converted to condominiums, there are a number of statutes that have to be complied with by developers.²⁹ Since the Unit Ownership Act already addressed the procedures for conversion projects, when the...