The Supreme Court of North Carolina has issued an opinion after discretionary review of a unanimous decision of the Court of Appeals, ___ N.C. App. ___, 620 S.E.2d 294 (2005), in which that court had affirmed a summary judgment order of the trial court denying the petitioners' requests for injunctive relief. We discussed the Court of Appeals decision in our November 2005 Statewide Title Newsletter and Legal Memorandum with some concern about the lack of limiting language in that decision. The broad language of that opinion seemed to invite the interpretation that a requisite majority could adopt virtually any changes to a declaration and enforce them against the remainder of the lot owners. In Armstrong v. The Ledges Homeowners Association, Inc., No. 640PA05 filed on August 18, 2006, the Supreme Court has imposed a reasonableness standard and has ruled that the amendments at issue in the case were unreasonable and unenforceable.

The petitioning property owners brought a declaratory judgment action against the subdivision’s homeowners' association. They asked the trial court to determine enforceability of covenant amendments which authorized assessments “for the general purposes of promoting the safety, welfare, recreation, health, common benefit, and enjoyment of the residents of Lots in The Ledges as may be more specifically authorized from time to time by the Board.” The Supreme Court stated that the dispositive question before it was to what extent the homeowners' association may amend restrictive covenants. The facts were not in dispute and it had been stipulated that the declaration, by its terms, may be amended and that the subdivision is not subject to North Carolina's Planned Community Act.

The Court sets out an unambiguous rule that “amendments to a declaration of restrictive covenants must be reasonable.” Since it was stipulated that the subdivision is not subject to the Planned Community Act, this broad statement begs the question of whether this limitation is applicable to amendments under Section 47F-2-117 or to pre-adoption subdivisions brought under the Act pursuant to 47F-2-102(d).

The Supreme Court begins by declaring the rule that one must look to “the language of the declaration, deeds, and plats, together with other objective circumstances surrounding the parties' bargain, including the nature and character of the community” in order to determine what constitutes a reasonable amendment. The Court does not leave the reader of the opinion in suspense as to the outcome of their consideration. Very early in the decision, the Court states that the amendment at issue is unreasonable, invalid and unenforceable.

What follows initially is an edited recitation of the facts in the record on appeal deemed significant by the Court. “Petitioners own lots in The Ledges of Hidden Hills subdivision (the Ledges) in Henderson County. The Ledges was developed in 1988 by Vogel Development Corporation (Vogel) pursuant to a plat recorded in the Henderson County Public Registry. Forty-nine lots are set out along two main roads that form a Y shape. There are four cul de sacs. The plat designates the roads as ‘public roads,’ which are maintained by the State, and shows no common areas or amenities.”

“Before selling any lots, Vogel recorded a Declaration of Limitations, Restrictions and Uses (Declaration). The Declaration contained thirty-six provisions which restricted the lots to single family residential use; established setbacks, side building lines, minimum square footage and architectural controls; and otherwise ensured a sanitary and aesthetically pleasing neighborhood. The Declaration emphasized that roads in the Ledges are ‘dedicated to public use . . . forever’ and that Vogel may ‘dedicate the roads . . . to the North Carolina Department of Transportation.’”

“Finally, the Declaration provided for the establishment of a homeowners' association:
The Developer [Vogel] intends to establish a non-profit corporation known as THE LEDGES OF THE HIDDEN HILLS HOMEOWNERS [sic] ASSOCIATION, and said Homeowner's [sic] Association, upon the recording of its Articles of Incorporation in the office of the Register of Deeds for Henderson County, North Carolina, shall have the right, together with the lot owners of lots within this Subdivision, either acting individually or as a group, to administer and enforce the provisions of this Declaration of Restrictive Covenants as the same now exists or may hereafter from time to time be amended. (Emphasis added.) The Declaration did not contain any provision for the collection of dues or assessments, and it appears that formation of a homeowners' association was primarily intended to relieve Vogel from the ongoing responsibility to enforce the architectural control covenants.”

“Vogel began conveying lots in the Ledges after recording the Declaration and plat. Later, Vogel decided to construct a lighted sign on private property in the Sunlight Ridge Drive right of way. Sunlight Ridge Drive is the entry road to the Ledges. Because lighting the sign required ongoing payment of a utility bill, Vogel included the following additional language in subsequent conveyances:

The grantor herein contemplates the establishment of a non-profit corporation to be known as The Ledges of Hidden Hills Homeowners Association, and by acceptance of this deed the grantees agree to become and shall automatically so become members of said Homeowners Association when so formed by said grantor; and said grantees agree to abide by the corporate charter, bylaws, and rules and regulations of said Homeowners Association and agree to pay prorata [sic] charges and assessments which may be levied by said Homeowners Association when so formed. Until the above contemplated Homeowners Association is formed or in the event the same is not formed, the grantor reserves the right to assess the above- described lot and the owners thereof an equal pro-rata [sic] share of the common expense for electrical street lights and electrical subdivision entrance sign lights and any other common utility expense for various lots within the Subdivision. (Emphasis added.)”

“This language appears in each petitioner's deed, together with a reference to the previously recorded Declaration.”

The Supreme Court, relying on traditional rules of construction, first determined that the specific language alleviating the developer from responsibility for utility payments for the lighted signs and imposing lot owner responsibility for the same, controlled the general language referencing assessments. The Ledges Homeowners' Association was formed in1994 and organized in1995. The organizational documents contained broad authority, implicitly providing wide discretion in imposing assessments. The Court determined that the bylaws were “administrative provisions” adopted for the “internal governance” of the Association. In a community that is not subject to the North Carolina Planned Community Act, “the powers of a homeowners' association are contractual and limited to those powers granted to it by the declaration. Therefore, to be consistent with law, an association's by-laws must necessarily also be consistent with the declaration.”

The history of activities of the Association was outlined in the opinion. “At the first annual meeting, the by-laws were amended to provide that the Association would have a lien on the lot of any owner who failed to pay an assessment. Thereafter, the Association began assessing lot owners for the bills incurred for lighting the Ledges entrance sign. Additionally, the Association assessed owners for mowing the roadside on individual private lots along Sunlight Ridge Drive, for snow removal from subdivision roads, and for operating and legal expenses.” In undisputed evidence the Association billed lot owners assessments of up to one hundred dollars per year, while the annual electrical bill for the sign was less than eight dollars per year, per lot. In 2003, the board amended the Association by-laws again, greatly expanding its powers and duties. The amended by-laws included the power to “[i]mpose charges for late payment of assessments and, after notice and an opportunity to be heard, levy reasonable fines not to exceed One Hundred Fifty Dollars ($150.00) per violation (on a daily basis for continuing violations) of the Restrictive Covenants, Bylaws, and Rules and Regulations of the Association pursuant to Section 47F-3-107.1 of the North Carolina Planned Community Act.”

The association was well aware of the petitioners’ opposition to the assessments and to their having purchased their property due to the absence of the charges at the time of purchase, yet continued to attempt to expand its authority. After the petitioners filed a declaratory judgment action in seeking declaratory relief that the subdivision was not a “planned community” as defined in Chapter 47F and that the amended by-laws were unenforceable, the Board of Directors amended the by-laws omitting reference to the Planned Community Act. Thereafter, by vote of a majority of the Association members, it amended the restrictive covenants of the subdivision. The Court stated that the “Amended Declaration contains substantially different covenants from the originally recorded Declaration, including a clause requiring Association membership, a clause restricting rentals to terms of six months or greater, and clauses conferring powers and duties on the Association which correspond to the powers and duties previously adopted in the Association's amended by-laws.” The Amended Declaration also attempted to impose additional obligations on lot owners. It authorized the assessment of fees and imposition of a lien against lots for failure to pay assessed fees. The Court noted that it contained a broad statement of purpose purporting these charges to be “assessed for common expenses” and “shall be used for the general purposes of promoting the safety, welfare, recreation, health, common benefit, and enjoyment of the residents of Lots in The Ledges as may be more specifically authorized from time to time by the Board.”

The trial court entered summary judgment for the respondents and the Court of Appeals affirmed, determining that the original declaration contained sufficient language to support “any amendment thereto made by a majority vote of Association members”. The Supreme Court opinion states that the “court further concluded that [p]roviding for mandatory membership in the [A]ssociation and permitting the [A]ssociation to assess and collect fees from the [A]ssociation's members is not clearly outside the intention of the original restrictive covenants and is generally consistent with the rights and obligations of lot owners of subdivisions subject to restrictive covenants and homeowners' associations. Id. at ___, 620 S.E.2d at 298.”

The Supreme Court outlines the doctrine traditionally controlling covenant construction in North Carolina. The doctrine holds that covenants are “contracts which create private incorporeal rights, meaning non-possessory rights held by the seller, a third-party, or a group of people, to use or limit the use of the purchased property.” The Court recites a litany of modern cases for support in that regard, many of which are often, cited in modern covenant cases. The court, with appropriate citations, notes that because “covenants originate in contract, the primary purpose of a court when interpreting a covenant is to give effect to the original intent of the parties; however, covenants are strictly construed in favor of the free use of land whenever strict construction does not contradict the plain and obvious purpose of the contracting parties.” (emphasis in the original)

It is important to note that the Court cited Beech Mountain Prop. Owner's Ass'n v. Seifart, 48 N.C. App. 286, 269 S.E.2d 178, (1980) for the proposition that covenants requiring an assessment for “'road maintenance and maintenance of the trails and recreational areas,'” “'road maintenance, recreational fees, and other charges assessed by the Association,'” and “'all dues, fees, charges, and assessments made by that organization, but not limited to charges for road maintenance, fire protection, and security services'” were not sufficiently definite and certain to be enforceable”. For similar guidance the court noted that Allen v. Sea Gate Ass'n, 119 N.C. App. 761, 460 S.E.2d 197, (1995) had held that a covenant requiring an assessment “'for the maintenance, upkeep and operations of the various areas and facilities by Sea Gate Association, Inc.'” was void because there was no standard by which a court could assess how the Association chooses the properties to maintain” and Snug Harbor Prop. Owners Ass'n v.Curran, 55 N.C. App. 199, 284 S.E.2d 752, (1981) for the holding that covenants requiring owners to pay an annual fee for the “'[m]aintenance and improvement of Snug Harbor and its appearance, sanitation, easements, recreation areas and parks'” and “'[f]or the maintenance of the recreation area and park'” were not enforceable because there was “no standard by which the maintenance [was] to be judged”. These cases illustrate our appellate courts’ unwillingness to support overly broad statements of authority in covenant cases. Presumably, this is an implementation of the doctrine that covenants are in derogation of private rights and will be strictly construed.

The opinion compares Figure Eight Beach Homeowners' Ass'n v. Parker, 62 N.C. App. 367, 303 S.E.2d 336, (1983).  Here the Court of Appeals held that a covenant was enforceable where the “assessment was described with sufficient particularity” in authorizing assessments for “'[m]aintaining, operating and improving the bridges; protection of the property from erosion; collecting and disposing of garbage, ashes, rubbish and the like; maintenance and improvement of the streets, roads, drives, rights of way, community land and facilities, tennis courts, marsh and waterways; employing watchmen; enforcing these restrictions; and, in addition, doing any other things necessary or desirable in the opinion of the Company to keep the property in neat and good order and to provide for the health, welfare and safety of owners and residents of Figure Eight Island'”  

The Court observes that in a “community that is not subject to the North Carolina Planned Community Act, the powers of a homeowners' association are contractual and are limited to those powers granted to it by the declaration.” With respect to evidence that shows compliance by objecting owners, the Court says that even though “individual lot owners may voluntarily undertake additional responsibilities that are not set forth in the declaration, or undertake additional responsibilities by mistake, lot owners are not contractually bound to perform or continue to perform such tasks.” (emphasis in the original)

The Supreme Court then summarizes the law concerning amendment. The following selected quotations from this section of the opinion omit citations but serve to articulate the summary very well. “Declarations of covenants that are intended to govern communities over long periods of time are necessarily unable to resolve every question or community concern that may arise during the term of years.” “For this reason, most declarations contain specific provisions authorizing the homeowners' association to amend the covenants contained therein.” “Amendment provisions are enforceable; however, such provisions give rise to a serious question about the permissible scope of amendment, which results from a conflict between the legitimate desire of a homeowners' association to respond to new and unanticipated circumstances and the need to protect minority or dissenting homeowners by preserving the original nature of their bargain.”

This analysis leads the Supreme Court to conclude that the broad amendment language in this case is invalid and unenforceable. The respondents contended that any amendment adopted that is not illegal or against public policy is valid and enforceable, regardless of how broad or on what subject. The Supreme Court responded by holding “that a provision authorizing a homeowners' association to amend a declaration of covenants does not permit amendments of unlimited scope; rather, every amendment must be reasonable in light of the contracting parties' original intent. …A disputing party will necessarily argue that an amendment is reasonable if he believes that it benefits him and unreasonable if he believes that it harms him. However, the court may ascertain reasonableness from the language of the original declaration of covenants, deeds, and plats, together with other objective circumstances surrounding the parties' bargain, including the nature and character of the community.” Emphasis in the original)

Of particular note to attorneys counseling homeowners’ associations is that the Court may have indirectly spoken to issues that are occurring with much greater frequency. These issues concern amendments limiting an owner’s right to engage in short term rentals in resort areas or frequent increases in assessments. In providing examples of a lack of authority the Court said “it may not be reasonable to retroactively prohibit rentals in a mountain community during ski season or in a beach community during the summer.” Similarly, it may not be reasonable to continually raise assessments in a retirement community where residents live primarily on a fixed income. Finally, a homeowners' association cannot unreasonably restrict property rental by implementing a garnishment or “taking” of rents (which is essentially an assessment); although it may be reasonable to restrict the frequency of rentals to prevent rented property from becoming like a motel.”

The Court makes it clear that the limitation on amendment authority is not to be read as a further limitation on a declarant’s ability to create restrictions that are generally enforceable when clearly set forth in the original declaration. “Thus, rentals may be prohibited by the original declaration. In this way, the declaration may prevent a simple majority of association members from turning established non-rental property into a rental complex, and vice-versa.” In all such cases, a court reviewing the disputed declaration amendment must consider both the legitimate needs of the homeowners' association and the legitimate expectations of lot owners.

It is important to realize as did the Supreme Court that a “court may determine that an amendment is unreasonable, and, therefore, invalid and unenforceable against existing owners who purchased their property before the amendment was passed; however, the same court may also find that the amendment is binding as to subsequent purchasers who buy their property with notice of a recorded amended declaration.” (emphasis in the original)

The Court’s determination that the amendment was unreasonable in that it “grants the Association practically unlimited power to assess lot owners and is contrary to the original intent of the contracting parties” is couched in the broadest terms. It is interesting that while the Court concluded that the disputed amendment was invalid and unenforceable, it did not indicate whether that determination was limited only to those lot owners owning lots prior to the amendment and not assenting to the amendment. The Court stated that it “will not permit the Association to use the Declaration's amendment provision as a vehicle for imposing a new and different set of covenants, thereby substituting a new obligation for the original bargain of the covenanting parties.” In light of the analysis delineated in the decision and those cases cited therein, it would seem that an argument could be made that decision suggests that the amendments are not enforceable against pre-existing owners but may be against subsequent purchasers. On the other hand, Beech Mountain Prop. Owner's Ass'n and Allen struck down as unenforceable original declarations containing overly broad and imprecise language. Logic should constrain us to conclude that these amendments are unenforceable in all cases as a narrow reading would indicate.

Attorneys counseling homeowners’ associations subject to North Carolina’s Planned Community Act would be wise to pay heed to the clear implications of this decision and consider advising their clients to limit amendments to matters that appear reasonable and clearly contemplated in the original Declarant. In the alternative, it would be prudent to secure the consent of all lot owners to any amendments broaching new matters not contemplated originally.