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Issue  216  Article  352
Published:  9/1/2014

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HOA Covenant Amendment Unreasonable under Armstrong Analysis
Chris Burti, Vice President and Senior Legal Counsel

Wallach v. Linville Owners Ass'n, Inc., (COA 13-1116)

This opinion addresses the effectiveness of certain amendments to the Declaration of Covenants, Conditions, Easements and Restrictions (the "Declaration") for a Wake County subdivision. The Declaration was recorded in 2003 and re-recorded in 2005 to include an exhibit that was inadvertently omitted during the first recording. At this point, the Declaration governed only those lots in "phase one" of the subdivision and subsequently in 2005, a supplementary declaration was recorded subjecting additional land, "Phase II" to the Declaration.

Additional amendments to the Declaration were recorded Between October and December of 2011 that revised or added the following provisions: "Subdividing and Recombination of Lots," "Architectural Control," "Performance Bond and Builder Agreement," and "Date of Commencement of Annual Assessment." Particularly relevant to this appeal, the amendment regarding "Date of Commencement of Annual Assessment" (the "Assessment Amendment") was recorded on November 7, 2011.

The plaintiffs and Philip C. Miller, all of whom owned vacant lots in the subdivision, filed a complaint seeking a declaratory judgment that the amendments to the Declaration were invalid and unenforceable. The Association and all other lot owners at the time the sui was filed were named as defendants. In order to provide notice of the action to those subsequently acquiring title to lots following commencement of the action, plaintiffs filed a notice of lis pendens. James B. Cushman, II, and Kirsten M. Cushman, acquired title to Lot 2 from Capital Bank in the time between the commencement of this action and the filing of the lis pendens and as a result, the lis pendens, however, did not provide them notice of the action. The trial court allowed plaintiffs' motion to amend the complaint to substitute the Cushmans as defendants and the plaintiffs filed a subsequent notice of lis pendens naming the Cushmans as owners of Lot 2. The plaintiffs never attempted to substitute any parties acquiring title after the filing of the notice of lis pendens as defendants.

The 2012, plaintiffs moved for summary judgment on the ground that the amendments were unreasonable, that they exceeded the purpose of the original Declaration and were inconsistent with its original intent. The Association moved to quash the lis pendens as unnecessary and to dismiss the complaint pursuant to N.C. Gen. Stat. § lA-i, Rule 12(b) (7) for failure to join the any parties acquiring title after the filing of the notice of lis pendens as defendants, contending that they were necessary parties.

The trial court denied the Association's motion to dismiss concluding that all owners in the subdivision are not necessary parties to this action because of the notice of lis pendens and all lot owners in this case are bound by the final judgment in this case even though they are not named parties to this action. Following the denial of its motion, the Association filed an answer and counterclaim seeking to collect unpaid assessments owed by plaintiffs, foreclose on its Claims of Lien, and collect attorneys' fees incurred in prosecuting the action. After the HOA filed a motion for summary judgment on the plaintiffs' claims, they filed a response to the Association's counterclaim arguing no past due assessments were owed because the amendments to the declaration were invalid and unenforceable. The trial court determined the Assessment Amendment was valid and enforceable leaving the Association's counterclaim as the only remaining matter to be tried. Following trial, the trial court entered judgment in favor of the Association, ordering payment of unpaid assessments, that a Commissioner be appointed and directed to sell the lots to satisfy the indebtedness due the Association and ultimately awarding attorney fees to the Association. The Association appealed the trial court's denial of its motion to dismiss and the plaintiffs appealed the trial court's partial summary judgment order finding the Assessment Amendment valid and enforceable and the trial court's order awarding the Association attorneys' fees.

Relying on Karner v. Roy White Flowers, Inc., 351 N.C. 433, (2000) and Page v. Bald Head Ass'n., 170 N.C. App. 151, disc. rev, denied, 359 N.C. 635, (2005), the Association argues the trial court erred in denying its motion to dismiss because any parties who acquired their lot after the filing of the notice of lis pendens, were not named as defendants in the action and all lot owners were necessary parties.

In Karner, the North Carolina Supreme Court held that all property owners in a subdivision were necessary parties to an action to enjoin a property owner from violating a residential use restrictive covenant running with each lot reasoning that the right of each lot owner to enforce the restriction has a "distinct worth" which is abrogated unless those parties are afforded their "day in court." Subsequently, the Court of Appeals in Page affirmed the trial court's dismissal of an assessment claim for failure to join all property owners. That panel of the Court simply cited Karner for the holding that "all property owners affected by a residential use restrictive covenant were necessary parties to an action to invalidate that covenant[]" and indicated the plaintiffs acknowledged Karner controlled their case. In the opinion under discussion this panel of the Court of Appeals found the facts of the present case distinguishable. Citing Midsouth Golf, LLC v. Fairfield Harbourside Condo. Ass'n., Inc., 187 N.C. App. 22, (2007) the Court of Appeals distinguished a covenant for the payment of recreational amenity fees from the residential use restriction at issue in Karner explaining that a residential use restrictive covenant affecting all lots in a subdivision was a valuable property right enforceable by all property owners, the rights in Midsouth Golf were not enforceable by the property owners within the subdivision against any of the other owners. "Accordingly, the extinguishment of the restrictive covenant in [Midsouth Golf] would not deprive the other property owners of any property right akin to the right that the nonparty property owners were deprived of in Karner. Id. at 28-29, 652 S.E.2d at 383. In Midsouth Golf, this Court also addressed its decision in Page, indicating it could not rely upon Page because "Page does not reveal sufficient facts for us to determine whether the covenant at issue was similar to the one at issue in the present case." Id. at 29, 652 S.E.2d at
383." Following this reasoning the Court held that the parties in question were "proper parties to the action seeking to declare the amendments to the Declaration invalid and unenforceable, but were not necessary parties. The amendments at issue in the present case did not extinguish any property rights … akin to those in Karner." Therefore, we hold the trial court did not err in denying the Association's motion to dismiss. Finding them not to be necessary parties, the court did not address whether the notice of lis pendens was proper in this action.

Of, perhaps more significance to practitioners dealing with convent amendments, the Court of Appeals found the plaintiffs' argument convincing that the amendment was not enforceable because it is not reasonable in light of the contracting parties' original intent. The original Declaration required each lot owner to pay annual assessments, but Builders were assessed at a rate of twenty five percent (25%) of the amount of the regular assessment while owned by the Builder. The Assessment Amendment purported to eliminate these benefits to builders. Specifically, the Assessment Amendment provides:

On appeal, the plaintiffs first contended that the trial court erred in upholding the Assessment Amendment because the Assessment amendment was not properly signed by the required number of lot owners, but the opinions treatment of the surround facts suggests that this issue was not given much credence by the Court of Appeals.

This disposition of the plaintiffs' procedural argument is not determinative in this case. They also argued that the trial court erred in upholding the Assessment Amendment because it contravenes the original intent of the Declaration. In support of their argument, plaintiffs relied on Armstrong v. Ledges Homeowners Ass'n., Inc., 360 N.C. 547, (2006) the North Carolina Supreme Court in Armstrong, our Supreme Court held that the HOA could amend a restriction in order to improve, remedy or correct an error. Such amendments are enforceable when reasonable and they give rise to serious questions about the permissible scope of the amendment. This results from a conflict between the legitimate desire of a HOA to respond to new and unanticipated circumstances offset by the need to protect minority or dissenting homeowners from overreaching and preserving the original nature of their bargain. In the same way that the powers of a homeowners' association are limited to those powers granted to it by the original declaration, an amendment should not exceed the purpose of the original declaration. Id. at 558, 633 S.E.2d at 87 (citations omitted) . Thus, the Armstrong Court held 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." Id. at 559, 633 S.E.2d at 87 (emphasis in original)

Applying this doctrine to the facts of Armstrong, the Supreme Court held an amendment authorizing "broad assessments ‘for the general purposes of promoting the safety, welfare, recreation, health, common benefit, and enjoyment of the residents of [the community] as may be more specifically authorized from time to time by the Board' [was] unreasonable[,]" and thus invalid and unenforceable. Id. at 560-61, 633 S.E.2d at 88. In reaching its conclusion, the Supreme Court noted as significant the nature of the community as a small development and the fact that there was nothing in the original declaration suggesting any intent to confer unlimited powers of assessment on the homeowners' association. The Court of Appeals application of Armstrong to the facts in this case is significant:

We find it evident from the Declaration's original language that the intent of the provision providing builders with reduced assessments and deferrals in the payment of assessments was to encourage builders to purchase lots from the developer earlier than they might otherwise have purchased them; even before builders were ready to build. Not only did the provisions benefit builders, they also benefited the developer who was able to sell the lots more expeditiously. In a complete reversal, the Assessment Amendment eliminated the benefits that were essential to the original bargain with builders like plaintiffs.

While the primary purpose of the assessment provisions in the Declaration may be to provide sufficient funds for the Association to maintain the community and amenities, the Association originally approved the Declaration with the benefits to builders included. Now that all lots in Linville Subdivision are sold and the Association has the required number of votes for amendment, the Association cannot now amend the Declaration to the detriment of the builders who purchased lots with the expectation that they would be afforded the benefits. Moreover, with the exception of the easement for a separate construction entrance, the costs that the Association claims it cannot now afford because three out of the forty—four lots in Linville Subdivision do not pay the full assessment rate are costs that should have been anticipated to begin with. Lastly, we are not persuaded that the language in builder agreements requiring builders to build promptly controls where the intent of the Declaration's original provisions are clear. Besides, even if the builder agreements did control, this Court will not determine what constitutes prompt as a matter of law.

Where the Assessment Amendment disregards the purpose of the Declaration's original provisions and completely eliminates the benefits to builders, we hold the amendment unreasonable, invalid, and unenforceable. Holding otherwise would permit homeowners' associations to amend similar provisions whenever they acquire the requisite number of votes for approval, regardless of the original intent. As our Supreme Court stated in Armstrong, "[t]his Court 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." Armstrong, 360 N.C. at 561, 633 S.E.2d at 89.

Attorneys counselling HOA's should pay particular attention to this opinion in conjunction with set out by the Supreme Court in Armstrong. These courts have set clear limitations on the ability of a majority of homeowners in a planned community to run roughshod over the rights the minority owners. Perhaps the next shoe to drop in this ongoing discussion of amendment authority is the question of whether a board taking impermissible action such as described in this case, is acting sufficiently ultra vires to be at risk of imposition of personal liability upon the board members by a court.

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