Subdivision Bonds

Subdivision Bonds are a type of Surety Bond that guarantee that improvements will be completed to a property or properties in a given amount of time. Subdivision Bonds are also referred to as Developer Bonds, Site Improvement Bonds, Platt Bonds or even Completion Bonds.

On a Subdivision Bond, either the Developer or the Property’s Owner could be listed a The Principal. The city or municipality requiring the improvements is The Obligee and the Bond company guaranteeing the improvements is The Surety.

Subdivision Bonds guarantee that improvements will be made to a property. This could include utilities, sidewalks, grading, and/or many other construction improvements. What makes Developer Bonds different from other types of Contract Surety Bonds such as Performance Bonds is that the improvements must be completed regardless of whether payment is received. In other words, the Principal or Surety must complete the obligation regardless of whether funds are ever received on the project. This makes these Bonds a form of Completion Bonds and they are more risky for the Principal and Surety Bond company.

Because Subdivision Bonds are considered a higher risk than Contract Bonds (like bid bonds), they also carry a higher rate. This is because subdivision bonds are a form of completion bond as discussed above. Generally Subdivision Bonds carry a rate of between 1% – 4% per year until they are released. Unlike Performance Bonds and Payment Bonds, the premium is due each year that the obligation is open so the Principal needs to to price that accordingly.

Most Subdivision Bonds require a copy of the Subdivision Agreement or Development Agreement. This agreement will spell out the exact scope of work to be completed and bonded. They also require a financial statement on the Principal company and Principal owners. The bond company will also want an experience application on the Principal to know that they have successfully completed similar projects in the past.

The surety bond underwriter will want to understand who is doing the work. Work can be done directly by the Developer but usually the Developer subcontracts this out to other contractors. In that case, the bond company may want to know who is doing the work, where the contracts bid out or negotiated, has the Developer worked with the contractors before and will any of the work be bonded back to the Developer?

The latter may seem unnecessary to many Developers. They might fee like the work is being bonded twice. However, bonding back the subcontractors protects the Developer. If the subcontractors can not perform or pay their suppliers, the Developer would be responsible for any addition expense to complete he project or clear Mechanic’s liens. Surety bond underwriters prefer for Developers to bond subcontractors on their projects.

Understanding how the project is financed is a key part to underwriting Subdivision Bonds. Is the Developer financing the project themselves or going through a lender? Usually a lender is involved and a copy of the financing agreement will be required. Surety Bond underwriters want to see that the funds are 100% approved by the lender to cover the project and set aside in most cases. Many previous bond claims have taken place when Developers get partial or contingent financing

When underwriting Developer Bonds, it is important for the underwriter to understand how long the obligation will take to complete. The longer the completion time, the more risk the bond carriers. Many subdivisions are built in phases. When possible, surety bond underwriters prefer to issue different contracts and subdivision bonds for each phase. This way, the liability can be closed out with each phase instead of remaining open for very long periods.

Most Subdivision Bonds include a maintenance or warranty period. In general, surety bond companies do not like long term warranties. A lot can change over time and repairing roads, utilities, etc. can be expensive for both the Developer and the Bond Company. As such, most surety bond companies will want to see that the warranty period is 24 months or less.

Because these bonds are considered high risk, many companies do not write them at all. Some bond companies may only write them with 100% collateral to reduce their risk. It’s important to pick a surety bond company that understands Developer Bonds and has an appetite to write them. This ensures that the Developer will get the best terms for the bonds and that the underwriting process will go smoother.

An alternative to a Subdivision Bond is an Irrevocable Letter of Credit (ILOC). Subdivision Bonds may be superior for a few reasons. First, bonds are generally considered unsecured credit meaning they do not tie up a Principal’s assets borrowing ability. This frees up those assets to be used for other business purposes. On the contrary, an ILOC ties up resources and borrowing ability that could be better used in the business.

Secondly, a Subdivision Bond requires a claim to be reviewed by experienced claims staff from a Surety Bond company. This prevents fraudulent or frivolous claims from being paid. ILOCs offer little protection since only a demand must be made. The Principal may be faced with an expensive legal battle to get any funds returned. You can read about the differences between surety bonds and letters of credit here.

Instead of Subdivision Bonds, a municipality will usually accept cash or cash equivalents such as a certificate of deposit. Cash is cheaper than subdivision bonds but it comes with opportunity costs for the Developer. A Developer can usually get a better return for using cash for other investment purposes. Restricting the cash may also hurt the Developer’s borrowing ability with their lender. Subdivision Bonds on the other hand are usually considered “unsecured credit” so the Developer can use their cash for other purposes.

Similarly to the ILOC discussed above, cash gives the Developer no protection from disputes with the Obligee. If a dispute arises, the Developer will likely have to litigate to get their cash returned. Meanwhile, an experienced surety claims department would have to investigate an Obligee’s claim and make sure it is valid before paying out on a subdivision bond.

Subdivision Bonds require Indemnity. That means that if a Bond company pays a valid claim, they will seek reimbursement from the Developer Principal and other indemnitors. Developers often reduce their risk by setting up different LLCs or other entities for each of their developments. Depending on the financial strength of the Development being bonded, the surety bond company may want the indemnity of the related entities. This can be a point of frustration and negotiation for the Developer.

These bonds are not insurance and claims should be avoided. You can read more about surety bond indemnity here.

Subdivision or Developer Bonds do not have to be complicated. Axcess Surety has the expertise and bond markets to help Developers. Contact us today to see how we can open doors to bonding your subdivision or development.