Know Surety Bonds.com
Subdivision Bonds: Also known as site improvement bonds or plat bonds, subdivision bonds are a set of bonds that are required by developers, builders or individual(s) to guarantee successful completion of subdivision work to a public entity.
Developers will often start the subdivision process by filing maps (sometimes referred to as plats) with the public agencies responsible for overseeing land use where the projects are located. These maps show the proposed configuration of the project, including public improvements necessary to serve the project. Public improvements may include curbs and gutters, streets, sidewalks, utility lines, landscaping and storm drains. These off-site improvements will become the property of the public entity once the work is completed.
Subdivision bonds are different from the more common contract bonds used for construction projects. With subdivision bonds, the owner of the project provides bonds to the public agency to guarantee the installation of improvements that will ultimately be dedicated to the public but paid for by the owner/developer. Another key difference with subdivision bonds is that the owner/developer (the Principal) has to pay the cost of building the bonded improvements rather than the public agency (the Obligee). This is also an important point to remember if a general contractor should agree to secure/post the subdivision bonds on behalf of the owner/developer. Normally, the general contractor has the contractual right to stop work if the owner does not pay him. However, if the general contractor posts the improvement bonds in favor of the public agency, the general contractor is obligated to complete the improvements and pay all the bills irrespective of whether the owner/developer paid him.
Generally, installation of public improvements is a condition imposed on a developer for the project to proceed, and the developer is required to furnish acceptable security to guarantee completion and payment of the work.
In lieu of the the subdivision bonds, the public entity will all allow the guarantee to come in the form of the following other than subdivision bonds:
- Irrevocable letters of credit issued by a financial institution, e.g. bank
- Certificates of deposit (CDs)
- Cash, certified/cashiers check or money order
- Tripartite agreement
Although the public entity will accept any of the above aforementioned guarantees, subdivision bonds are usually the most advantageous format when you consider the disadvantages of the following other methods.
- Irrevocable Letter of Credit (ILOC): In order to secure an ILOC from a banking institution, the owner/developer typically commit a portion of its line of credit for a fee. The security for the ILOC may be funds on deposit at the bank with their immediate right of set-off (seizure). If the bank elects not to renew the ILOC, the public agency would have the right to promptly draw down on the full amount of the ILOC. Such a draw down of the ILOC will create a loan, which the bank could promptly call for immediate repayment.
- The governmental entity holding the ILOC has the right to draw on the ILOC anytime they believe there is a breach of the owner’s obligations and the owner would have little or no opportunity to stop the draw down. The ILOC is strictly a financial instrument and the bank provides no pre qualification services to assure the owner/developer has the capacity or experience to perform.
- Certificates of Deposit (CD): It is in essence cash or short term liquid assets that greatly reduces the owner/developer’s working capital, which otherwise could be put to more efficient use. The CD is subject to forfeiture by the unilateral demand of the public body. For the public body accepting the CD as security, it provides no pre qualification benefits. In addition, it saddles the public body with administrative burdens to make sure they accepted a CD that was in proper-assignable form, that they in fact had unequivocal authority to draw down on the CD, that they don’t release it until all possibility of nonperformance had passed, and that they hold the instrument in safekeeping and properly return it to the owner/developer.
- Cash, cashier's check or money order: This option has many of the same concerns as with CDs. In addition, the public agency would have to make some determination that the cash being deposited was “legitimate” and not subject to possible bankruptcy preference rules.
- Tripartite Agreement: These agreements (used infrequently) may involve set-aside letters from a bank, special escrow accounts, and/or fund controls. Tripartite agreements typically place disbursement of the construction funds under the direct control of the governmental agency. Disbursement of monies may be delayed by concerns about the value of completed work or the adequacy of monies to complete the improvements and provide the required maintenance. Tripartite agreements are not really performance guarantees but rather control over a fund of monies that may not be adequate to pay for all the improvements. These type arrangements place significant additional administrative burden on the public agency and can create liabilities if the funds are not properly administered.
Subdivision bonds generally have none of the disadvantages of the alternative guarantees referenced above, but represent the following distinct advantages.
What are some of the benefits on subdivision bonding?
- Surety bonds provide pre qualification of the owner/developer through the underwriting process.
- Surety credit is often unsecured and does not reduce or tie-up the owner/developer’s source of funding.
- Surety’s claim department will work to facilitate a resolution of any problem and not merely to forfeit the owner/developer’s security.
- Corporate surety bonds typically provide the public agency with a 100 percent performance, 100 percent payment, and 1-year maintenance bond.
- Irrespective of how much the owner/developer may have spent to complete the improvements up to the time of default, the full amount of the bonds are available to complete the work.
With some sureties, if the builder,developer or individual(s) is lacking in any of the above "C's" they might require collateral in the form of cash or letter of credit. Also if external market conditions, such as a decreasing real estate environment or a tight credit market, surety companies will be reluctant to underwrite subdivision bonds in the absence of collateral.
How are subdivision bonds underwritten?
* Each surety company has their own guidelines and criteria for underwriting a contract bond. But in general, they will follow the 3 "C's" when determining whether a builder, developer or individual(s) qualifies for subdivision bonds. The 3 "C's" are as follow:
1) Character: applicant's standing and reputation are such to warrant the conclusion that they are of good character and worthy of trust.
2) Capacity: if the obligation entered into by the applicant requires particular skills or ability in its performance, the applicant should possess those necessary skills and ability
3) Capital: the applicant should be solvent and would be unlikely to commit dishonest act or perform inefficiently because of strained financial resources.
Surety will also analyze the potential profitability of the project during the underwriting process.
******** In submitting the initial request for bonding, the following information should be included to insure a quicker response.
1) Subdivision or Developer's questionnaire: An application that provides a basic summary of the company, including information on the owners and key personnel of the company. Additional information includes history of projects completed, key suppliers, insurance providers, banking institutions, type of project being undertaken, who is the contractor being hired to do the work.
2) Business Financial Statements (Balance sheet, income statement, statement of cash flows and and aging schedule for account receivables and account payables) are classified into 4 categories, in order of preference by the surety.
- Audited Statements: An audit verifies relevant items in the financial statement with internal and external investigations of their accuracy. The accountant certifies that the financial statement is presented in accordance with generally accepted accounting principles.
- Reviewed Statements: A review statement, which does not require the outside verification present in an audit, consists principally of a thorough review of the contractor’s financial records and the application of certain analytical procedures to the financial data. Although narrower in scope than a full audit, the review does provide some limited assurance about the financial statements.
- Compilation Statements: A compilation statement provides little or no assurance of the credibility of the figures presented and would typically be accepted only for interim statements.
- In-house Statements: An in-house statement is internally prepares and very little weight or credibility at attached to the information on the statements.
3) Personal financial statement for all owners (indemnitors) of the entity. Like the business financial statements, they can be audited, reviewed, compilation or in-house. Most sureties will accept in house statements as long as the key assets (cash, stocks, short term assets can be verified).
4) Resume of all key personnel: Provides a clear and concise history of the people who will be overseeing the business and subdivision work. Let's the surety know that the key employees has the knowledge and experience to run the business and undertake the subdivision work.
5) Copy of insurance certificates: As most contracts require certain insurance policies to be obtained by the contractor and/or be active during the completion of the contract. To avoid any potential performance bond claims, surety companies will ask for copies of all insurance certificates. Such insurance includes, general liability insurance, worker's compensation insurance, professional liability insurance, etc.
6) Bank reference letter and bank statements: In an effort to better gauge a contractor's access to short term funds and their working capital, sureties will look to current bank statements and bank lines of credit (BLOC) statements to verify that the contractor has sufficient funds to take on further contracts. It is recommended that the 3 most recent month's statement be submitted.
7) Proof of funding: Surety companies will want to verify that the developer, builder, individual(s) has the proper amount of funding set aside to finish the subdivision work. Typically such proof of funding may consist of a set aside letter from a reputable bank that shows the surety that the developer has already arranged for a committed amount of funds to be tied to the referenced project. If no set aside letter is available, surety will want verify that the developer,builder or individual(s) will have the amount needed through verification of existing access to cash or lines of credit.
8) Copies of all relevant licenses: In most states, a contractor's license is required to contract projects. In some instances, there are specialty licenses, such as those required for hazardous work and environmental contracts. Such licenses are requisites in contracts, so the surety will want to verify that all licenses are currently active as to avoid performance bond claims.
9) Documentation showing ownership structure: As part of the indemnification process, surety company will want to verify how the company is structured. If the entity is a corporation, provide a copy of the articles of incorporation. If entity is a LLC, provide a copy of the LLC agreement. If it is a partnership, provide a copy of the partnership agreement. If any owners of the entity owns a related entity, also submit the document showing the ownership of the related entity.
10) Copies of applicable trust: If any owners of the entity has any assets held in trust, the surety company will require that trust be indemnified, so a copy of any trust should be included in the initial submission.
11) Copy of the subdivision agreement and required bond forms: The subdivision agreement and the required bond forms are documents provided by the obligee (puublic entity). The subdivision agreement is a document that outlines the terms of agreement with which the developer, builder, or individual(s) has entered into with the public entity. It details the scope of work that is expected from the public entity for the developer,builder, or individual(s) to successfully complete and during what time frame.
12) A copy of the public entity's own engineer's estimate. Document provides a basic assessment of what the public entity's believe the work will cost. It is from this estimate that the bond amount is usually derived from.