Secrets of Bonding #10: Site / Subdivision

Site / Subdivision: Oh what a tangled web we weave…

Feel like you’re not an expert on these?  You’re not alone!  In this article we’ll cover the basics as well as some of the tricky stuff.

Site and Subdivision (Sub-D) Bonds are both similar for the surety.  A Site Bond is needed when a business expands their facilities whereas Sub-D arises on residential development projects.

In both cases, the property owner or developer has obtained zoning board approval to proceed, but is required to build certain elements the township wants such as sidewalks, roads or lighting.  Contractors call this “site work,” thus the name Site Bond.  Site bonds do not concern the construction of the buildings.  “Improved Lots” are property where such elements have been completed.

This required work is collectively called the Public Improvements.  A township engineer will prepare an “Engineers Estimate” with an estimated current cost for each item.  The bond amount is the sum of these costs plus an added cushion in case the bond is called at a future date when construction costs are higher.

The purpose of all Site and Sub-D Bonds is to guarantee that public improvements will be built at the developer or surety’s expense, not the taxpayers.  For example, if the developer fails to topcoat the road, the township makes a bond claim and the surety must complete the work.

How Site & Sub-D differs from Performance Bonds:

  • There is no contract with the obligee (township)
  • The obligee is not paying for the work.  It is self-funded by the principal (property owner)
  • There is no definite completion date

FIRST TANGLED WEB: Since the work is self-funded, the property owner must either have cash on hand or arrange for a construction loan. If the latter, it is likely that the property in question will be collateral for the lender. This means in the event of the principals failure (such as bankruptcy), the bank becomes the new property owner but the surety remains obligated to the township.

In the borrowers absence the bank has no obligation to disburse the remainder of the loan (the purpose of which was to improve and increase the value of property THE BANK NOW OWNS) – but the surety is still required to complete the work.

Untangle this by obtaining a “Set Aside Letter” from the lender prior to issuing the bond.  This requires the bank to continue disbursing funds to the surety in the event of the borrower’s failure – with no pay back required.  In this manner, the work can be completed as intended.

SECOND TANGLED WEB: When the property owner hires a contractor to build the public improvements, it is not uncommon to require the construction firm to obtain the Site / Sub-D bond.  After all, the contractor may already have a surety relationship.  Problem: In the event of the property owner’s default, the construction contract is terminated however the Site / Sub-D bond obligation remains in force.  No more money is coming to the contractor to complete the work. The contractor is now solely responsible to the township and the surety and must self-fund the completion of improvements for property they do not own.

Untangle this one by a) requiring the developer, not the contractor, to be the bond applicant, or b) at least get the financial statements and indemnity of the developer so the contractor is not solely obligated to the surety and township, and c) a set-aside letter or escrow account (for funding by cash) could still be required.

Summary: Key questions are:

  • Who will build the public improvements?
  • If built under a construction contract, is it bonded to the developer? (Performance and Payment Bond)
  • How will the work be paid for?
  • How will the surety be funded in the event of failure by the property owner?

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