Law of Developers or Subdivision Bonds
Ch. 2, THE LAW OF MISCELLANEOUS AND COMMERCIAL SURETY BONDS, ABA TIPS (Kazlow and King, eds., 2001)
The land development laws of most, if not all states, counties, cities or other local governmental agencies (hereinafter collectively referred to as Public Agency) are intended to regulate land use and subdivision growth. The Public Agency enacts statutes, codes or ordinances (hereinafter Statutory Scheme) to regulate and control the design and improvements of subdivision developments within its jurisdiction. Obtaining approval from the Public Agency, whether through a subdivision map, permit or otherwise, is often the initial step a developer must take in developing a parcel of real property. This requirement provides the governing body with a mechanism to regulate and control the design and implementation of subdivision improvements.1 Among the conditions and requirements which a Public Agency may impose before issuing a subdivision map, or(hereinafter Subdivision Bonds).2
Although Subdivision Bonds are somewhat similar to traditional Public Works Bonds, there are important differences and distinctions. For example, (1) Subdivision Bonds are generally required as part of the Statutory Scheme requiring a developer to enter into a Subdivision Agreement with the Public Agency, (2) the roles, positions and obligations of the principal and obligee on Subdivision Bonds differ from those imposed under Public Works Bonds, (3) where Subdivision Bonds are issued, it is the principal, rather than the obligee, who bears the financial responsibility for the placement and construction of the required improvements, and (4) there are distinctions both in coverages and limitation periods. In addition to discussing the unique characteristics of Subdivision Bonds, this article will address and suggest special claims handling procedures, methodologies and defenses to be considered in responding to, and dealing with, claims made on Subdivision Bonds.
I. The Statutory Scheme of Subdivision Bonds.
A. Statutory Purpose.
The law relating to subdivision of land is entirely a creature of legislation.3 While the Statutory Scheme mandated by a Public Agency is not uniform, the general purpose and intent is to regulate and control the design and improvement of a subdivision with proper consideration to its relation to adjoining areas. The Statutory Scheme therefore facilitates the coordination of subdivision planning (lot size, configuration, street patterns and utility easements), as well as overall community planning.4
Through the Statutory Scheme, the Public Agency can assure consistency of subdivision design and improvements with local standards considering public health and other environmental concerns. Most importantly, the Statutory Scheme ensures that the developer properly installs streets, sewers, lighting, sidewalks and drains prior to their dedication to the Public Agency and its taking over their maintenance.5 These goals and purposes will prevent the subdivision from becoming an undue burden on the community and local taxpayers"6
B. Subdivision Agreements and Bond Requirements.
(1) The Subdivision Agreement.
Prior to the development of unimproved land, the Public Agency, as part of the Statutory Scheme, often requires a developer to enter into a Subdivision Agreement.7 The Subdivision Agreement will generally require the developer to construct improvements required by the Public Agency as part of the Statutory Scheme and will set forth the time within which the improvements must be completed.
The types of improvements often mandated by a Public Agency in a Subdivision Agreement include any or all of the following: streets, grading, pavement, gutters, curbs, sidewalks, street lighting, shade trees, surveyor's monuments, water mains, culverts, storm sewers, sanitary sewers or other means of sewerage disposal, drainage structures, erosion control, sediment control, landscaping and public improvements of open space. Further, the Public Agency may require that the developer warrant the work required under the Subdivision Agreement for one year following completion and acceptance of the improvements, including liability for defective work, labor and materials.8
(2) The Subdivision Bond
To ensure the faithful performance of the required subdivision improvements, including liability for changes or alterations in the work, the Public Agency may require the developer to post security usually in the form of Subdivision Bonds acceptable to the Public Agency.9 Subdivision Bonds are required by the Public Agency to provide a financial assurance that a developer of either residential or commercial land will complete the requisite improvements.
While Subdivision Bonds uniformly provide assurances to the Public Agency if a developer defaults on its obligations under a Subdivision Agreement, there are differences in bond forms. Typically, Subdivision Bonds are indemnity bonds requiring performance or payment up to the bond penalty from a surety if a developer defaults on its obligations under the Subdivision Agreement. In some jurisdictions, Subdivision Bonds are treated as either pure forfeiture bonds or financial guarantee bonds. In other instances, the applicable statute may require or treat Subdivision Bonds as an indemnity bond. Some jurisdictions also require a Subdivision Payment Bond, guaranteeing payment to laborers, subcontractors and material suppliers.10 Statutes requiring Subdivision Bonds may also specify the form and content of the bond to be submitted.11
(3) The Bond Amount
The amount of security required to secure performance of the obligation under a Subdivision Agreement is determined by the Public Agency, generally within a prescribed monetary range. For example, the portion of the security which guarantees faithful performance of the completion of the improvements under the Subdivision Agreement (i.e. the Subdivision Performance Bond) is generally calculated as a percentage of the total estimated cost of the improvements to be installed.12 The Subdivision Payment Bond which secures payment to the contractor, subcontractors, laborers, materialmen and persons furnishing equipment is generally required in an amount not less than fifty percent and no more than one hundred percent of the total estimated cost of the improvements.13 In addition to the base cost of the improvements, the security often covers costs and reasonable expenses, including attorneys' fees, that the Public Agency may incur in successfully enforcing the secured obligation.14
(4) Reducing the Bond Amount.
Once a Subdivision Bond has been issued and delivered to the Public Agency, the surety may be held liable up to the full penal sum of the Subdivision Bond.15 However, several jurisdictions provide a statutory mechanism to obtain a reduction of the penal sum of the Subdivision Bond as construction of the required improvements is completed.16 Such reductions in the penal sum act as a partial release of the surety and therefore limit the surety's potential liability should the developer be declared in default or otherwise fail to complete the remaining improvements. A reduction of the bond penalty is not automatic. The developer must comply with statutory requirements for obtaining the Public Agency's approval of completed work and a reduction of the bond.17 Therefore, a prudent developer and surety must be cognizant and vigilant in making sure that bond reductions are requested as work progresses.
II. The Differing Roles, Positions and Obligations of the Principal and Obligee on Subdivision Bonds as Compared with Public Works Bonds.
A. The Differing Roles of the Principal.
A public works project (e.g., the construction of bridges, highways and schools) is initiated and controlled by the governing Public Agency. The Public Agency will put the project out for bid before entering into a construction contract. As part of the contract, the Public Agency will require the contractor to post a Performance Bond securing the contractor's performance of the underlying contract, as well as a Labor and Material Payment Bond securing payment to subcontractors, suppliers and laborers (hereinafter Public Works Bonds). The contractor entering into the contract with the Public Agency is the principal on the Public Works Bonds.
Although Subdivision Bonds are somewhat similar to Public Works Bonds, the developer's role, position and obligations are quite different from those of a contractor entering into a public works contract. In subdivision development, it is the developer, not the Public Agency, who initiates the development of unimproved land. The developer must comply with the Statutory Scheme and enter into a Subdivision Agreement before obtaining the approval and authorization of the Public Agency to commence construction. As previously noted, this authorization may be conditioned upon the construction of various subdivision improvements as required by the Statutory Scheme and as set forth in a Subdivision Agreement between the developer and the Public Agency. The developer, as opposed to the contractor, is the principal on the Subdivision Bonds.
Where the developer is not the actual builder of the subdivision improvements and has separately contracted with a builder, there is no privity of contract between the surety and the builder. In the event the improvements are not completed, whether as a result of the default of the developer or builder, the Public Agency's claim is against the developer under the Subdivision Agreement and the surety under the Subdivision Bonds. Although the surety must deal directly with the developer, as its principal, if the developer is nonresponsive, the surety may also communicate with the builder in an attempt to resolve the Public Agency's claim and mitigate its damages.
B. The Differing Roles of the Obligee.
The Public Agency is the obligee on Public Works Bonds and Subdivision Bonds. The primary distinction in the role of the Public Agency as an obligee on Subdivision Bonds, as opposed to Public Works Bonds, is that the Public Agency has no obligation to pay the developer for the cost of the subdivision improvements. The consideration given by the Public Agency for the protections afforded under the Subdivision Bonds is the right to develop the subdivision. By accepting and acting upon this right, the developer assumes the obligation to pay for the subdivision improvements required under the Subdivision Agreement.
A secondary distinction is that the obligee on Public Works Bonds, as opposed to an obligee on Subdivision Bonds, takes a far more active role in determining and dictating the scope, method and operation of the work to be performed. In a typical public works contract there are often detailed plans, specifications and subcontractor requirements. By comparison, a typical Subdivision Agreement incorporates simple plans, a limited engineer's estimate and no subcontracting requirements, allowing the developer to utilize its own broad discretion in arranging for completion.
Another key distinction between a public works contract and a Subdivision Agreement is the contrast in the time requirements and the potential damage and liability to which the parties may be exposed. Public works contracts generally include a detailed schedule of performance with fixed dates for completion, including exposure for delay, liquidated and consequential damages. A Subdivision Agreement generally provides for completion within one to two years and allows for relatively easy extensions. Within these broad time parameters, the developer generally can independently schedule its work without exposure to delay, liquidated or consequential damages.
III. Construction Costs and Funding Obligations.
The developer assumes responsibility to fund the costs of constructing or placing the subdivision improvements required by the Public Agency. From the surety's perspective, this shift in funding responsibility should be a critical part of its underwriting evaluation. Following are the key areas of inquiry for the surety underwriters.
A. Estimated Costs of Completion.
Has the developer properly estimated the costs necessary to complete the improvements? The Public Agency generally provides engineer's estimates for these expenses. The surety underwriter should attempt to ascertain the accuracy of the engineer's estimates and whether there are any major deviations between the engineer's estimates and the amount the developer has budgeted for completion.
B. Funding of Subdivision Improvements.
Has the developer set aside sufficient funds to complete the subdivision improvements? If a project is to be self-funded by the developer, the surety must be assured that the developer has committed sufficient funds to complete the required improvements. If a project is to be financed through a bank (hereafter Set Aside Bank), the surety should request and obtain a Set Aside Agreement from the Set Aside Bank which provides that as part of its commitment to fund the entire project, the Set Aside Bank has segregated sufficient funds to be used solely for the completion of the subdivision improvements.18 Ascertaining the precise source of payment and procedure to be followed in funding the subdivision improvements is an essential underwriting consideration.
C. Proper Use of Set Aside Funds.
Have the developer and the Set Aside Bank complied with their obligations? The developer and the Set Aside Bank must use the funds set aside to pay for the completion of the improvements including payments to the builder, subcontractors and suppliers completing the improvements.
IV. Differences in the Scope of Coverage on Subdivision Bonds as compared with Public Works Bonds.
There are important distinctions in the scope of coverage between Public Works Bonds and Subdivision Bonds. While both types of bonds typically incorporate the underlying contracts by reference,19 i.e., a public works contract and Subdivision Agreement, respectively, Public Works Bonds provide security for the performance of all of the principal's contract work. By contrast, Subdivision Bonds guarantee only the required public improvements (often referred to as offsite improvements) which are a small portion of the overall development.20
For example, a developer with a project to build a tract of single family residences may be required to enter into a Subdivision Agreement which includes completion of specified subdivision improvements. The Subdivision Bonds guarantee only the developer's completion of the subdivision improvements to be dedicated to the public (including streets, curbs, gutters, storm drains, sewers and any grading necessary to accomplish these public improvements) and do not include the building of the private houses (often referred to as on-site improvements). Therefore, if a developer fails to complete any portion of the actual homes, the Public Agency has no claim against the Subdivision Bonds for the completion of the homes.21
Another distinction in coverage is that a public works contract secured by Public Works Bonds generally includes significant contract obligations. Those obligations may involve performance guarantees, warranties and specific damage exposures, including delay, consequential and liquidated damages. Although Subdivision Agreements often require the posting of a separate Warranty Bond or the subsequent reduction of the Subdivision Bonds to cover warranty obligations once the improvements are completed, Subdivision Bonds generally do not include coverage for delay, consequential or liquidated damages.22
V. Limitations and Expansion of Coverage.
There are situations where the Public Agency makes performance demands on the surety for items which are not sanctioned by the Statutory Scheme or are outside the scope of the Subdivision Agreement. In New Jersey, a Public Agency attempted to impose on the developer the electricity costs for lighting improvements incurred prior to the acceptance of the streets.23 Under the local Statutory Scheme, while the developer was responsible to pay for the costs to install underground electric facilities, the public utility owned the facilities. In fact, under the controlling statute,24 the municipality was expressly prohibited from requiring a performance guarantee of the underground electrical facilities built and owned by a public utility (albeit at the developer's expense). With respect to the electricity needed for the street lighting, the Appellate Division found that the legislative purpose of the Municipal Land Use Law authorized the enactment of subdivision ordinances to protect public interest by requiring installation of necessary improvements but neither the statute itself, nor case law, defined whether electricity costs are included in "street lighting" or are considered an improvement. The court therefore concluded that the cost of electricity was not an improvement and therefore not a proper claim against the Subdivision Bond.25
Another example of limits on claims against Subdivision Bonds arose where the Public Agency refused to release the developer's Subdivision Bonds solely because the developer "failed to form a homeowner's association as required by the planning board resolution.26 Noting that the Public Agency derived its power through statutory delegation, the court held that the Public Agency was without authority to retain the bonds.
Other states have similarly followed the general proposition that a Public Agency may not impose upon a developer a bonding requirement of broader scope than that set forth within the Statutory Scheme. This principle has been applied to defeat claims of contractors that allege that they are third party beneficiaries of the Subdivision Bonds .27 A different result occurred where a developer and its surety were found to have volunteered a payment bond not required by the Public Agency. While the Statutory Scheme did not require a Subdivision Payment Bond, a surety was held bound to an express Material and Labor Bond which was printed and executed on the reverse side of a (Subdivision) Performance Bond.28 Under the circumstances, the court held, "We conclude that since there is nothing in the record indicating that the material and labor bond was written under the compulsion of the county, there is no reason why it is not a valid common-law bond."29 A surety may also be liable where it voluntarily executes a bond of broader scope than contemplated by the Statutory Scheme.30
VI. Differences Between the Limitations Periods.
As noted above, while performance and payment bonds generally include broader coverage, the limitations period for making a claim on such bonds is often limited to within one or two years from the date of acceptance or completion of the project or of the last performance by the contractor or claimant.
In sharp contrast, the limitations period on most Subdivision Bonds runs from the completion date in the Subdivision Agreement.31 This beginning date for the limitations period may be modified by any extensions granted by the Public Agency. The nature of a subdivision development and the changes in the housing marketplace often require the developer to seek one or several extensions of time for the completion of the improvements. Unless the public is threatened by a dangerous condition or some other health hazard, the Public Agency generally grants a requested extension.
Most forms of Subdivision Bonds do not require that the Public Agency or the developer notify the Surety of an extension.32 Whereas in most cases, the surety can determine its exposure on a Public Works Bond within a couple of years of completion, the surety's exposure on Subdivision Bonds may be extended for six to ten years or more. To properly monitor its exposure, the surety should monitor the financial status of the developer and the progress of the required improvements.
A particularly difficult issue arises when the surety has obtained a Set Aside Agreement from a Set Aside Bank. If the project is extended, it is incumbent upon the developer and the surety to make sure that the Set Aside Agreement is also extended. The surety must not only monitor the completion of the project, it should assure itself that the developer has funds or financing in place during the extension. If the project is selffunded by the developer, the surety must be vigilant in assessing the developer's continuing ability to install the improvements. Where the surety has legitimate concerns relative to the ability of the developer to pay for the costs of completion, the surety should request collateral.
Assuming that the surety is able to properly monitor the situation and limit its exposure, time extensions often assist in avoiding exposure on the Subdivision Bonds. Subdivision development is often delayed when the economy or housing market is slow. When the market turns, in many cases it is possible for the developer to obtain new sources of revenue to complete the improvements so that it can sell the units. From the surety's perspective, it is important to understand and appreciate these issues and to work with the developer and Public Agency to mitigate exposure to loss.
VII. Pre-Claims Handling Procedures.
Special pre-claim and post-claim handling procedures and methodologies may be established to limit or eliminate exposure on Subdivision Bonds. The best pre-claim action the surety can take is to properly underwrite the bond. Avoiding exposure to loss on Subdivision Bonds requires vigilant and consistent monitoring and communication with the developer principal. Once Subdivision Bonds are issued, the surety should also consider the following procedures to reduce its exposure:
l. The surety should obtain a projected schedule of completion of the subdivision improvements from the developer. The surety should monitor the progress of the subdivision improvement work. It should obtain periodic status reports from the developer to compare the actual completion of the work with the developer's projected schedule. The surety should determine the reasons for any delay and obtain assurances that the project will be completed on a timely schedule.
2. If the developer is self-funding, it is essential for the surety to closely monitor the developer's financial ability to complete the required improvements. If the developer has bank financing, it is incumbent upon the surety to communicate often with the Set Aside Bank to assure that the Set Aside Bank is properly disbursing funds as subdivision improvements are completed and that set aside funds are used solely for their intended purpose.
3. The surety must communicate with the developer to determine if there are any major changes in its development plans or financial condition which could impact its ability to timely complete the subdivision improvements. If a developer's financial condition changes or economic or marketplace conditions change, the developer must work with the Public Agency to assure that appropriate extensions are applied for and obtained, and that the Set Aside Bank understands and agrees to maintain its financing and/or Set Aside Agreement during the extended time frame.
4. The surety must communicate with the developer and the Set Aside Bank to ensure that if the Set Aside Bank forecloses on the property, it will require any third party purchaser to assume or take title to the property subject to the developer's subdivision improvement obligations. These negotiations should also deal with the Set Aside Bank's obligations under the Set Aside Agreement. Although a Set Aside Bank may not have a legal obligation to work with the surety, if properly presented as an option, a Set Aside Bank will often work with the parties to deal fairly with the property.
VIII. Defenses to Subdivision Bond Claims.
If the principal is declared in default on a Public Works Bond, the surety must evaluate the default in the context of the terms and conditions of the construction contract. As a matter of practice, the Public Works Bond surety should generally contact the principal to determine if there are any legitimate defenses to the default. Based upon its investigation, and assuming that the default is determined to be proper, the surety may exercise a variety of options, including, inter alia, financing the principal, tendering a completion contractor, providing a completion contractor or paying the bond penalty. The surety will evaluate a variety of factors including the availability and amount of remaining contract funds, the status of the completed work, the percentage of the completed work, whether the remaining work is to be performed by subcontractors and whether the subcontractors' contracts can be ratified and completed by the subcontractors.
If a principal is declared in default on Subdivision Bonds, the initial investigation relative to the default is rather straightforward. If the time frame for completing the subdivision improvements has expired and it is within the limitations period for making a claim, generally the principal will have no defense to a demand on the Subdivision Bonds. As compared with the options available when a claim is made on Public Works Bonds, the options available to the surety on a default against Subdivision Bonds are limited. In most cases, if no other defenses are available, the surety will either complete the work with a completion contractor or pay the obligee an amount necessary for the construction and installation of the required improvements.33
Claims against Subdivision Bonds often expose the surety to substantial loss without subrogation rights. As a result of time extensions sought by the developer and granted by the Public Agency, partially completed improvements which were not accepted by or dedicated to the Public Agency may deteriorate over time requiring repair or replacement. There is no balance of unpaid funds to which the surety may become subrogated. Thus, losses on Subdivision Bonds tend to be substantial. To mitigate against exposure to loss on Subdivision Bonds, the surety should consider the following factors and potential defenses in evaluating, investigating and defending a claim.
1. Who is making the claim? Most Subdivision Performance Bonds identify the Public Agency as the sole obligee. Therefore any claim brought by any other party maybe subject to denial.34
2. Has the claim been timely presented? The Subdivision Agreement must be reviewed for the completion date and the appropriate statute of limitations must be applied.35 If upon review of the Subdivision Agreement it appears that a claim is time barred, that should not be the end of the surety's investigation. Some Statutory Schemes and Subdivision Bonds allow extensions of the completion dates without the surety's consent.36 The surety must determine if any extensions have been granted. It should also ascertain the extension procedures available to the developer and Public Agency and whether they complied with the rules in extending the time for completion.
In addition to a statute of limitation defense, if the appropriate facts exists, the surety may also be entitled to assert equitable estoppel or laches defenses. To the extent the Public Agency, either expressly or through its conduct, accepted the improvements or waived any further obligation of the developer, the Public Agency may similarly have waived its claim against the Subdivision Bonds. For example, a Public Agency may have an inspector monitoring and approving the completion of improvements. The inspector's daily reports often include the inspector's observations at the site with respect to work completed. These reports may be helpful in establishing the improvements completed. The inspection reports may also evidence that the Public Agency permitted the developer to deviate from procedures identified in either the Subdivision Agreement or the Statutory Scheme.
A potential estoppel defense may arise where the Public Agency prematurely issues certificates of occupancy or building permits in violation of its own laws. Some Statutory Schemes require that all public improvements (with limited exceptions) be installed before certificates of occupancy are issued. If the certificate of occupancy or building permits are issued before all improvements are completed, the Public Agency may be estopped from making claim on the Subdivision Bonds or from later taking a position that the improvements are not completed satisfactorily.
Depending upon the Statutory Scheme or the provisions of the Subdivision Agreement, a laches defense may be available to a surety. It is not unusual for a subdivision claim to be made many years after the developer has left the site. Statutory Schemes and Subdivision Agreements generally require that subdivision improvements be completed within a certain time frame. Nonetheless, it is not uncommon for the Public Agency to neglect bringing a claim or filing suit against the surety for months or even years. By then, the surety's interests often have been compromised as the financial condition of the principal may be considerably worse than it would have been had the claim been timely made at or near the time the developer sold the improved lots or built and sold homes thereon.
3. Has the municipality complied with the applicable enabling statute and/or its own ordinances?
As stated in Section V, supra, a municipality may include as part of its subdivision bond claim the installation or provision of items beyond those for which the applicable enabling statute authorized the municipality to require a performance guaranty. In such cases, the municipality's demands upon the developer and surety are ulta vires and should create no liability.37 Nonetheless, it has also been held that where a developer agreed, without protest, to install certain improvements which the governmental unit lacked authority to require, the developer and its surety were estopped from asserting that the requirement of the improvements was ultra vires.38
Similarly, where a municipality imposes conditions upon a developer without statutory authority, the developer and surety may also have a defense of ultra vires. Depending upon the facts of the case, however, the developer or surety may be held to lack standing to, or to be estopped from, raising such a defense.
The case of Bama, Inc. v. Anne Arundel County,39 for example, concerned a subdivision bond guaranteeing a developer's agreement to improve a road ad