Many political jurisdictions have statutes that require an owner or developer of real property to post financial security to guarantee the completion of designated improvements as a precondition to granting a construction permit or to allow the recordation of a final parcel map.
There are various ways to satisfy the financial security obligation, including:
- Cash Deposits
- Irrevocable Letters of Credit
- Surety Bonds (Subdivision/Improvement Bonds)
The tool that should be seriously considered by all builders and developers is the use of surety bonds issued by licensed sureties, obtained through an experienced bond agent that specializes in subdivision/improvement bonds. Generally, all jurisdictions accept surety bonds (there may be some minor exceptions in a few isolated jurisdictions.)
The problem with cash is, of course, it may be tied up for a long time, and be more than enough to complete the improvements. The same can be said for letters of credit. A surety bond, or in most cases, multiple surety bonds may be a far better alternative. The following are some of the benefits of surety bonds over other alternatives.
- The premiums for surety bonds are usually competitive with the fees for letters of credit. In many cases surety bonds are less costly.
- There is, usually, no collateral requirement to obtain these surety bonds.
- Most bank loans will include letters of credit as additional credit, so that it reduces the amount that can be borrowed. In some cases with smaller banks it affects the “loan to single borrower” limitation.
- If there is cash or real estate collateralizing letters of credit, such assets may be tied up long after the work is substantially completed before the letters of credit are released. Typically, surety companies view bond exposure on a cost to complete basis so amounts can be reduced as progress is made towards completion.
- If the developer does not need or have a bank loan, it may be very difficult to obtain a letter of credit. It is a big advantage for a developer to have a surety line of credit or relationship with a surety in such cases.
- By law, the bank must comply with a demand made against a letter of credit within 3 days, typically. With a surety bond, the surety is given a reasonable time (it can be as long as 45 days) to respond to a claim or demand against its bond. Thus the surety will investigate and give the principal time to have the demand reversed or to cure the default.
The bottom line is that the bond principal has a partner-like relationship with the surety, and the surety will be inclined to defend their client and not be fenced in by restrictive banking regulations. This is not to imply that the surety and bank are in conflict. Many times they can work together to resolve an issue impacting the project in question.
With this in mind, an experienced bond agent will understand how to communicate with the surety company and developer in order to avoid potential issues with not only the bank but the surety company. For these reasons it’s important to work with an agent specializes in working with developers and who will actively look out for their client’s best interests.
Information about the Author: Adam Grap joined Marsh & McLennan Agency, known locally as Insurance Associates Company in 2015 as part of a merger with Allegiance Surety Associates, Inc. Adam has been in the surety industry for 7 years and has focused on working with developers and contractors throughout the Mid-Atlantic region. Adam is responsible for developing new client relationships and servicing his existing clients. Adam is involved in committees for the American Subcontractors Association, Inc., Maryland Building Industry Association, The Cornerstone Group and various other local organizations. He is a graduate of the University of Hartford with a B.S. in Business Administration. In Adam’s free time he enjoys playing golf, basketball and spending time with his family and friends.