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What Are Subdivision Bonds?
A subdivision bond, also called a plat bond, developer bond, or completion bond, is a specialized type of performance bond guaranteeing that certain improvements will be made in a subdivision. Such improvements include streets, sidewalks, streetlights, curbs, gutters, sewers, water mains, fire hydrants, and more—anything considered to be public infrastructure.
A subdivision bond guarantees these improvements will be completed and tied in with public infrastructure according to municipal code. The bond gives the municipal authority or other party requiring the bond (the “obligee”) a way to recover monetary damages from the developer (the bond’s “principal”) if the subdivision work is not completed satisfactorily.
Who Needs a Subdivision Bond and Why?
Developers, not contractors, are required to purchase subdivision bonds. A subdivision bond is needed when a developer divides a piece of land to build homes for individual sale. With a subdivision bond in place, the developer can go ahead and sell individual lots or homes before the public improvements have been made. With the bond as a guarantee, prospective homeowners can make a purchase with confidence that the infrastructure will be completed within a certain period of time and to the required standards.
The ability to sell homes before all improvements have been made improves the developer’s cash flow during construction, while the bond protects the obligee against financial liability in the event that the developer does not complete the required improvements.
A Common Misunderstanding
Subdivision bonds have much in common with site improvement bonds, and the two are often interchangeable. However, they are not exactly the same thing. While a subdivision bond guarantees the completion of new public infrastructure, a site improvement bond guarantees the completion of improvements to existing public infrastructure.
How Do Subdivision Bonds Work?
A subdivision bond is a legally binding contract among the bond’s obligee, principal, and a third party, the bond’s guarantor (known as the “surety”). Each party plays a different role
The obligee determines the needed bond amount (the bond’s “penal sum”) based on the engineer’s estimate of the amount needed for the public infrastructure to be built or installed. The obligee also has the right to file a claim against the bond and be compensated for monetary damages resulting from the principal’s failure to complete the project.
The surety determines the annual premium rate for each subdivision bond on a case-by-case basis. In guaranteeing the bond, the surety agrees to extend credit to the principal for the specific purpose of paying claims, if necessary. The surety investigates each claim received and determines whether it is valid.
The principal is legally obligated to pay all claims the surety finds to be valid. If the surety has paid the claim initially on the principal’s behalf, which is the usual practice, the principal must repay that debt. (Otherwise, the surety can take legal action against the principal to recover the funds.)
How Much Does a Subdivision Bond Cost?
The cost of a subdivision bond is determined by multiplying the bond’s penal sum by the premium rate the surety establishes through underwriting. Given these bonds are seen as a straight completion bond with no contract receivables to fall back upon, they are deemed riskier and often come with a higher premium rate in the range of 1.5% to 3% per annum.
Other Construction Bonds You Might Need
Both public and private project owners typically require certain construction surety bonds (also called contractor surety bonds) as protection against financial losses incurred as a result of a contractor’s default or unlawful or unethical actions.
The Federal Miller Act mandates performance and payment bonds for federally-funded projects valued at more than $100,000, while state-level “Little Miller Acts” impose similar bonding requirements on state-funded projects of a certain size. Private project owners are increasingly requiring both performance and payment bonds as well. And bid bonds often are required in competitive bidding situations. Other commonly required construction bonds include maintenance bonds, supply bonds, site improvement bonds, and subdivision bonds.
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