Subdivision Bonds – Alternative Security to Letters of Credit

Contract bonds are a well known and utilized financial security instrument for construction projects in Canada. A number of jurisdictions in Canada make it mandatory for contractors to provide bonds for public projects above a certain threshold – Ontario’s new Construction Act of 2018 set the limit at $500,000 while the threshold for B.C.’s Ministry of Transport and Infrastructure is set at $200,000.

Prior to the development of real estate as a precondition to granting construction permits, government entities will require an owner or developer to post financial security to guarantee the completion of designated improvements. These improvements may include gutters, sidewalks, curbs, lighting, sewers and drainage systems. The go-to security for many developers is an irrevocable letter of credit which encumbers a portion of their credit facility and is acceptable in all jurisdictions.

Subdivision bonds is an alternative form of security widely accepted in the US and several jurisdictions in Canada. In the 2 years pre-Covid, 3 jurisdictions in B.C. began accepting these bonds from developers with a handful further indicating that they are receptive to them, given uptake by developers in their region. A key difference between subdivision bonds from regular contract performance 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).

BENEFITS TO MUNICIPALITIES:

• Demand instrument – a subdivision bond is comparable to a letter of credit, representing a very liquid instrument that provides the municipality with the funds required in case of a claim. • Customizable – The bond wording can be amended and made suitable for each municipality, providing financial guarantee consistent with the municipality’s servicing agreement. • Prequalification – Prior to issuance of subdivision bonds, the Surety performs a comprehensive assessment of the developer’s financial strength and source of funds along with their experience and capacity required to successfully complete the project. • Indemnification – In case of a claim, the surety has recourse to recover all amounts paid under the subdivision bond. This keeps the developer accountable and driven to fulfill its responsibilities to the municipality. • Encourages Growth – A municipality that accepts subdivision bonds as an alternate form of security indicates to developers the municipality’s innovation and consideration of the developers needs. This in turn drives an increase in development opportunities with no additional risk to the municipality ensuring growth benefits are felt by its communities.

BENEFITS TO DEVELOPERS:

• The bond is an off-balance sheet security which increases working capital significantly at the later stages of development. • Surety credit is unsecured and does not reduce or tie-up the developer’s source of funding – letters of credit are usually fully collateralized by cash by the end of the project. • The Surety claim department will work to facilitate a resolution of any problem within the demand window prior to forfeiting the security.

The fundamental aim of surety is to avoid detrimental occurrences through stringent underwriting of a developer’s character, capacity and capital (3 Cs of Surety) before issuing bonds. Municipalities would therefore view subdivision bonds more as an assurance than insurance.

GILBERT KIMANI, CPA, CA, Associate Vice President – Surety, Aon Construction Services Group, is an advocate for finding win-win bonding solutions for both owners/municipalities and contactors/developers through pushing innovation and an in depth understanding of risk mitigation. Gilbert holds an Honors (Sustainability in Business) BBA Degree from Simon Fraser University.

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