Construction Law Section

By Luke J. Farley

Payment and performance bonds get all our attention. But there is another type of construction bond you might encounter, especially if the housing market in North Carolina stays hot[1]—the so-called “subdivision development bond.”[2] Both cities and counties can provide for “more orderly development of subdivisions by requiring the construction of community service facilities” like roads, sidewalks, utilities, etc.[3] To ensure that the infrastructure improvements are completed, local governments can require “performance guarantees” from developers.[4] All performance guarantees must meet the same basic requirements.[5] The purpose of a performance guarantee is to prevent a situation where a developer begins work on a subdivision, builds some houses, and then runs out of money without completing the infrastructure, leaving residents in a half-built community without roads, sidewalks, sewer, etc. Unfortunately, incomplete subdivisions were a common problem during the last economic downturn.[6]

Performance guarantees usually take the form of surety bonds, though the developer also has the option of getting a letter of credit[7] or some other equivalent security.[8] According to the International Risk Management Institute, a bond is the preferred option because it does not require any security[9] (though the developer or its principals should still expect to sign an indemnity agreement). Other performance guarantees, like a letter of credit or certificate of deposit, would either tie up the developer’s capital or put it directly at risk as collateral.[10]

If the developer chooses a surety bond, it will be bound as the principal and the city or county will be the obligee. The local government cannot require a penal sum greater than 125 percent of the estimated cost to complete the improvements[11] that are planned at the time the subdivision plat is recorded.[12] The bond must ensure that the improvements “will be finished as required by the plat”[13] but cannot be used to pay for repairs or maintenance after the project is completed.[14] This last provision was added to the law in 2015[15] and clarifies that developers and their sureties are only obliged to finish the improvements, not maintain them, something which is typically the responsibility of a subdivision HOA. While the amendment is helpful, it is still easy to imagine a dispute between a developer and town over whether streets are crumbling because they have not been maintained or because they were defectively constructed and thus never completed in the first place. In the context of development bond claims, no appellate court in North Carolina has been faced with that issue yet.

Once the improvements have been completed and the city or county acknowledges that the work is finished, the bond or other security must be returned or released to the developer.[16] Note that it is the completion of the “improvements for which the performance guarantee is being required,” not the completion of the entire subdivision that entitles the developer to a release of the bond.[17] The statute does not provide any specific procedures for how the city or county acknowledges completion, but a form prepared by the developer with a place for a city or county official to acknowledge completion with their signature is probably the best practice. If someone from the local government will not formally sign off on completion, there may still be other ways to show acknowledgment. For example, if the improvements have passed inspection and the inspections department is an agency of the city or county that required the performance guarantee, then it would be difficult to say that the city or county had not acknowledged completion of the work.

Some of the foregoing problems could be alleviated by carefully drafting the bond and defining terms like “completion,” “acknowledgement,” and “maintenance.” Since there is no statutory form required under § 160A-372, the parties should have latitude to define their rights as they do, for instance, when preparing a lien discharge bond under N.C. Gen. Stat. § 44A-16(a)(6). Like a development bond, there is no statutory form for a lien discharge bond. The party filing the discharge bond is free to include terms like a reservation of rights and defenses for the surety and the conditions that void the bond. A subdivision development bond should include similar terms.

If the developer does not complete the improvement, the city or county, as obligee, may make a claim under the bond for the surety to complete the work, making it effectively a performance bond claim. It is important to note that only the city or county can make a claim under a development bond. In the 2017 case of Brookline Residential, LLC v. City of Charlotte[18] a developer purchased an incomplete subdivision and sought to compel the municipality to make a claim under the bond to complete road improvements in the community. The N.C. Court of Appeals determined that the successor developer had no rights under the bond and could not compel the municipality to make a claim. Sureties should welcome this decision since it essentially eliminated an entire class of potential claimants against development bonds.

The International Risk Management Institute warns of a situation where the developer is not self-performing the work and pushes off responsibility for the performance guarantees to the general contractor.[19] Most contracts permit the contractor to stop work if it is not getting paid,[20] but if the contractor obtains the development bond and is the bond principal, then it has undertaken an independent duty to the city or county to ensure the subdivision improvements are completed, whether or not it has been paid. Contractors should be leery of any contractual provisions that require them to obtain a bond under § 160A-372(c).

Development bonds are an important tool that cities and counties can use to clean up the mess of an unfinished development. Given that residential construction in North Carolina seems to be humming along, we can expect to see these bonds more and more. Since the statute does not require any particular bond form and there is not much case law dealing with performance guarantees under § 160A-372(c), there is room for clever lawyering in both the drafting of the bonds and defending claims, even if the Brookline decision has shown us the outer limits of creativity.

Luke Farley is an associate in the Raleigh office of Conner Gwyn Schenck PLLC. He primarily represents sureties and large general contractors and is a member of the Construction Law Section of the North Carolina Bar Association.

[1] See, e.g., Amanda Hoyle, “New Deal to Restart 1,100-Home Community at the Raleigh, Durham Border,” Triangle Business Journal, Feb. 17, 2017, http://www.bizjournals.com/triangle/news/2017/02/17/fendol-farms-durham-rialto-fowler-shenandoah-homes.html; Marc DeRoberts, “Raleigh Suburb on Top 10 List of Suburban Hotspots,” Triangle Business Journal, Feb. 14, 2017, http://www.bizjournals.com/triangle/news/2017/02/14/raleigh-suburb-on-top-10-list-of-suburban-hotspots.html; Amanda Hoyle, “Maryland Homebuilder Making Big Push into the Triangle, Pays $10 Million for Raleigh Land,” Triangle Business Journal, Feb. 7, 2017, http://www.bizjournals.com/triangle/news/2017/02/07/maryland-home-builder-making-big-push-into-the.html.

[2] These bonds are also sometimes called site improvement, plat, or completion bonds.

[3] City performance guarantees are authorized by N.C. Gen. Stat. § 160A-372 (2015). County performance guarantees are authorized by N.C. Gen. Stat. § 153A-331(2015).

[4] The term “performance guarantee” was added to § 160A-372 in 2005. Prior to that, the statute only required a “guarantee of compliance.” See 2005 N.C. Sess. Laws 2005-426. The 2015 amendments to the statute defined “performance guarantee” with reference to the instruments that provide the needed security (e.g., surety bond, letter of credit, or some equivalent security). 2015 N.C. Sess. Laws 2015-187. This definition is lacking though because it only sets out what instruments can serve as performance guarantees without specifying exactly what guarantees these instruments must provide. In an unpublished decision, the U.S. District Court for the Western District of North Carolina defined a performance guarantee as “an assurance or promise that a contractual obligation will be fulfilled.” In re Versant Properties, LLC, 1:10CV198, 2011 WL 1131057, at *7 (W.D.N.C. Mar. 25, 2011).

[5] N.C. Gen. Stat. § 153A-331(e) (2015).

[6] See, e.g., Alana Semuels, “The Unfinished Suburbs of America,” The Atlantic, Nov. 14, 2014, https://www.theatlantic.com/business/archive/2014/11/the-unfinished-suburbs-of-America/382707/. The statute has been substantially amended since the downturn to clarify a developer’s obligations under the statute. See 2015 N.C. Sess. Laws 2015-187.

[7] N.C. Gen. Stat. § 160A-372(c) (2015).

[8] N.C. Gen. Stat. § 160A-372(g)(1)c (2015). The statute does not indicate what other instruments would provide “equivalent security.”

[9] Rolf A. Neuschaefer, “Expert Commentary: Subdivision/Improvement Bonds,” International Risk Management Institute, Inc., April 2003, https://www.irmi.com/articles/expert-commentary/subdivision-improvement-bonds.

[10] Id.

[11] N.C. Gen. Stat. § 160A-372(g)(3) (2015).

[12] N.C. Gen. Stat. § 160A-372(b), (c) (2015). If the subdivision plans change substantially after the plat has been recorded, the development bond surety should have no liability for the additional improvements on the basis that the there has been a change to the underlying obligation which has materially increased the surety’s risk.  See Bd. of Cty. Sup’rs of Henrico Cty., Virginia v. Ins. Co. of N. Am., 494 F.2d 660 (4th Cir. 1974).

[13] In re Versant Properties, LLC, 1:10CV198, 2011 WL 1131057, at *7 (W.D.N.C. Mar. 25, 2011) (unpub.) (emphasis supplied).

[14] N.C. Gen. Stat. § 160A-372(g)(4) (2015).

[15] 2015 N.C. Sess. Laws 2015-187.

[16] N.C. Gen. Stat. § 160A-372(g)(2) (2015).

[17] Id.

[18] COA16-202, 2017 WL 163776 (N.C. Ct. App. Jan. 17, 2017).

[19] Rolf A. Neuschaefer, International Risk Management Institute, Inc., April 2003, https://www.irmi.com/articles/expert-commentary/subdivision-improvement-bonds.

[20] See, e.g., AIA A201-2007 “General Conditions of the Contract for Construction,” ¶ 9.7.