Bonds | Building in California

What Is A Bond?

A bond is a three-party agreement in which

a Bond-Issuer (surety company), as the obligor, guarantees the performance or warrants the workmanship of

a Bond-Buyer (contractor or property owner), as the principal, to

a Bond-Holder (jurisdiction), as the obligee.

Development bonds typically have an expressed monetary limitation (face amount) and time limitation (expiration date). Surety companies collect a fee (typically, 3% of the bond’s face amount) and require collateral (typically, 100% of the bond’s face amount) from the Bond-Buyer.

What Are The Types Of Development Bonds?

Jurisdictions typically require three types of surety bonds for development projects:

Contract Bonds (also called Construction Bonds) have three sub-categories:

A Performance Bond reimburses the Bond-Holder (up to the bond’s face amount) for completing a project or repairing/replacing deficient workmanship, materials, or equipment if the contractor defaults. Although rarely exercised, Bond-Issuers have an option to complete the work themselves.

A Payment Bond reimburses the Bond-Holder (up to the bond’s face amount) for project-related equipment, labor, materials, and services if the contractor fails to pay workmen, subcontractors, or suppliers.

A Warranty Bond reimburses the Bond-Holder (up to the bond’s face amount) for repairing or replacing latent (unknown) defects in workmanship, equipment, and materials after a Certificate of Completion for the project has been issued. After expiration of the bond, jurisdictions typically assume maintenance of the public improvement.

An Encroachment Bond reimburses the Bond-Holder (up to the bond’s face amount) for maintaining or removing privately owned objects installed in the public right-of-way and for restoring the r.o.w. to i`ts original condition if the Bond-Buyer fails to perform. Jurisdictions may require liability and damage insurance as a companion to a bond (typically, for above-ground installations) or in lieu of a bond (typically, for below-ground installations).

Subdivision Bonds are required by the California Government Code (Subdivision Map Act) and by municipal ordinance for lot splits which require new public improvements. The types (performance, payment, and warranty), the wording, and the minimum face amounts of the bonds are specified by the SMA (GC Section 64499.1 et seq.) and set forth as part of the terms and conditions in the Subdivision Improvement Agreement with the property owner.

Are There Alternative Types Of Development Securities?

Jurisdictions (and the SMA) typically accept other instruments as security for development construction, including the following:

cash deposit
irrevocable Letter of Credit
Certificate of Deposit assigned to the jurisdiction.
Negotiable Bond (type approved for securing deposits of public money)

The differences are not relevant to the project’s construction, but there are important nuances for the Bond-Buyer (cost) and Bond-Holder (redemption):

Bonds are not readily redeemable (“liquid”) by the jurisdiction. Redeeming (“calling”) a bond can be a lengthy legal process.

Certificates of Deposit continue to accrue interest for the depositor while assigned to the jurisdiction.

Jurisdictions typically do not pay interest on cash deposits.

Tips

1. Avoid shorter expiration dates for Performance and Payment bonds

Using the project completion date does not account for a contractor’s default, which generally occurs after the completion date has passed

2. Re-inspect the project before the Warranty Bond expires...

and allow sufficient time to notify the contractor and Bond-Buyer of latent defects and to notify the Bond-Issuer of potential (or actual) redemption prior to the expiration date.

3. Use the jurisdiction’s current construction costs...

(e.g., local capital improvement projects, CalTrans projects) to determine the Performance Bond’s face amount. Since the public contracting process is inherently more expensive than private contracting, using the Engineer of Record’s cost extensions of material quantities most probably will result in a revenue short-fall in the event the jurisdiction has to complete the work.

Check the Links below and your local jurisdiction’s website for additional information.