Successor developers: untapped opportunities for subdivision bond sureties.

AuthorKlinger, Marilyn

MANY states require the developer of a planned subdivision to post what is known as a "subdivision bond" or "plat bond." (See box on page - for the states and statutory references.) These bonds are essentially performance bonds that guarantee the developer's construction of certain public infrastructure improvements in connection with an otherwise private subdivision development. The bonds commonly guarantee the installation of streets, sewers, storm drains and similar items that will be dedicated to the county, city or municipality on completion of the subdivision.

Subdivision bonds, as this article will call them, are issued to a county, city or other municipal corporation, as obligee, on behalf of a developer, as principal. In practice, the bond often guarantees the developer's performance of a separate subdivision improvement agreement between the developer and the public entity, which agreement identifies the exact public improvements to be completed and establishes a timetable for same.

If the developer completes the public improvements pursuant to the subdivision improvement agreement, then the bond is exonerated. But, what happens when the developer defaults on this obligation? There are several possibilities.

If construction of the subdivision has not commenced or is not substantially advanced, the public entity might agree to rescind the subdivision improvement agreement, release the subdivision bond, and allow the property to revert to it former status. Even if construction has commenced, the public entity could agree to release the existing bond and require any successor developer to post a new bond prior to resuming work on the subdivision.

Unfortunately for the surety, these situations rarely occur. Instead, the public entity usually makes demand on the subdivision bond surety either to complete the public improvements, pay the cost of same, or tender the penal sum of the bond if the cost of the improvements exceeds the bond amount. Once the surety does so, the subdivision is usually completed by a "successor" developer, which in effect obtains the subdivision with the public infrastructure improvements already in place. Even if the successor developer is required to install the public infrastructure improvements, the public entity will often pay to the successor developer the funds it received from the subdivision bond surety to defray the costs of the improvements. Under either scenario, the successor developer receives a windfall at the surety's expense.

The surety, of course, will look to its bond principal - the original developer - and its indemnitors for reimbursement of any amounts paid under its subdivision bond. However, if the original developer or indemnitors are insolvent, the surety can expect minimal, if any, recovery. Should not the surety have some right to seek reimbursement from the "successor developer" who has benefited from its subdivision bond?

There are several theories a subdivision bond surety can pursue in an attempt to recover its bond losses from a successor developer. For the purpose of this article, they are successor in interest, unjust enrichment, and equitable lien.

Successor in Interest

A surety typically has three primary methods for recovering its bond losses: (1) the surety's common law or statutory right of indemnity from the bond principal; (2) the surety's right to enforce the general indemnity agreement against the principal and its indemnitors; and (3) the surety's right of equitable subrogation. Each of these methods - even equitable subrogation - is essentially contractual, as they all have their genesis in the surety contract. The surety's right to indemnity arises either because of an express indemnity agreement, or by virtue of the tripartite relationship among the surety, its principal and the bond obligee.

A subdivision bond surety has no direct contractual relationship with a successor developer. Thus, the surety's three traditional methods of recovery seem inapplicable. However, what if the successor developer is viewed as a "successor in interest" to one of the contracting parties - that is, the bond principal? Consider the following.

  1. Successor under the Subdivision

    Improvement Agreement

    As noted, subdivision bonds often guarantee the developer's performance of a subdivision improvement agreement between the developer and the public entity. When a developer defaults on its obligations under that agreement, it usually defaults on other obligations as well, including its obligations to the project lender that holds a mortgage or deed of trust on the property. The lender thereafter takes control of the property by foreclosure and begins searching for a new developer willing to purchase and complete the subdivision. That new developer will often complete the subdivision pursuant to the terms of the existing subdivision improvement agreement between the public entity and the original developer. In such cases, the new developer can...

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