Public Improvements and Performance Guarantees
(from Maine Townsman, March 2002)
by Jim Katsiaficas, Senior Staff Attorney, MMA

As you might imagine, the telephone rings fairly often at MMA Legal Services, bringing many tales of woe. One type of call we've received with greater frequency lately involves public improvements - or the lack of them - in subdivisions and other developments.

A selectman will call, saying that homeowners in a subdivision approved 10 years ago want the town to accept the street, but the street has not been built to town standards and/or there is no deed to the street. A variation on this theme is where the town meeting accepted the street years ago, but the street is still just an unfinished gravel path, and the town doesn't want to pay to bring it up to town standards.

Another common call involves persons who have purchased a lot, but can't obtain a building permit until the subdivider builds the street. In each of these situations, the homeowner or lot owner will tell the municipal officials "But the developer promised … " and then you can fill in the rest - a town-maintained street, a water line, a sewer line, a playground, fire hydrants, a fire pond or any other public improvement.

In many of these cases involving older subdivisions, condominiums or other developments, there is little that the municipality can do now unless the taxpayers are willing to pay to correct the developer's mistakes and omissions. However, municipalities can avoid similar problems in the future by taking a few steps to ensure that public improvements are properly secured, built and given to the municipality.

PUBLIC IMPROVEMENTS

In order to create new subdivisions or major developments, developers frequently have to create new streets to provide the access and frontage required by zoning and subdivision ordinances. Most subdivision and site plan ordinances require the developer to construct streets to specific standards outlined in the ordinance or in a separate road standards ordinance. When lots are sold (after subdivision approval by the planning board) with reference to the recorded subdivision plan, there is an "incipient dedication" of the streets shown on that plan ("paper streets") to the municipality. This means that the legislative body (town meeting or council) may (but is not required to) formally accept the streets so that the municipality then will own the streets.

The municipality should not accept the streets until after they are properly constructed, since once a municipality accepts a street as a "town way" (as most municipal streets are classified), it is required by State law to maintain and to plow that street. However, in some subdivisions, site plans and condominium developments, the developer seeks to have the streets remain private roads; the developer still has to build these to ordinance standards, and the municipality should be sure that there is some entity with an obligation to repair and maintain the private roads.

Subdivision and site plan ordinances often also require construction of other public improvements, such as dry hydrants and fire ponds, storm water drainage systems, lighting, trails, playgrounds, water and sewer lines and sidewalks. Many ordinances require the developer to construct these public improvements within a specific period of time after receiving the land use approval or after recording the subdivision plan in the registry of deeds. The municipality's legislative body also has the discretion to accept these other public improvements following their satisfactory completion.

PERFORMANCE GUARANTEES

Problems occur when developers fail to construct the public improvements, sell the project before the public improvements are complete, inadequately construct the public improvements or fail to convey the public improvements to the municipality. Problems also occur when municipalities accept incomplete or improperly constructed public improvements.

In order to ensure that these public improvements are constructed to the satisfaction of the municipality for the benefit of both the public and the lot or unit owners (who buy in reliance upon these improvements being constructed), most municipalities also require the developer to post a performance guarantee. The performance guarantee ensures that the developer will construct the public improvements in a timely fashion. If not, the municipality may call the guarantee and use the money it obtains either to construct the public improvements or to restore the land to its original state.

Types of Guarantees

By ordinance, a municipality may require a developer to provide performance guarantees to secure the satisfactory completion of public improvements in subdivisions and in other developments, such as site plan and condominium developments, within the time limits set by the ordinance. Performance guarantees authorized by ordinances generally include the following three types.

Performance Bond. The developer obtains a bond from an insurance company or other surety, who guarantees completion of the public improvements if the developer does not complete them by the specified time. However, this form of guarantee can pose problems for both the municipality and the developer. Often, the municipality must sue in order to collect on the performance bond, and so the municipality suffers the delay and expense of litigation before it can recover the money to complete the public improvements. From the developer's perspective, performance bonds are expensive and, depending upon the financial capacity of the developer, may not be available.

Cash or Escrow Account. A cash account is the simplest form of guarantee, and is the easiest for the municipality to administer. The developer deposits with the municipality an amount of money equal to the estimated cost of public improvements. The municipality either will release the money after the improvements are complete or will use the money to complete the improvements if the developer fails to do so. A cash deposit that a municipality can draw upon unilaterally is fine from the municipal perspective. Developers, however, dislike cash deposits (or escrows) for all but the smallest improvements, since they force the developer to tie up both the amount of money necessary to build the improvements and an additional sum, in the same amount as the cost of improvements, as security.

In the escrow situation, the developer deposits the money with a third party to be paid to the municipality under the terms of a written agreement if the developer defaults on his obligations. If the improvements are completed satisfactorily, then the amounts are released, either as each portion of the improvements is completed or at the end of construction, back to the developer. The use of an escrow account is a relatively straightforward process for municipalities so long as the municipality can unilaterally withdraw sums from the account. As with cash deposits, few developers are willing to take advantage of this method since it requires them not only to pay the actual costs of construction of the public improvements, but also to set aside an equivalent amount of money to secure construction.

Irrevocable Letter of Credit. The irrevocable standby letter of credit originally was used to facilitate the international sale of goods, and in the 1980s it was adopted as a method to secure performance of public improvement guarantees under land use approval ordinances.

The letter of credit essentially is two contracts: (1) the developer agrees to pay the bank sums of money which it (the bank) may be obligated to pay in the future with regard to the subdivision, and (2) the bank contracts with the municipality to pay sums on demand. The bank's obligation to pay the municipality is terminated if the improvements are completed satisfactorily by the specified completion date.

To collect on the guarantee, the municipality need only present a "sight draft" to the bank before the letter's expiration date, together with any other documentation the letter of credit may require (usually a certificate that the developer is in default).

Letters of credit, properly drafted, can provide reasonable assurance to the municipality that the developer will complete the public improvements in a timely and satisfactory manner. However, the use of letters of credit can present issues for both the developer and the municipality.

For the subdivider, letters of credit have a significant cost, although not as great as the financial burden of both depositing the full amount of the cost of improvements in a cash account or escrow and paying for those improvements.

Municipalities have found that these letters of credit sometimes are not as easy to draw upon as originally intended, although they are more easily drawn upon than performance bonds. Municipalities also are finding that calling a letter of credit can result in litigation - developers have sued banks and municipalities when banks honor municipalities' requests to draw upon the letters of credit.

Alternatives to Financial Guarantees

Some municipalities also allow for an alternative to financial performance guarantees, such as the so-called "conditional agreement" in some land use ordinances that allows the developer to sell the one or two lots that have frontage upon an existing public way, but prohibits sales of, or building upon, the remaining lots until the improvements are completed. In theory, the sale of one or two lots would provide the developer with enough money to pay for the public improvements for the rest of the development.

In practice, however, the developer may sell the other lots before completion of the public improvements with the restriction that no building be constructed until the improvements are complete. These lot owners frequently don't appreciate at the time of purchase that the ordinance prohibits issuance of a building permit for their lots until the public improvements are complete. Major political problems can develop when the developer walks away with the money but without constructing the improvements, since the lot owners will look to the municipality to correct these problems.

Enforcement of Guarantees

Where municipalities have enacted land use ordinances that require developers to provide performance guarantees to secure the construction of public improvements, the issue often is the enforcement of these requirements.

Municipalities must require that performance guarantees remain in place until the improvements are complete. Municipal planners, code enforcement officers, building inspectors and engineers must inspect those improvements before guarantees are released or expire. Once guarantees are released or expire, it is too late to recover money easily for the developer's failure to satisfactorily complete improvements. Even if a municipality faithfully checks the calendar for expiration dates and inspects the improvements, it still may have trouble collecting on a performance guarantee (because of failure to strictly comply with the conditions for making a sight draft or because of a law suit by a developer). However, the municipality still should require and diligently enforce performance guarantees, as these are the best insurance that a developer will carry out its obligations to the public and to the its purchasers.

DEFECT BONDS/ACCEPTANCE OF PUBLIC IMPROVEMENTS/HOMEOWNERS ASSOCIATIONS

It is not enough for municipalities to require the developer to construct required public improvements and to provide a performance guarantee for their timely construction, and for the municipalities to enforce those requirements strictly. The municipality also must require the developer to guarantee the materials and workmanship in the construction of the improvements and must make sure that someone has the responsibility to maintain and repair them.

It is common (and recommended) that municipal ordinances require the developer to post a defect bond for one year following satisfactory completion of the public improvements. In this way, the municipality will be able to recover the cost of repair of shoddy workmanship or materials in the improvements without having the taxpayers pay these costs.

To ensure that the improvements are kept functioning and in good repair, someone - the municipality, the homeowners or the condominium owners - must be made responsible for repairs and maintenance. If the municipality is going to assume responsibility for the improvements, then it must accept the improvements - the streets, sewer and water lines, streetlights, parks, trails and sidewalks - through its legislative body.

The municipality is not required to accept the public improvements, but most land use approvals contemplate municipal ownership of these. (Municipalities should be sure to receive signed deeds, with metes and bounds descriptions, to the "paper streets" shown on subdivision plans at the time of plan release or subdivision approval.

The municipality will not "own" the streets until it accepts them, but after a subdivision has changed ownership two or three times, those deeds can be almost impossible to obtain.) If these improvements are to be privately owned and maintained, the approval and the recorded plan (if any) must plainly state that the improvements are to be privately owned and maintained.

Also, the developer should provide the appropriate documents to create a homeowners' or condominium association. These documents should specify the owners' obligation to maintain and repair the improvements, should provide a method for assessment of owners to pay the costs and should give the municipality the right to perform the work if the association fails to do so. The municipality should have its attorney review these association documents.

CONCLUSION

Requiring and enforcing performance guarantees is the best insurance a municipality can have that a developer will do what was promised in the land use approval process.

In order to minimize or prevent some of the problems described at the beginning of this article, municipalities should be sure that their ordinances require developers to provide adequate performance guarantees before a subdivision plan is released for recording or before other land use approvals and building permits are granted.

It also is important for the municipal attorney and engineer to review and approve of the form and content of the performance guarantees offered by developers.

To the extent that a land use ordinance authorizes the planning board to waive the requirement of a performance guarantee, such waiver authority should be used sparingly and should be available only in the circumstances specified in the ordinance.

In addition, municipalities should carefully monitor developers' construction of improvements and compliance with deadlines so that a timely claim can be made under the performance guarantee if necessary.

Municipal ordinances should require developers to post defect bonds.

If the municipality is to assume ownership of and responsibility for the improvements, these must be dedicated to and accepted by the municipality.