Ontario Seeks Feedback on Pay-on-Demand Surety Bonds to Secure Land Use Planning Obligations

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New Financial Security for Land Use Planning Obligations

As a condition of land use planning approvals, municipalities often require developers to provide financial assurance to ensure work is carried out in accordance with approved plans. Municipalities typically mandate that this financial assurance be provided in the form of a Letter of Credit (“LOC”) issued by a bank. If a developer fails to carry out the work as intended, the municipality can draw on the LOC to complete the work to its satisfaction.

The Province of Ontario (the “Province”) has recently announced that it is seeking feedback on a proposed regulation under section 70.3.1 of the Planning Act that would authorize developers to stipulate the form of financial assurance to be provided to secure obligations that are conditions of land use planning approvals. Specifically, the Province is considering a regulation that would authorize landowners to choose to provide a pay-on-demand surety bond as an alternative to a LOC.

In light of this potential regulatory change, municipalities and developers are encouraged to educate themselves regarding the use of on-demand surety bonds as a form of financial security.

This article provides a brief overview of on-demand surety bonds and why they might be an appropriate choice for some developers, as well as some initial considerations for municipalities, should a developer elect to proceed by way of a surety bond.

The consultation process will end on October 16, 2024.

Securing Performance

While securing the performance of a developer’s obligations is often a necessity for any municipal authority, the posting of cash or LOCs as security under a development agreement or other approval can create new issues. The developer’s capital is tied up for the duration of the security. There may be disagreements between the developer and the municipality as to when a security can be reduced or released. There may also be disagreements over how much security must be retained over longer periods of time (e.g., infrastructure monitoring periods). 

This is in addition to the potential need to provide security for separate elements of a development project (roads vs. parks vs. sewers) or to different municipal authorities (upper-tier vs. lower-tier). The issue of security can accordingly put pressure on both sides of a development project in structuring the relevant development agreement and in deeming the secured work complete sufficient to allow the release of the held security.

Bonds as Security

A bond is a form of certificate that is provided to ensure work is completed as agreed upon. A common form, known as a performance bond, provides for a surety to perform or make payment for the obligations of the principal to the obligee in the event the principal fails to do so. In the land development context, the developer is generally the principal who is bound by the obligations under an agreement; the municipality is the obligee to whom the obligations under the agreement are owed; and the third party, who guarantees the obligations, is the surety.

Municipalities have often been reluctant to accept bonds, as issued by sureties, as a form of security under a development agreement due to the following concerns:

• bonds are provided by a private company and are not secured through funds by a bank, and are thus seen as less “secured” than traditional LOCs; and
• there is an increased risk of potential litigation involved in accessing a bond (such as may be seen with accessing funds under a performance bond or a labour and material bond).

Developers, in turn, prefer the use of bonds as a security product because:

• bonds do not “tie up” a developer’s capital in the same way that a LOC or cash security does and, as a result, bonds can help a developer use their capital more efficiently; and
• by being able to access the unproductive funds tied up by a LOC or cash, developers could put those funds to work to develop more projects, faster.

On-Demand Bond Option

The benefit of a LOC or cash, over a traditional bond, is that it represents greater liquidity. To overcome this hurdle and allow greater acceptance of bonds in untraditional uses, sureties have accepted the use of an “on-demand bond.”

An on-demand bond works similarly to a LOC but is an instrument issued by a surety, not a bank. As its name implies – and if properly drafted – the on-demand bond is payable on demand. Accordingly, in the event of default by a developer, the municipality can make a demand on the bond and be in immediate possession of funds to correct the default, with limited recourse by the surety.

Municipalities would be required to implement appropriate internal policies and procedures to manage the acceptance of on-demand bonds. As well, a municipality would require the customization of the form of bond to ensure risk is managed, mitigated and transferred appropriately.

As with all bonds, a developer would be required to enter into an indemnity agreement with the surety, obligating the repayment of any funds issued against the on-demand bond.

Proposed Regulation

The Province is considering the following mandatory elements of the pay-on-demand surety bond:

• A requirement that the bond be issued by an insurer that is licensed under the Insurance Act to write surety insurance.
• The insurer would be required to meet certain credit ratings.
• The bond issuer would guarantee the payment to the municipality if the developer defaults in performing the obligation guaranteed by the bond.
• The insurer would be required to make payment to the municipality within 15 days of being provided with a written notice of default.
• The bond would provide for partial drawdowns.
• The insurer would be required to provide a written notice to the municipality and the developer at least 90 days in advance of its intention to terminate the bond.

Going Forward

The requirement for municipalities to accept on-demand bonds as security under development agreements may become a reality. Certain municipalities have already voluntarily implemented their use, and the use of on-demand bonds could further expand within municipalities as similar arguments can be made to replace LOCs required under other types of agreements (e.g., construction agreements).

If you are a developer or a municipality looking to further understand the use and implementation of on-demand bonds, please feel free to contact the authors or a member of our Construction Group or Municipal & Land Use Planning Group.