In Ontario, legislation requires developers to provide financial security for the development of condominiums. Over the past 20 years, surety companies have stepped in to provide different products to guarantee these security obligations.
Tarion Warranty Corporation
First of all, Tarion Warranty Corporation (“Tarion”) is a not for profit corporation that was established in 1976 by the Ontario New Home Warranties Plan act. It ensures that builders abide by the act and steps in to protect consumers when developers fail to perform their obligations under the Act. All developers must be registered with Tarion to build and sell condominiums in Ontario. In addition, each new condominium project must be enrolled with Tarion prior to any marketing efforts to sell condo units.
What’s a Tarion Bond and why do I need it?
Tarion requires developers to post security in order to protect the purchaser’s interests. An amount of $20,000 per unit must be given to Tarion to protect purchaser’s deposits as well as provide the warranty protection required by Tarion. Although it isn’t mandatory to post a bond for the Tarion requirement, developers benefit from a bond because it eliminates the need to post a letter of credit or cash security.
To put it into context, if you are building a 200 unit condominium, at $20,000, you would be required to post $4 million dollars to Tarion. By posting a bond, you can use that $4 million dollars to fund the project or for other cash flow needs.
Excess Condominium Deposit Insurance (ECDI) & Condominium Deposit Insurance (CDI)
Provincial legislation sets out the rights and obligations of condominium purchasers and sellers. In Ontario, the Condominium Act requires that deposits paid by a condominium purchaser to the developer must be held by a prescribed trustee in a separate trust account. These deposits may be released from the trust account to the developer so long as an Excess Condominium Deposit Insurance (ECDI) or a Condominium Deposit Insurance (CDI) policy is issued to the prescribed trustee. These policies guarantee that the deposits will be repaid if the developer fails to deliver the purchaser’s condominium in accordance with the purchase agreement.
The ECDI policy is issued on new residential condominium projects in Ontario. The ECDI policy guarantees purchasers’ deposits in excess of the $20,000 that is guaranteed by the Tarion Bond.
The CDI policy is issued in Ontario for condominium projects that are not covered by the Ontario New Home Warranties Plan Act, such as:
- Commercial condominiums
- Office condominiums
- Retail condominiums
- Residential condominium conversions
Purchaser’s Deposit Bond
When purchasing a new condominium unit, substantial deposits are usually required by the developer. The Purchaser’s Deposit Bond allows the purchaser to defer the payment of some of these deposits until the purchaser occupies the condominium unit. A Purchaser’s Deposit Bond program is initiated by the developer and then made available as a marketing tool to prospective buyers.
Four crucial factors when negotiating a Developer Surety Facility
There are several different bond companies that offer Tarion Bonds and ECDI/CDI facilities in Canada. Much like bank financing, each facility is project specific and the industry is highly competitive. Each bond company has a different appetite for business and terms and conditions can vary from company to company. There are four main areas of focus that should be examined before you make your decision:
1. Fees and costs for the Tarion Bond and the Deposits released by CDI.
In your commitment letter it will outline the rate that you will be charged for the Tarion Bond as well as the rate charged for the use of deposits during construction. This rate is highly negotiable and can be driven down when you understand the market. Rates can range anywhere from 0.5% to 2.0% depending on the developer so there is lots of room to negotiate.
2. Deposit Release Terms and Deposit Release Ratios.
Likely the single most important factor in your bond facility. The deposit release terms and ratios govern how and when deposits can be released from the Trust account. For example, if you have a 3:1 release ratio, that means that when the bank releases funding of $300,000, your deposit insurance will allow $100,000 to be released from Trust. In a 1:1 scenario, if $300,000 is released by the bank, a corresponding amount of $300,000 will be released. Sometimes, the bond company will require an initial chunk to be released by the bank before the deposits will be released in a specified ratio.
3. Indemnity and Security agreement that you will be required to enter into.
Any and all bond facilities are written with indemnity agreements in place. The indemnity can be entered into corporately, personally by the shareholders and sometimes spouses of the shareholders will be required to indemnify. The surety companies will generally try to have as much indemnity as possible so it is important to understand what is reasonable when entering into these agreements.
4. Holdback Security that is retained against warranty obligations upon condo delivery.
With respect to the Tarion Bond, the bond company will hold security at the end of a project to cover off warranty obligations. This can be in the form of cash or it can be security against units in the development. As time passes and the warranty obligations diminish, this security will be reduced accordingly.