Since 2005, the Local Government Budget and Fiscal Control Act (“LGBFCA”) has required finance officers of units of local government and public authorities in North Carolina to provide to their respective entities a “faithful performance bond with sufficient sureties in an amount not less than fifty thousand dollars.”  G.S. § 159-29(a); S.L. 2005-238, Sec. 2.  Due to the General Assembly’s enactment of Section 9.(a) of S.L. 2022-53, that minimum coverage amount will increase as of January 1, 2023 for units of local government and public authorities with “annually budgeted funds” in excess of $500,000.

A new bulletin released today (Local Finance Bulletin #62: Impending Changes to Bonding Requirements for Finance Officers: Prepare Now for January 1, 2023, and Beyond) explains how units of local government and public authorities subject to the LGBFCA should prepare for this change.  This blog post summarizes several key points from the bulletin.

What is a Faithful Performance Bond?

A faithful performance bond is a surety bond that creates obligations between three parties: (1) a principal (e.g., a finance officer), (2) a surety (i.e., the bonding company), and (3) an obligee (e.g., a unit of local government or public authority).  If a finance officer fails to faithfully perform its duties, the surety assumes liability for the principal’s failure to properly perform.  For example, if a finance officer misappropriates public funds, a surety can be liable to the obligee for that loss.

Surety Bonds and Insurance Are Not Legally Equivalent in North Carolina

Surety bonds and insurance policies are not legally equivalent under North Carolina law.  See Gibbs v. Mayo, 591 S.E.2d 905, 916 (N.C. App. 2004) (“In North Carolina, insurance and suretyship are not synonymous terms, but rather involve different functions, relationships, rights, and obligations.”) (internal quotations and citations omitted).  A unit of local government or public authority that only obtains an insurance policy to cover a finance officer’s failure to faithfully perform his or her duties (e.g., through embezzlement) will not comply with G.S. 159-29(a).

From the perspective of a local government or public authority, a faithful performance bond is largely identical to an insurance policy because it protects the local government (labeled the “obligee”) against loss arising from a named risk (i.e., a finance officer’s failure to fulfill its obligations).  But insurance policies and surety bonds bear important legal differences.

First, and perhaps most obviously, whereas an insurance policy typically creates obligations between two parties (i.e., the insurer and the insured), a surety bond creates obligations between three parties (i.e., a principal, surety, and obligee).

Second, whereas an insurer does not seek indemnification or reimbursement from its insured, a surety has a common law right to seek reimbursement from a principal that has failed to fulfill its obligations to an obligee.  For example, if a surety pays a unit of local government for losses arising from a finance officer’s misappropriation of funds, a surety could (and would) seek reimbursement from the finance officer.  In practice, most sureties do not rely solely upon this common law right, and instead typically condition their issuance of a surety bond upon a principal’s execution of an indemnification agreement providing the surety with a broad set of rights (including a right of reimbursement) against the principal.  Finance officers should be aware that they can be personally liable to sureties for losses that a surety incurs under the terms of a faithful performance bond.

What Does S.L. 2022-53, Section 9.(a) Change?

Prior to the enactment of S.L. 2022,53, North Carolina law required governing boards of units of local government and public authorities subject to the LGBFCA to fix the exact coverage amount of a finance officer’s faithful performance bond, subject to a mandatory minimum coverage amount of $50,000.  A board could fix the bond’s amount to require a higher coverage level (with no maximum cap), but many did not.

With the passage of S.L. 2022-53, Section 9.(a), the General Assembly raised the minimum coverage amount for units of local government and public authorities with “annually budgeted funds” exceeding $500,000.  Effective as of January 1, 2023, the governing board of a local government or public authority subject to G.S. 159-29(a) must fix the amount of a finance officer’s faithful performance bond to equal or exceed the greater of (1) $50,000, or (2) an amount equal to 10 percent of the unit or authority’s “annually budgeted funds,” up to a cap of $1,000,000.

Failure to Obtain the Required Bond – Consequences

The revisions to G.S. 159-29(a) make clear that a “person unable to obtain” the required faithful performance bond may not be appointed as finance officer of a unit of local government or public authority subject to the LGBFCA.  In underwriting a surety bond or increasing the coverage level of an existing bond, a bonding company likely will undertake some due diligence to determine whether an individual presents an unacceptable risk of default.  It may ask whether the individual has previously been convicted or accused of a crime, whether the individual has past experience as a finance officer, or other questions related to the individual’s ability to faithfully perform the duties of finance officer. It also may perform a check of the individual’s credit history.  According to several underwriters with whom I have spoken, this credit check is a “soft” check rather than a “hard” check.

If a surety is not satisfied with the responses to these questions or determines that the particular individual poses a high level of risk, it may either decline to issue the bond or instead charge a higher premium to compensate.  The revised version of G.S. 159-29(a) does not mandate that a particular surety provide a bond.  Therefore, if one surety declines to issue a bond, a unit of local government or public authority can seek out another surety.  Ultimately, though, an individual must tender a bond meeting the coverage amounts set forth in S.L. 2022-53, Section 9.(a) in order to serve as a finance officer.

Costs of Obtaining Increased Coverage

Units of local government and public authorities that must obtain an increase in coverage will pay a higher premium.  Pricing is not standardized across the industry and will necessarily differ based upon the particular individual to be bonded.  Anecdotally, finance officers have reported annual premium costs for a $1,000,000 bond that range from $1,500 to $6,000.

Some Finance Officers Not Affected by the New Requirements

S.L. 2022-53 modifies bonding requirements for finance officers of units of local government and public authorities subject to the LGBFCA (e.g., cities, counties, water-and-sewer authorities, sanitary districts, airport authorities, transportation authorities, councils of government, and tourism-development authorities)—but not all local governments are subject to the LGBFCA. For example, local school administrative units are subject to the School Budget and Fiscal Control Act (G.S. 115C, Art. 31) and the financial operations of ABC boards are subject to Article 7 of Chapter 18B of the General Statutes. The General Assembly has not amended the minimum coverage amounts for faithful performance bonds obtained by finance officers of school administrative units or ABC boards.

Implementation and Questions

Please feel free to contact me (ccrews@sog.unc.edu) if you have any questions about the revisions to G.S. 159-29(a) or would like to speak in more detail about Local Finance Bulletin #62.