What is a Bid Bond
A bid bond is a debt secured by a bidder for a construction job, or similar type of bid-based selection process, for the purpose of providing a guarantee to the project owner that the bidder will take on the job if selected. The existence of a bid bond provides the owner with assurance that the bidder has the financial means to accept the job for the price quoted in the bid.
BREAKING DOWN Bid Bond
Most public construction contracts require contractors or subcontractors to secure their bids by providing bonds which serve as a means of legal and financial protection to the client. These bonds, referred to as bid bonds, provide sufficient assurance to the project owner that the contractor can comply with the bid contract and will fulfill the job responsibilities listed in the agreement policy for an agreed price. Without bid bonds, project owners would have no way of guaranteeing that the bidder they select for a job would be able to properly complete the job without running into cash flow problems along the way.
A bid bond can be a written guarantee made out by a third party guarantor and submitted to a client or project owner to affirm that a contractor has the required funds necessary to carry out a project. Typically, bid bonds are submitted as a cash deposit by contractors for a tendered bid. A bid bond is purchased from a surety which carries out extensive financial and background checks on a contractor before approving a bond. Some of the checks that determine whether a contractor will be issued a bid bond include his personal credit history, number of years of experience in the field, and the financial health of his company through the company's financial statements. If the obligations of the bid bond are not met, the contractor and the surety are held jointly and severally liable for the bond.
Normally, a client will usually opt for the lowest bidder since it will mean less costs for the company. However, if a contractor wins the bid but decides not to execute the contract for one reason or another, the client will be forced to award the second-lowest bidder the contract, thus, paying more. In this instance, the project owner will make a claim against the full or partial amount of the bid bond due to the first contractor’s failure to enter into a contract after it was awarded. A bid bond, therefore, is an indemnity bond that protects a client in the event that a winning bidder fails to execute the contract or provide the required performance bonds.
A bid bond is replaced by a performance bond when a contractor accepts a bid and proceeds to work on the project. A performance bond protects a client from a contractor’s failure to perform according to the contractual terms signed. In the event that the work done by a contractor is poor or defective, a project owner may make a claim against the performance bond to provide compensation for the cost of re-doing or correcting the subpar job.
The amount claimed against a bid bond typically covers the difference between the lowest bid and the next lowest bid. This difference will be paid by the bonding company or surety which may sue the contractor to recover the costs. Whether the contractor can be sued by the surety depends on the terms of the bid bond.
While most project owners typically require between 5% and 10% of the tender price upfront as a penalty sum, federally funded projects require 20% of the bid as a penalty sum. The cost of the bond depends on a number of factors, including jurisdiction of the project work, bid amount, and contractual terms. A contractor that is making a $250,000 bid to provide roofing for an elementary school will have to submit a bid bond of $50,000 along with his proposal to be taken seriously as a contender for the federal contract. Therefore, a bid bond also helps to avoid frivolous and unserious bids, saving the client time in analyzing and choosing a contractor.