What Is a Bid Bond?
A bid bond guarantees compensation to the bond owner if the bidder fails to begin a project. Bid bonds are often used for construction jobs or other projects with similar bid-based selection processes.
The function of the bid bond is to provide a guarantee to the project owner that the bidder will complete the work if selected. The existence of a bid bond gives the owner assurance that the bidder has the financial means to accept the job for the price quoted in the bid.
Reasons for Bid Bonds
Bid bonds ensure that contractors can comply with bid contracts and will fulfill their job responsibilities at agreed prices. Most public construction contracts require contractors or subcontractors to secure their bids by providing bonds that serve as a means of legal and financial protection to the client.
Without bid bonds, project owners would have no way of guaranteeing that the bidder they select for a project would be able to complete the job properly. For example, an underfunded bidder might run into cash flow problems along the way. Bid bonds also help clients avoid frivolous bids, which saves time when analyzing and choosing contractors.
Requirements for Bid Bonds
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. The cost of the bond depends on several factors, including the jurisdiction of the project work, bid amount, and contractual terms.
For example, 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. This bid bond is required along with a proposal to be taken seriously as a contender for a federal contract.
Writing Bid Bonds
A bid bond can be a written guarantee made out by a third-party guarantor and submitted to a client or project owner. The bid bond affirms that the contractor has the required funds necessary to carry out the project.
Typically, bid bonds are submitted as a cash deposit by contractors for a tendered bid. A contractor purchases a bid bond from a surety, which carries out extensive financial and background checks on a contractor before approving the bond.
Several factors determine whether a contractor will be issued a bid bond. They include the company's credit history and the number of years of experience in the field. Financial statements may also be examined to determine the overall financial health of the company.
Performance Bonds: Success
A bid bond is replaced by a performance bond when a bid is accepted and the contractor proceeds to work on the project. A performance bond protects a client from a contractor's failure to perform according to the contractual terms. If the work done by a contractor is poor or defective, a project owner can make a claim against the performance bond. The bond provides compensation for the cost of redoing or correcting the job.
Failure to Meet Obligations
If the contractor does not meet the obligations of the bid bond, the contractor and the surety are held jointly and severally liable for the bond. A client will usually opt for the lowest bidder since it will mean reduced costs for the company.
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 and pay more. In this instance, the project owner can make a claim against the full or partial amount of the bid bond. A bid bond is thus an indemnity bond that protects a client if a winning bidder fails to execute the contract or provide the required performance bonds.
Bid Bond Liability
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 surety can sue the contractor depends on the terms of the bid bond.