There’s a type of surety bond that we rarely discuss: bid bonds.
Much like payment and performance bonds, construction bid bonds are required from general contractors on public projects and occasionally, on private projects, too. And as you could probably guess, bid bonds are required during the bidding phase of the project.
What Are Bid Bonds?
On public projects, and some private projects, bid bonds are required from all of the general contractors that are bidding for the job. These bonds guarantee that, if a contractor’s bid is selected, the contractor will accept the job as bid. If the contractor does not go forward with the contract under the terms of their bid, the awarding authority or property owner can make a claim against the bid bond.
These bonds raise the stakes for those bidding on projects. They ward off frivolous bids, prevent contractors from exaggerating their capacity or abilities, and stop contractors from changing their mind after entering their bids.
How Do They Work?
My insurance law professor would describe a bid bond as a “tripartite agreement,” which is a fancy way of saying that bid bonds are three-way agreements, just like payment bonds. They involve the contractor, the awarding authority/owner, and the surety. All 3 parties’ obligations are interrelated, which creates complications not found in ordinary contractual agreements.
Securing the Bond
To bid on a public project, a contractor must first secure a bid bond. Securing a bond is a lot like applying for credit with a bank. Before a surety will provide a bond to a contractor, the surety will comb through that contractor’s background. They will look at the contractor’s history, reputation, and liquidity to determine whether the contractor has the capacity, ability, and expertise to complete the project. The cost of securing a bid bond is often very low, and for contractors who regularly post bonds, a surety may even post a bid bond at no cost.
However, this only represents the cost to obtain the bond. If the bond holder defaults, the awarding authority may make a bond claim against the surety. When the surety has to pay, that means the bond holder – the GC – will, too. (More on that in a second.)
Claims Against The Bond
If the contractor’s bid is accepted but the contractor does not go forward with the project for any reason, the awarding authority will file a bond claim. Price adjustments made after a bid is accepted could also trigger a bond claim- even when it’s the result of an honest mistake in the bid calculation.
If a valid claim is made, the surety will have to pay a penalty. The penalty is often a specified percentage of the bid, but could also be the difference between the abandoned bid and the one that was eventually accepted. The contractor is not off the hook, though…
Surety bonds can appear a lot like insurance policies, but there’s a crucial difference: when a bond claim is paid out, the surety and contractor are both liable. Unlike a standard insurance agreement, surety bonds require that a contractor reimburse the surety for bond claims paid.
The ability to secure bonding relies on the health of a contractor’s business. The insurance industry is all about calculating risk, and a surety won’t make a bad bet. But construction payment and financial risk go hand-in-hand. You can only hope to minimize risk and put yourself in the best position possible- and levelset is here to help.