A bid bond is a guarantee, from a surety company to the project owner or general contractor, that a contractor will fulfill the obligations laid out in their bid. A bid bond provides assurance to GCs and owners—if a subcontractor does not complete their work, the surety company will provide compensation.
Bid bonds are required on federal projects because of the Miller Act, though other types of projects may require bid bonds as well.
If you’ve been wondering about bid bonds in construction, read on for more details about how bid bonds work, how to get a bid bond, and why bid bonds are an important part of the construction bidding process.
How a bid bond works
When a general contractor needs a bid bond, they buy one from a surety for a certain percentage of the bid amount. Most of the time, this percentage is around 10 percent. (On federal projects, it’s set at 20 percent.) So, for a $500,000 bid, the contractor will have to secure a bid bond for $50,000.
That $50,000 serves as insurance that the contractor will complete the project for the $500,000 bid value. Should the general contractor win the bid but not take the project, the owner can place a claim against the $50,000 bond.
The Miller Act requires contractors on federal projects to post certain bonds. While payment and performance bonds are the headlining stars of The Miller Act, bid bonds are also a requirement. On Miller Act projects, bid bond amounts are typically 20 percent of the bid’s value.
There are three parties to a bid bond: the principal, the obligee, and the surety. The principal is the contractor purchasing the bond, while the obligee is the project owner or general contractor protected by the bond. The surety is the company providing the bid bond.
Claims against bid bonds
Usually, the obligee’s claim will be in the amount of the difference between the original bid and the next bid the owner accepts. Let’s say the winning contractor bid $500,000, but fails to declines to take the job. If the bid from the next contractor was $525,000, the project owner can typically file a claim against the bond for $25,000.
This fact in itself promotes competitive bidding. If a company submits a bid significantly lower than other bidders, the owner might think twice before awarding the project. With a value of 10 percent, the bid bond might not be enough to cover the difference between the awarded-but-failed contractor and the next competitive bid. This difference can have a significant effect on the project’s financing.
Other reasons for bid bond claims
There are other scenarios in which an owner can place a claim against a bid bond. If the bid was inaccurate and the contractor needs to bill for more, the bond can serve as an overflow of sorts for the owner.
Also, if the contractor abandons the job while it’s in progress, the owner can use the bid bond to help pay the difference to have another contractor come in and take over.
Paying back a claim
The absconding contractor isn’t off the hook, though — this bond isn’t a standard insurance policy where a claim may or may not increase their monthly premium. Instead, the contractor has to pay the claim amount back to the surety, and the surety establishes the terms.
How to get a bid bond
While the consequences and insurances that a bid bond represents are serious business, securing a bid bond isn’t quite as difficult (or expensive).
As long as a general contractor isn’t attempting to take on a project they can’t handle and they keep their finances in order, a bid bond shouldn’t be too difficult to obtain. However, the bond limit available to a contractor will depend on a number of factors, from their financial history to similar projects completed.
Bid bond requirements
Bid bond requirements differ a bit from job to job. While most federal-funded projects require bid bonds valued at 20 percent of the bid amount, other projects may require less. Private projects that opt for bid bonds — and public projects at the state and municipality level — often require bid bonds valued at 5 to 10 percent of the bid.
In general, their subcontractors aren’t expected to post bid bonds.
The application process
Contractors can apply for bid bonds through a surety agency. Most of the time, this agency will be an insurance company or bank. Establishing a relationship with an agency can help move bid bond applications along.
For smaller projects (let’s use $350,000 as the threshold), many sureties won’t require much more than a bid bond request form. This form will have the information necessary to apply for the bond. It will also allow the surety to check into the general contractor’s personal finances — the basis used to determine smaller bond eligibility.
However, for larger projects, the contractor might need to supply a bit more information with their application. In this case, the more useful information the contractor can provide, the better.
Breaking down the job costs, supporting bids from subcontractors, and quotes from materials suppliers can help. Also, the company’s financial reports, prepared by a CPA, can go a long way toward securing a bond.
Once the surety receives the application, they’ll review it to determine whether the risk is worth the reward.
The first area the surety will look at is the contractor’s ability to complete the project, as that poses the greatest risk for their bond money. The surety will look at current projects, past projects, and the company’s history.
Writing the bid bond
The surety company will write the bond based on both the contractor’s financial information and the details in the invitation for bid. Because they are guaranteeing performance based on the bid, they need to be confident that the company actually has the experience and money to follow through.
How much does a bid bond cost?
The good news for contractors is that securing a bond large enough to cover a big project might not cost them much. In many cases, sureties issue bonds for flat rates between $100 and $500.
For repeat customers with established relationships, some sureties will issue bid bonds for free. This courtesy is actually in hopes of securing the larger performance bond (often a requirement) if the contractor wins the project.
Why bid bonds are important in construction
Essentially, bid bonds help keep everything fair. They ensure that general contractors aren’t submitting frivolous or unbalanced bids that they can’t live up to. Bid bonds protect the project owner from entering into a contract with a company that won’t take that project as-bid.
They keep contractors from exaggerating their capacity or abilities, and stop contractors from changing their mind after entering their bids for a project.
In some ways, bid bonds also help keep bids competitive — an especially important point when it comes to projects paid for with taxpayer money.