A bid bond is a type of construction bond that protects the owner or developer in a construction bidding process. It is a guarantee that you, as the bidder, provide to the project owner to ensure that if you fail to honor the terms of the bid, the owner will be compensated. A bid bond is typically obtained through a surety agency, such as an insurance company or bank, and it helps guarantee that a contractor is financially stable and has the necessary resources to take on a project. Bid bonds are commonly required on projects that also involve performance bids and payment bonds.
Bid Bond Basics
A bid bond typically involves three parties: the obligee, the principal, and the surety. The obligee is the owner or developer of the construction project under bid. The principal is the bidder or proposed contractor. The surety is the agency that issues the bid bond to the principal. The principal purchases the bid bond from the surety for a set price, much like a premium for an insurance policy. The coverage value of the bond is called the penal sum and represents the maximum amount of damages the surety will cover with the bond. Penal sums can range from 5 to 20 percent of the bid amount.
How Bid Bonds Work
Bid bonds help to prevent contractors from submitting frivolous or inappropriately low bids to win a contract. During a construction bidding process, various contractors (principals) estimate what the job will cost to complete, and they submit their price to the owner (the obligee) in the form of a bid. The contractor who wins the bid is given a contract for the project.
A bid bond serves as a guarantee that the contractor who wins the bid will honor the terms of the bid after the contract is signed. If the contractor fails to honor the terms of the bid—for example, he raises his price for the job after the contract is signed—the contract may be broken and the owner will have to find another contractor for the project, presumably the next-lowest bidder. A bid bond compensates the owner for the cost difference between the initial contractor's bid and the next-lowest bid. Sometimes, the surety agency sues the contractor to recover these costs, depending on the terms of the bond.
How Much Will a Bid Bond Cost?
The cost of a bid bond—the premium paid by the contractor to the surety—is based on several factors, including the cost of the project (bid cost), the location of the project, the owner, and the financial history of the contractor. For small projects, bid bond premiums may be a flat fee, such as $100 or $200. For larger projects, the bid bond premium usually is based on a percentage of the total project cost and the penal sum of the bid bond.
The standard penal sum for non-federal projects ranges between 5 and 10 percent of the total project cost. The penal sum for federally funded projects is mandated at 20 percent of the project cost. Bond premiums typically range from 1 to 5 percent of the penal sum. For example, if the project cost is $500,000, and the penal sum is $50,000, the contractor's cost for the bond may be $500 to $2,500.
Bid Bond Requirements
Under the Miller Act, which is still the standard today, all bidders are required to submit bid bonds on any federal project. Many private firms also adopt this requirement to protect themselves from risk during the bid process. Getting a surety bond is very important if you want your company to become competitive in the construction industry. In some areas, a surety bond is required to obtain licenses and permits. Most importantly, almost all project owners and developers require a bond from you before you can bid on their projects.
Federal surety bond requirements may be met in different ways:
- Surety bonds issued by an approved corporate surety agency
- Surety bonds issued by an individual surety that pledges certain defined types of assets
- Individuals act as sureties to satisfy bonding requirements on federal projects if they have acceptable assets in the required amounts to support the bonds
Acceptable assets include cash or certificates of deposit; U.S. agency securities; stocks and bonds traded on the New York, American, and other exchanges. There are also unacceptable assets. These are assets that may be difficult to liquidate, such as life estate in real property, jewelry, individual sureties, and several others.