Performance Bonds and Bid Bonds are both important types of construction bonds. However, these are two very different tools with different guarantees. Learn more about what separates these contract bonds.
A Bid Bond is a type of contract surety bond that guarantees that a contractor will honor their bid amount and enter into a contract if awarded. A Bid Bond protects the project owner or General Contractor by making sure that the bidding party does not back out of their bid or increase the bid price. If the bidding contractor will not enter into a contract at the bid price, an Owner can file a claim on the Bid Bond.
A Performance Bond is a type of contract surety bond that guarantees that a Contractor will complete a project according to the contract and specifications including the contract price. A Performance Bond protects a Project Owner or Upstream Contractor by ensuring that they get a project completed at the agreed upon price.
Both Bid Bonds and Performance Bonds have the same parties involved. This is usually a Contractor who is bidding the project or performing the work. This party is called a Principal on both of the bonds. The Project Owner or Contractor that is benefitting from both bonds is called the Obligee. Both bonds are written by a Surety who is the bond company that is backing the Contractor’s guarantee on both Bid Bonds and Performance Bonds.
Underwriting is the same for both Bid Bonds and Performance Bonds. The contractor must be underwritten by a surety bond company in order to receive both bonds. This underwriting process is referred to as the “3Cs” which stands for Credit, Capacity and Character.
Credit refers to a Contractor’s financial capacity to complete the project being bid or built, along with the contractor’s other workload. Surety Bond underwriters review a contractor’s business and personal financial statements, bank statements, work in progress, and credit reports to determine if the contractor can qualify. This often involves assessing a contractor’s liquidity and project trends.
Capacity refers to Contractor’s non-financial ability to complete the project being bid or built. Bond underwriters assess a contractor’s equipment, labor force, supervision, management, accounting and estimating systems to determine if they are likely to have the resources to complete their projects or if additional investments may be needed.
Experience is an important part of Capacity. Usually surety bond companies do not want to support bid bonds or performance bonds for contractors that are larger than 2 -4 times as large as a previously completed project.
Character refers to a Contractor’s history in keeping their commitments. Character is the hardest to underwrite, but bond underwriters want to make sure that a contractor will finish the bonded projects, even if things go bad. Underwriters will often ask for project references, supplier references, and analyze a contractor’s track record.
Underwriting Bid Bonds and Performance Bonds is similar because a Surety Bond underwriter must assume that a contractor is going to be low bidder, awarded the project and that they will eventually have to issue Performance Bond and Payment Bonds on the project.
Bid Bonds and Performance Bonds are both a type of contract surety bond. All surety bonds require indemnity. Indemnity means that if the bond company pays a valid claim on either a bid bond or a performance bond, they will seek reimbursement from the contractor and any indemnitors. More can be read about indemnity here.
Both Bid Bonds and Performance Bonds need the surety bond company’s seal in order to be valid. This seal can be a raised seal “wet seal” or it can be electronic. The important thing is that it matches the seal on the Power of Attorney included with the bond.
Both Bid Bonds and Performance Bonds need to be accompanied by a valid Power of Attorney to be enforceable. A power of attorney should match the name of the Surety Bond Company listed on the bond. The Power of Attorney will list the Agents and Brokers that are authorized to sign the bond on behalf of the surety bond company. The Surety signature on either bond should match one of the names listed on the Power of Attorney.
Both Bid Bonds and Performance Bonds need to be signed by both the Principal Contractor and a representative from the Surety Bond Company. As mentioned above, the signature from the Surety should match a name listed on the Power of Attorney. Signatures can be either electronic or original and depends on the Obligee. Many Obligees will accept electronic signatures for Bid Bonds but prefer original signatures for Performance Bonds. These requirements keep changing with technology though.
Although it varies from contract to contract, there is typically the same rating requirement for both Bid Bonds and Performance Bonds. If a bid specification requires a bid bond company to be rated “A-” or better by service such as A.M. Best, a Performance Bond will typically have the same requirement.
Although they are both contract surety bonds, Bid Bonds and Performance Bonds have some important differences as well.
The cost of these two bonds is significantly different. Most surety bond companies and bond brokers do not charge for bid bonds. If there is a charge, it is usually minimal such as $100 for administration. On the other hand, Performance Bonds do carry a charge. Performance Bonds normally cost between 0.5% - 3% of the contract amount. Performance Bond Cost depends on several factors including the underwriting strength of the contractor, the type of work and the surety bond company’s filed rates in the state where the project is being built. You can read more about how Performance Bond Costs are determined here.
The amount of the bond varies significantly for Bid Bonds and Performance Bonds. Bid Bonds are written as a percentage of the contractor’s bid. 5%, 10%, 15% and 20% are all common bid percentages, but a bid bond on a private project could be in any amount. The bid bond amount is the maximum a surety bond company and contractor would have to pay if there is a claim on the bid bond.
For example, if a contractor bids $1 million on a project and has a 5% bid bond, the most an Obligee could claim on the bond is $50,000 ($1,000,000 x 5%). The penalty could be even less though. For example, say the second bidder on the project bids $975,000. If the contractor does not move forward, the bid bond penalty is only the difference between the two bidders which would be $25,000.
More detail can be read about bid bonds and bid bond claims here.
On the other hand, the bond amount and penalty on a Performance Bond is much greater. Performance Bonds are written for 100% of the contract amount. That means that on the same $1 million contract, the surety bond company and contractor could be liable for the full $1 million. Regardless of how much the contractor completes, the Surety must complete the job, or pay for completion up to the $1 million bond amount.
More can be read about Performance Bonds and Performance Bond Claims here.
As discussed earlier, Bid Bonds and Performance Bonds have different guarantees. However, they are also related. If a contractor uses a bid bond to bid on a project and then is awarded the project, the owner may ask the contractor to provide a Performance Bond and Payment Bond on the project. Although the guarantees are different, they work in conjunction with each other.
Understanding different types of Surety Bonds can be complicated. The experts at Axcess Surety can help you understand whether you need a Bid Bond or Performance Bond and how to obtain them. Contact our surety bond experts anytime.