Bid Bonds

A Bid Bond is a type of Contract Surety Bond that acts as a form of prequalification and protects Owners and Contractors during the bidding process.

A Bid Bond is a three-party guarantee between the Principal (The Contractor on the Bond), the Obligee (The Owner or Contractor Requesting the Bond) and the Surety (the Bond Company Guaranteeing the obligation)

The Bid Bond guarantees that if a bidding contractor is the low bidder, they will enter into a contract for the price and terms of their submitted bid. The Bid Bond protects the Obligee. Without it, a Contractor may have an incentive to not honor a submitted bid if the results are not to their liking. A Bid Bond compensates the Obligee for costs associated with rebidding the project if the Contractor on the Bid Bond is the low bidder and does not enter into the contract for the project.

A secondary purpose of a Bid Bond is to prequalify a contractor and make sure they are a capable of completing the project. Bid Bonds must be approved by a qualified surety bond underwriter. This means a qualified party has reviewed the contractor and believes they are a responsible bidder. Such review and prequalification may be required by the Bid documents.

How to Get a Bid Bond

Bid bonds and other contract surety bonds are underwriten according to the 3Cs. These are Credit, Character and Capacity.

Surety Bond underwriters want to make sure that contractors have the financial strength to complete a project before providing a bid bond on that project. An underwriter will generally want to see three years of a contractor’s financial statements to qualify for a bid bond. They will usually want to review the personal financial statements of the owner(s) as well.

They will also request a contractor’s Work-In-Progress report to see how the contractor’s current backlog is going and and to look at trends on projects. Finally, an underwriter will likely ask for an Aging of Accounts Receivable and a copy of the contractor’s bank line of credit.

For bid bonds, an surety underwriter is looking for history of profitability on similar projects. They also want to make sure the contractor has the cash and liquidity to finish the project, pay subcontractor and suppliers and continue company operations throughout the life of the project.

Character is a contractor doing what they say they are going to do. Surety bond companies want to make sure a contractor will stand behind their commitments, finish projects and reimburse the surety bond company if necessary.

Bond companies underwrite character by meeting the contractor and having annual meetings. They may also call the contractors suppliers, subcontractors, and previous customers to get references. The purpose of these meetings and calls is to understand the processes the contractor uses and to see if other believe the contractor has a history of fair dealings.

Finally, the third “C” is Capacity. Capacity refers to a contractor’s ability to perform the work. This includes having adequate experience, staff, equipment, accounting and estimating systems in place. A surety bond company will not write a bid bond unless it believes the contractor has the capacity to do the project.

The Miller Act requires a contractor to submit a Bid Bond on Federal Projects for $150,000 and larger. Many states and municipalities have also adopted similar requirements referred to as Little Miller Acts. Even when Bid Bonds are not required by law, it is common for them to be required on private projects as well. Additionally, many General Contractors require Subcontractors to provide Bid Bonds when bidding sub trades. These Subcontractor bid bonds help prequalify subcontractors and help ensure that you will honor their bid price if selected.

The Amount of a Bid Bond depends on the amount of the contractor’s Bid. Bid Bonds are expressed as a percentage of the contractor’s Bid amount. Most public projects have a required bid bond penalty of 5%. However, 10% or even 20% is not uncommon. That means the Contractor and/or Surety Bond company could be liable up to percentage of the Contractor’s Bid if a Bid Bond claim is made. This is referred to as the Bid Bond’s Penal Sum. An example is below:

5% Bid Bond = $50,000 Penal Sum

10% Bid Bond = $100,000 Penal Sum

20% Bid Bond = $200,000 Penal Sum

The Penal Sum is meant to be the maximum amount of the Bid Bond. Often the penalty is less because of the second place Bid. For example, assume that in the scenario above, the second-place bidder Bid $850,000. This would change the Bid Bond’s Penal Sum on the 20% Bid Bond. This is because the difference between the first and second bidder is only $150,000. The Obligee could claim $150,000 and go to the second bidder. On the other hand, the Bid Bond payout would remain the same on both the 5% Bid Bond and the 10% Bid Bond. This is because the $150,000 bid spread would be is greater than the Penal Sum on either Bid Bond. Therefore, the maximum claim under the Bid Bonds is just the Penal Sum.

As you can see, the actual dollars that a Bid Bond covers depends on the contractor’s Bid amount.

Surety Bond underwriters very rarely set a limit on a contractor’s Bid and Bid Bond. When an underwriter does set an absolute maximum on a Bid Bond, it is referred as, ” Capping a Bid Bond”. That means if the contractor bids more than the amount set on the bid bond, the contractor’s bid could be thrown out.

An example of wording that would “cap” a bid bond is:

Forfeiture Bid Bonds require the entire Penal Sum to be paid, regardless of what other bids have been submitted. These Bid Bonds contain more risk and will come under more scrutiny from a Surety Bond underwriter. Forfeiture bid bonds are very uncommon.

Axcess Surety Bonds does not charge for bid bonds. We want to build a long-term relationship with our clients and allow them to Bid freely. If you are the low bidder and are awarded the project, you may be required to provide other contract bonds such as performance bonds, payment bonds or maintenance bonds. These types of bonds do have a cost. Be aware that some brokers may charge a fee for Bid Bonds.

If a principal is read low bidder or most responsible bidder, the Obligee will likely award the contract. Most Bid Bond Forms give the Obligee up to 60 days to award and a contract. At that point, they may require the principal to provide Performance Bonds, Payment Bonds and Maintenance Bonds.

If the Bid is not low or successful, the Bid Bond guarantee is no longer valid. There is no need to have the Bid Bond returned.

Bid bond claims are rare. Normally they occur in one of two circumstances:

Both scenarios could happen when a contractor makes a large mistake. The second scenario can happen if the principal’s financial strength or bond capacity changes between the time of the Bid Bond issuance and the contract award. The Obligee could then make a claim on the bid bond. An example is below:

A Contractor bids a project with a 5% Bid Bond. The contractor’s bid is submitted at $800,000. The second lowest bidder turned in a bid at $1,000,000. After careful review the first Contractor realizes they made a mistake. The Contractor tells the Obligee that they will not be entering into the contract at that price. The Obligee can then make a claim on the Bid Bond for $40,000 ($800,000 x 5%) to compensate them for having to rebid the project or go to the next bidder.

Keep in mind that the Contractor may be making a wise business decision. After all, paying the $40,000 Bid Bond penalty may be much less expensive than trying to build the project with the error. Unfortunately, contractors often feel they can make up the mistake later and this can lead to trouble down the road.

In the example above, the Contractor may still want to build the project for $800,000, even though there is a significant Bid spread. Their Surety Bond company may decide they do not want to provide a Performance Bond or Payment Bond on the project due to the Bid spread. The Contractor must either find another Surety Bond company who will support the project, or the Obligee can make a Bid Bond claim. In the industry, when a new Surety Bond company writes the Performance Bond and/or Payment Bond after another Surety Bond company wrote the Bid Bond, it is referred to as “Jumping a Bid Bond”. Many Surety Bond companies will not jump another Surety’s Bid Bond.

A valid defense to a Bid Bond claim is an error in transposing the numbers or other clerical error. For example, a Subcontractor gives a contractor a bid for $200,000, but while rushing to get the Bid submitted, the contractor puts in $20,000 instead. The error in transposing the correct amount could be a valid defense to a Bid Bond claim.

Regardless of whether a bad bid is a mistake or error, a best practice would be to go to the Obligee as soon as possible. Many good Obligees realize that starting a project with a Contractor who will lose money on the project is a bad proposition for everyone. The Obligee may decide to move on to the second-place bidder to avoid problems on the project.

Bid Bonds and all Contract Surety Bonds are written on The Principle of Indemnity. That means that if a valid claim does happen, and the Surety Bond company pay a claim, they will seek reimbursement from the principal and other indemnitors under the General Indemnity Agreement (GIA). This is a significant difference between Surety Bonds and insurance. You can read more about indemnity and GIAs here.

Many Obligees have moved to electronic bidding. Electronic bidding does not require a raised seal like many Bid Bonds. Instead, bid information is entered into an online system for this purpose. This is especially true for many states’ Department of Transportation projects.  The Bid Bond is still approved by a Surety Bond company. Once approved is granted, the Surety Bond Broker enters the electronic bond into an approved bidding system such as Surety2000, Tinubu or other. You can read more about electronic bid bonds here.

Annual Bid Bonds are Bid Bonds that remain open for an entire year. A Contractor may bid many different projects under the Bond. The Annual Bid Bond simplifies the process for the Contractor, Surety, and Broker by not having to execute multiple Bid Bonds throughout the year. Annual Bid Bonds are most appropriate when multiple projects will be bid to the same Obligee throughout the year. Monthly bid lettings to the Department of Transportation are a great example. You can read more about Annual Bid Bonds here.

Most bid specifications require that your Bid Bond companies be rated A- or better by the rating agency A.M. Best or similar rating agency. Most bid specifications will also require Bid Bond companies to be listed on the U.S. Department of Treasury’s Circular 570 which you can check here. This is sometimes shorted as a “T-Listing”. Contractors should avoid Individual Surety Bond companies as providers of Bid Bonds. These companies are often backed by fraudulent assets and a contractor may have a worthless Bid Bond. It is always a good idea to verify your bond.

Bid Bonds should not be complicated. Contact the Surety Bond experts at Axcess Surety anytime.