Bid Bond: What It Is, How It Works, Vs. Performance Bond

What Is a Bid Bond?

A bid bond guarantees compensation to the bond owner if the bidder fails to begin a project. Bid bonds are often used for construction jobs or other projects with similar bid-based selection processes.

The function of the bid bond is to provide a guarantee to the project owner that the bidder will complete the work if selected. The existence of a bid bond gives the owner assurance that the bidder has the financial means to accept the job for the price quoted in the bid.

Key Takeaways

  • A bid bond is a legal agreement that ensures contractors fulfill their stated obligations on a project.
  • This form of assurance provides both financial and legal recourse to the owner of the project.
  • Bid bonds are usually submitted in conjunction with the project's contract.
  • Bid bonds are backed by specialized surety companies that guarantee the payments will be made if the contractor fails to uphold their end of the bargain.
  • The other main types of construction bonds are performance and payment bonds.

Understanding Bid Bonds

Bid bonds ensure that contractors can comply with bid contracts and will fulfill their job responsibilities at agreed prices. Most public construction contracts require contractors or subcontractors to secure their bids by providing bonds that serve as a means of legal and financial protection to the client.

Without bid bonds, project owners would have no way of guaranteeing that the bidder they select for a project would be able to complete the job properly. For example, an underfunded bidder might run into cash flow problems along the way. Bid bonds also help clients avoid frivolous bids, which saves time when analyzing and choosing contractors.

Requirements for Bid Bonds

While most project owners typically require between 5% and 10% of the tender price upfront as a penalty sum, federally funded projects require 20% of the bid. The cost of the bond depends on several factors, including the jurisdiction of the project work, bid amount, and contractual terms.

For example, a contractor that is making a $250,000 bid to provide roofing for an elementary school will have to submit a bid bond of $50,000. This bid bond is required along with a proposal to be taken seriously as a contender for a federal contract.

Writing a Bid Bond

A bid bond can be a written guarantee made out by a third-party guarantor and submitted to a client or project owner. The bid bond affirms that the contractor has the required funds necessary to carry out the project.

Typically, bid bonds are submitted as a cash deposit by contractors for a tendered bid. A contractor purchases a bid bond from a surety, which carries out extensive financial and background checks on a contractor before approving the bond.

Several factors determine whether a contractor will be issued a bid bond. They include the company's credit history and the number of years of experience in the field. Financial statements may also be examined to determine the overall financial health of the company.

Parties Involved

A surety bond involves three primary players: the financial guarantor or surety of a construction bond, guaranteeing the obligee that the contractor (called the principal) will act in accordance with the terms established by the bond.

  • The obligee is the owner of the project who hires the contractor and requests the bond. This person or other entity sets the terms and conditions of the bond, and will file a claim if the contractor fails to perform or violates the contract.
  • The principal is the contractor purchasing the bond. If the contractor fails to perform they will be liable based on the terms and conditions set forth in the contract and bond.
  • Surety companies will evaluate the financial merits of the principal builder and charge a premium according to their calculated likelihood that an adverse event will occur.

Both the surety and contractor are held liable if the contractor fails to abide by any of the contract's conditions.

Bid Bonds vs. Performance Bonds

A bid bond is replaced by a performance bond when a bid is accepted and the contractor proceeds to work on the project.

A performance bond protects a client from a contractor's failure to perform according to the contractual terms. If the work done by a contractor is poor or defective, a project owner can make a claim against the performance bond. The bond provides compensation for the cost of redoing or correcting the job.

Failure to Meet Obligations

If the contractor does not meet the obligations of the bid bond, the contractor and the surety are held jointly and severally liable for the bond. A client will usually opt for the lowest bidder since it will mean reduced costs for the company.

If a contractor wins the bid but decides not to execute the contract for one reason or another, the client will be forced to award the second-lowest bidder the contract and pay more. In this instance, the project owner can make a claim against the full or partial amount of the bid bond. A bid bond is thus an indemnity bond that protects a client if a winning bidder fails to execute the contract or provide the required performance bonds.

Bid Bond Liability

The amount claimed against a bid bond typically covers the difference between the lowest bid and the next lowest bid. This difference will be paid by the bonding company or surety, which may sue the contractor to recover the costs. Whether the surety can sue the contractor depends on the terms of the bid bond.

Frequently Asked Questions

What is a contract bid?

A contract bid is most commonly associated with a proposal and price submitted by a contractor or service provider to a soliciting firm for a business opportunity involving construction or renovation projects.

Can you get a bid bond with poor credit?

While having good credit is always helpful in matters like these, those with poor credit may still be able to obtain bid bonds from companies that agree to do so, but these will often be more costly to obtain.

Are bid bonds returned?

Once a project is successfully completed per the contract, the bid bond amount is returned.

What are the 3 major types of construction bond?

The three main types of construction bonds are bid, performance, and payment.

Compare Accounts
The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace.