What is a Bid Bond in Construction: A Comprehensive Guide to Contractors

When it comes to bidding larger projects, a project's protection is a vital component to project owners. To ensure that the construction project is protected, there is a need to consider a contract bond. A bid bond is one of the crucial bonds that you, the contractor, and the owner should know.

So, whether you are a general contractor or a licensed insurance agent trying to obtain bid bonds, this guide is for you. Learn more about how a bid bond in construction works, why you need one, and how claims work.

What is a Bid Bond in Construction?

A bid bond in construction is a type of surety bond to the owner that the contractor will enter into the construction contract if awarded the job, fulfil the contract obligations and provide a performance bond before the job begins.

The main purpose of this type of contract bond is to hold contractors accountable for the proposals they submit during the bidding process. Bid bonds are commonly purchased when a contractor is submitting a bid on tendered contracts and are usually submitted with the project's contract.

Most public projects need contractors and subcontractors to secure bids by providing bid bonds. This serves as a legal agreement between the two entities. So, if you plan to bid on federal projects, you must be properly bonded. You will need performance and payment bonds as indicated in the Miller Act.

If you are not properly bonded with performance bonds, bid bonds, and payment bonds, your chances of not being considered in the bidding process for federal construction projects are high. To get a bid bond, you must qualify for the bid bond for a particular project.

In most cases, it's ideal to have good credit when seeking a construction bid bond. But can you get a construction bid bond with poor credit? Well, it's possible to get a bid bond despite having challenged credit, but it will cost you more as the lender may see awarding your bid as a greater risk.

How Do Bid Bonds Work in the Typical Construction Bid Scenario?

A bid bond ensures that the contractor (also called the principal) will enter into a construction contract with the obligee (who is the project owner) if they are the lowest bidder and are awarded the bid.

So, owners ask for bid bonds to avoid the cost of re-tender, which happens if the lowest bidder gets awarded the project and then backs out of the construction contract. Generally, the penalty on bid bonds is 10% of the bidder's tender price.

Simply put it this way, the obligee gets paid the difference between the contractor's bid price and the next lowest bid price. This happens when the awarded contractor fails to enter into a contract with the project owner.

The bid bond says that when the lowest bidder gets awarded the project and then backs out, it's the owner's right to claim the bid bond for the bid bond value. Or, the owner can claim the difference between the first and second lowest bidder.

In a case where you have submitted an inaccurate bid, maybe because of the cost underestimates, and you win the project, then back out, or you cannot post a performance bond, the owner can file a claim against your bid bond, which you must pay. You are even more likely to lose the contract.

Ideally, bid bonds ensure the owner is not left hanging if you decide to back out or abandon the project. That is why bid proposals that have no valid bond get rejected. If your bid gets awarded, in most cases, you will provide a performance bond to begin the project.

What is Bid Bond an Example of?

Bid bonds are an example of surety bonds that general contractors purchase while bidding on a project or enter into a contract to perform the job for the owner.

Why Do You Need a Bid Bond?

As a contractor, you need a bid bond as it is a form of surety bond that will protect you from change orders in the scope of work. It ensures you meet the obligation of the construction project, which has already been paid in advance.

Project owners use bid bonds as a form of security from the surety company that they can fulfill the obligations listed in the contract and also provide contract bonds before they kickstart the project. Bid bonds are typically needed during the bidding process of a construction project before the winning bidder is awarded.

So, why are bid bonds important?

Bid bonds are beneficial to both the owners and contractors. Let's look at how they both benefit;

Bid Bonds and Owners

As mentioned earlier, owners get a bid bond as a guarantee that the principal (contractor) will finish the project within the stipulated time and budget. At times, the owners may make changes to their scope of work. If so, they need the contractor's approval first and that is how the bid bond comes in.

The project contract normally includes rules and regulations in case of change orders. This makes it easier for both parties to reach an agreement. Though bid bonds don't offer much security like performance bonds, they offer better protection for contractors as they are affordable.

Bid Bonds and Contractors

Contractors have to post their bid bond before beginning the bidding process. As said earlier, a bid bond is a type of surety bond that protects contractors from change orders. Bid bonds guarantee that the contractor will complete the project per the contract.

According to the Miller Act, it is a requirement that the contractor purchases a performance bond as a measure of security for the federal government. Though the performance and payment bond headlines the Miller Act projects, bid bonds are also needed to ensure the work contracted will be done as promised. That's why they are calculated as a percentage of the bid value which is common between 5-10%.

What is a 5% Bid Bond?

The 5% bid bond is the bid bond amount as a percentage of the contractor's bid amount. However, this percentage can vary between projects but it's commonly around 5-10% of the total cost.

Example

A $100,000 construction contract will need a $5,000 bond if it's a 5% bid bond requirement.

That means you will need a $10,000 bond if it's a 10% bid bond requirement.

Now, bid bonds are usually much smaller than the total costs in the contract. It's smaller because, when there are claims against bid bonds, the obligee (the owner) will incur damages that don't amount to the total contract price but, the difference between the lowest bid and second lowest bid proposal. Therefore, a 5-10% bid bond is enough to cover this spread if claims happen.

What is the Risk of a Bid Bond?

The risk of a bid bond is the failure to meet the obligations. If the winning contractor fails to execute the contract for reasons known to them, the project owner will award the second lowest bidder and pay more. In this case, the project owner can make claims against the partial or full bid bond cost.

Claims Against Bid Bonds

In most cases, claims against bid bonds are rare, but it does happen. There are two reasons for claims against bid bonds.

The surety company refuses to write performance and payment bonds

The contractor refuses to execute the construction project

A surety company can refuse to write the performance and payment bonds because of material changes, bidding over the approved amount, or a large bid spread of over 10%. The contractor's unwillingness to execute the project is mostly because of the unilateral mistake they made in their bid.

When a bid bond claim arises because of a unilateral mistake, the contractor can reform or rescind their bid. Generally, when claims against bid bonds occur, it's the responsibility of the surety companies to investigate these claims. If the surety company pays for the claims, the contractors are asked to compensate for all the costs incurred.

However, in many cases, once the surety company receives claims against bid bonds, they secure their position by filing liens against the contractor's property. They may ask the contractor to post collaterals to protect them when the loss is paid.

Who Requires Bid Bonds?

Bid bonds are required by law, especially for federally funded projects, since it's the taxpayer money, local, state, or federal money that is used to fund such projects. Private jobs also need bid bonds to protect their construction project. However, both the owner and the contractor benefit from it.

Contractors require bid bonds because it's a legal agreement that they will fulfil the construction project as stated in the contract. The main purpose of bid bonds is to ensure contractors comply with the bid contracts.

This is why most public projects need contractors to secure bids by providing their bid bond requirements as legal protection. Without bid bonds, the project owners are not guaranteed that the bid winner will complete the project as agreed.

The bigger question remains, why do most project owners require bid bonds? It's because of the risks involved. There are so many uncertainties in the construction industry.

You might have heard of municipalities filing bankruptcy or contractors closing their doors. These have made project owners afraid. They fear the same thing may happen to them, and that's why they need legal protection.

When Should You Ask for a Bid Bond?

You should ask for a bid bond typically when bidding for a particular construction project especially larger projects, before being awarded the job.

But can you withdraw a bid bond? You cannot withdraw a bid bond after the proposal is submitted and opened for bidding. However, if the job is yet to be awarded, you may edit the proposal without penalty but at the developer's discretion.