Bonding to Bid on Contracts: Everything You Need to Know
A bid bond is often used in the construction industry as a means of protection for the developer/owner in the construction bidding process.3 min read
Contractors need bonding to bid on contracts. A bid bond is often used in the construction industry as a means of protection for the developer/owner in the construction bidding process. The bid bond provides a guarantee that in the event the project contractor fails to honor the term of the bid, the developer/owner will be compensated.
Who Provides Bid Bonds?
Surety agencies, such as banks and insurance companies, provide bid bonds. This helps assure that a contractor is financially stable and able to manage and absorb risk to complete a particular job. Projects that involve performance bids and payment bids often include a bid bond as a requirement. Therefore, acquiring a bid bond ensures that if a contractor submits a bid and wins, a surety agency will write a performance bond.
The obligee, principal, and surety are the parties typically involved in a bid bond. The obligee represents the developer/owner of the project under bid. The principal is the intended contractor who will secure the bid bond to affirm that he/she is able to meet all the terms under which they bid. The agency that issues the bid bond to the principal is the surety.
What Is the Purpose of Bid Bonds?
The bid bond's chief function is to ensure that the winning contractor will hold to the original bid as set forth in the contract, preventing the contractor from increasing the cost of the project. In addition, the bond further guarantees to the developer that the contractor will secure payment and performance bonds as required throughout the project.
A breach in a contract by the contractor would allow the developer to the collect the remaining cost that it would take to complete the project. Typically, the bid would then be awarded to the next lowest bidder. The surety would be held accountable for paying compensation up to the bond's full face value, in the event the contractor could not cover the cost.
Multiple principals/contractors will estimate the cost to complete a project and submit the estimate to the obligee in the form of a bid. The obligee decides to whom to award the bid. The job typically goes to the lowest bidder. The bidder then becomes the winner of the contract and is responsible for completion. Bid bonds serve to prevent careless or improper low bids to win a contract from hasty contractors.
How Is the Cost of the Surety Determined?
The cost of the surety will vary from contractor to contractor and from job to job. The premium is based on multiple factors, such as:
- The obligee
- The contractor's financial history
- The actual project bid
- Location of the contractor's home office and the location of the project
Surety agencies will vary in bid bond premium cost and may offer a set flat fee for small projects. Generally, for large projects, the premium is based on a percentage of the total project cost and a penal fee.
What Fees Are Implemented?
For non-federal projects, a standard penal fee is between five and ten percent of the total project cost. For federally funded projects, the penal fee is a mandated 20 percent of total project cost. Typically, a bond premium will be between one and five percent of the penal sum. For instance, a contractor's bond may cost $500 to $2500, if the project cost is $500,000 and the penal sum is $50,000.
Most developers and owners require a surety bond from contractors that are submitting project bids. Depending on location, contractors are often required to obtain a surety bond before permits and licenses are issued. Contractors seeking work from the federal government are most likely required to be bonded as well.
What Are the Advantages of Having a Surety Bond?
In the construction industry, there are several benefits and advantages to having a surety bond. A surety will pre-qualify a contractor when submitting bids. It acts as a form of support and showcases the contractor's financial stability and construction expertise to complete a job. It will also provide a competitive advantage, as most companies prefer to conduct business with contractors who have taken the time to demonstrate the reliability of the services they provide. In addition to increasing a contractor's credibility, becoming bonded helps to protect a contractor's organization from unwarranted claims.
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