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FAQ – Frequent Asked Questions About Bid Bonds
Bid bonds along with other types of surety bonds are an important part of contracting. If you are new to the game you might not be as fluent in the terminology as you need to be – let’s take a look at some of the basics.
1. What is a Bid Bond?
A bid bond shows proof of guarantee to the owner of a project that you can comply with the bid contract. This means, you will be able to accomplish the job as it is laid out in the contract. A bond assures the project owner that you have the capability to take on the project and carry it out through completion if you are selected for the project during the bidding process. Most of the time, project owners have no idea if a contractor is able to financially handle a project. The bid bond takes that guess work out and protects the project owner. A contractor who has a bond, will more than likely get the job because if the project fails they can collect compensation.
2. What will happen if the obligation is not met?
If the obligations of the bid bond are not met the contractor and surety (the provider of the bid bond) are liable jointly for the bond. Penalties will be applied for failure to comply with bond obligations. Also, when the project owner has to go and find a new contractor to finish the work, if there are additional costs the owner of the bid bond must pay as well. The standard for the additional cost is calculated by the difference in the bid that was held and the new bid.
3. How do Bid bonds work?
When a bid bond requirement is requested for a project, it keeps contractors from submitting frivolous low ball bids and helps project managers to feel secure in their choice of contractor. The company issuing the Bond does a full and comprehensive credit and financial review before they will provide a bond to a company. During the bidding process contractors submit what they think it will cost to get the job done. It is standard practice that the surety (the provider of the bid bond) will pay the project owner the difference between the lowest and next lowest bids.
4. Government Bid Requirements
Under the Miller Act, all bidders are required to submit bid bonds on a federal project. Many private firms decide to follow suit with this act to protect themselves during the bidding process. If you want your business to be a competitive contractor for government projects, you will likely need to have bid bonds and know the process since many states require Bid Bonds for all projects.
There are several ways you can meet the federal standards for bid bonds. Bonds issued by an individual surety pledge certain defined types of assets.
- Marketable assets
- Letters of credit from a federally insured financial institution
- Bonds issued by an approved corporate surety. (The Department of the Treasury maintains a list of corporate sureties approved to issue bonds for federal projects, Treasury Department Circular 570.)
5. What other types of bonds are there?
Performance bonds guarantee to the owner that the contractor will perform its contractual obligations in accordance with the plans and specifications. These bonds can take a variety of forms, ranging from the very simple to the long and complicated. Whatever language is used, the underlying assumption is that the owner will perform its obligations to the contractor and, therefore, the surety is obligated to fulfill the duties of the contractor, if that contractor is unable to do so. The cost of a performance bond usually is less than 1% of the contract price; however, if the contract is under $1 million, the premium may run between1% and 2%. Bonds may be more costly, depending upon the credit-worthiness of the contractor.
Labor and Material Payment Bonds
Labor and material payment bonds are companions to the performance bond. They assure the owner that he labor, material, and subcontractor costs on the job will be paid. This assurance is for the use and benefit of all laborers, material suppliers, and subcontractors who are eligible by contract or statute for the protection afforded by the payment bonds. They can also act as a way to protect the project from liens. Because a performance bond nearly always is accompanied by labor and material payment bonds, they typically are included in the performance bond fee.
Maintenance bonds are used when an owner wants a warranty period beyond one year. A warranty period can be extended for an annual fee, but sureties generally do not go beyond a total of two or three years. The annual fee for a maintenance bond is a fraction of the cost of a performance bond.
Supply bonds guarantee that ordered materials will be delivered. Such bonds generally are employed if an item is critical, time-sensitive, hard to find, or proprietary. Supply bonds may guarantee only a purchase order, so the terms and conditions of that order should always be carefully drafted. The cost of these bonds is usually minimal.
Frequently, general contractors will require from their subcontractors the same types of bonds required by the owner. Generals may do this, for example, when the sub trade is critical to the project, the sub’s price was much lower than its competitors, the sub is not well-known to the general, or the general’s surety requires the bonding of some or all subs as a precondition to bonding the general. The bottom line is that the surety industry can go along way to removing much of the risk to bidder selection, of the project not being completed, or that the contractor’s unpaid creditors will place a lien on the project. Moreover, by reducing those risks, the owner may also reduce the cost of borrowing money to finance the project.
These are the basics of bid bonds, but there more to know when setting them up. If you have any questions you can always contact your local insurer to find out more.