Bid Bond

What are Bid Bonds and How Do They Work?

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A bid bond is a type of surety bond most often used in the construction industry. This surety bond specifically protects the project owner or developer in a construction bidding process as it guarantees that the bidder will honor the terms of the bid or the project owner will be compensated accordingly. 

Keep reading for more insight into how bid bonds work and what they cost. 

How Do Bid Bonds Work?

Bid bonds exist to prevent contractors from submitting too low of bids in order to win a contract. Why are low bids a problem? It’s fairly common in the construction industry to allow multiple contracts to submit bids for the job that estimate what it will cost them to complete it. 

The contractor (aka the principal) is the one to submit the estimate to the project owner. If the principal submits too low of a bid in order to win the project, they may struggle to honor the terms of the bid and complete the project. If this happens, a bid bond can compensate the project owner for the cost difference between the initial contractor's bid and the next-lowest bid.

A bid bond is a type of surety bond. All surety bonds are made up of three different parties:

    • Principal. The party that must take out the bond—in this case this is the contractor. 

      • Obligee. The party that requires the bond—this is usually a state government or municipality. 

        • Surety. This is the company that issues the bid bond and ensures that the principal fulfills the terms of their contract. 

        To better understand how notary bond pricing works, it helps to know what the following terms mean.

          • Bonding capacity. This is the maximum amount someone can claim against the bid bond. If the maximum bonding capacity is $15,000 then the obligee can’t claim more than $15,000.

            • Bond premium. How much the principal will spend on the bond is known as the bond premium and is typically 1% to 15% of the bonded amount.

              • Bond term. This is the time period in which the surety bond is active. 

              Thanks to the Miller Act, when it comes to federal projects any bidders have to submit a bid bond. Plenty of private firms also require bid bonds as a way of protecting themselves. For a construction company to compete effectively in the market, they need to take out a bid bond. 

              Essentially, bid bonds help project owners gauge how likely a contractor they receive a bid from is to complete the project without running into cash flow problems along the way. By choosing to only work with contractors that have bid bonds, project owners can help avoid choosing the wrong contractor for the job during the bid process. 

              Bid Bonds vs. Performance Bonds

              It’s really easy to confuse bid bonds and performance bonds, but these are two separate bonds that serve different purposes. Once a bid is accepted on a project, the contractor will then need to replace their bid bond with a performance bond so they can move forward and work on the project. 

              Similar to a bid bond, a performance bond protects the project owner. In this case, a performance bond helps protect them from the contractor's failure to perform according to the contractual terms. That way, if the contractor fails to complete their work or their work quality is poor or defective, then the project owner will be able to make a claim against the performance bond and can be financially compensated which will help them cover the costs of redoing the job or making repairs.

              The Cost of Bid Bonds

              The cost of a bid bond can vary based on the following factors.

                • Cost of the project

                  • Location of the project

                    • The project owner

                      • Financial history of the contractor

                      When it comes to smaller projects, bid bond premiums are often a flat fee like $100 or $200 and larger projects are usually priced out based on a percentage of the total project cost and the penal sum of the bid bond. Usually for non-federal projects that percentage is between 5 and 10 percent of the total project cost. For federal projects, the penal sum for federally funded projects is mandated at 20 percent of the project cost and bond premiums usually range from 1 to 5 percent of the penal sum. 

                      The principal’s credit score will usually be taken into account when determining pricing. The lower someone’s credit score is, the higher their bond premium tends to be. Having too low of a credit score can make it challenging to secure a bid bond. 

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