#5 - The Importance of Bid Bonds
Hello everyone, welcome back! This time around I am going to be getting into the specifics of one of the main types of bonds – bid bonds. The term was mentioned before, but today we will dive into the purpose of a bid bond, how they are underwritten, as well as some questions we tend to see when they are requested. If you haven’t already, be sure to check out my first and second post that will provide a little background on bonding in general and the process for getting started.
The goal of these posts are to inform you, the readers, whether you are a general contractor, service contractor, subcontractor, bond/insurance agent (or anyone else who is interested in surety for that matter) and provide the base knowledge necessary to navigate through this sometimes tricky and overwhelming industry. I hope that these posts will cover most everything you would need to know, however I am sure that along the way this information will lead to questions I did not even consider. When that inevitably happens, I encourage you to reach out to me as I would be more than happy to clear up anything I may have missed. My contact information is below:
Direct: (410) 910-0204
For many contractors, a bid bond requirement is a first introduction to the world of surety. In fact, I suspect some of you may have just been notified that you will need to obtain a bid bond and have been lucky enough to have stumbled upon this website/blog as your first resource. This is because for most all public projects over a certain amount (usually in the ballpark of $100,000) a bid bond will be required from the contractor in order to, you guessed it, be able to bid the project. They may also be required for private projects, but it is not as common.
Why are bid bonds used?
Like all surety bonds, a bid bond is a form of guarantee, but it guarantees something different than its counterpart(s) – performance and payment bonds, also referred to as final bonds. Bid bonds guarantee that when a contractor bids a job, they will accept if they are awarded the contract and post the required performance and payment bonds. If for some reason they are unable to take the job or can’t provide the final bonds, the surety will be on the hook for the lesser of the difference between the next highest bidder or the penal sum of the bond. This is typically 5% or 10% of the amount bid or a predetermined flat dollar amount. On public projects, this is a form of protection for tax payers and it ensures that they don’t end up paying extra if a low bidder backs out at the last second – the project will not cost more than the lowest bid unless there are change orders involved later in the process.
Do I NEED to get one?
No, but you should. Bid bonds are one form of “bid security” that can be used in place of other forms of security, such as a certified check or irrevocable letter of credit from a bank. There are also “bondability” or “good guy” letters that are sometimes requested by an owner of a project in place of a bid bond. These don’t have a penalty associated with them and there is no underwriting done until the final bonds are needed. They merely mention that the contractor may be able to get bonded, but in reality it is not holding the contractor or a surety accountable if they decide to back out at the last minute.
Getting a bid bond is advantageous over these alternative forms for a few reasons:
They don’t tie up working capital like handing over a check for $50,000 on a $1,000,000 bid (5%) that might be held for up to 90 days until the project has been awarded. Bid bonds are a chance to get something from a surety company for free, take advantage of it!
Going through the process of getting the bid bond also helps to get the surety familiar with the job – making the final bond process streamlined and gets yet another set of eyes on the job. Surety underwriters see many, many contracts come across their desk and can help point out tough payment terms, excessive warranty requirements, and other hazardous language.
They give the owner an extra level of confidence that a third party has backed a bid after they have done their due diligence on the company and feel the contractor has the capability of completing the job. All else equal – a bid bond carries more weight than other bid security.
What’s the process for getting one?
Obtaining a bid bond is very similar to getting payment and performance bonds. The answer varies depending on the estimated bid amount and specifications of the job as we discussed in post #2, but it involves the contractor contacting their agent and giving them the job information such as estimated bid amount, scope of work, completion time, warranty periods, etc. The agent then passes this information along and discusses with the surety company why the job makes sense. Once it is approved, the agent issues the bond and gets it over in time to be submitted with the completed bid.
If there are changes or addendums to the jobs before the bid is submitted, it is always a good idea to keep the agent updated so they can make sure the surety is aware. Changes such as the bid being postponed are usually no issue. If the change is in the scope of work and/or the estimated bid looks like it is going to be higher (10% or more), then the agent and surety should both be made aware. TIP: there are no problems with a bid being submitted for less than what the bid bond was approved for, so it doesn’t hurt to be conservative with the initial estimate.
I have submitted my bid bond with my bid, now what?
Once the bid bond is submitted, there’s a couple different scenarios:
1. You were low bidder.Congratulations! Usually, the surety will want to know where your bid placed in comparison to the other bidders. If there is a “bid spread” (the difference between one bidder and the next; ex. 1st lowest bid – 2nd lowest bid / 1st lowest bid) of more than 10%, they will likely ask some additional questions to make sure the bid is adequate before issuing the final bonds, especially if the rest of the bidders are clustered together. This isn’t a deal breaker as there are legitimate reasons for having a bid spread, however sometimes it can be caused by simply missing items in the final number. A bad bid will lead to a bad job.
2. I wasn’t the low bidder.Too bad! If you were 2nd or 3rd, the owner may hold your bid bond for up to the amount of time specified on the bond form or in the job specifications, maybe 60 or 90 days (aren’t you glad you didn’t post a certified check!?). They do this in case the low bidder falls through and they need to go with the next in line. If you were 4th or higher, typically the owner will release your bid bond as it is unlikely that the first three bidders will fall through. TIP: let your agent know of bid results as soon as possible – this will allow them to keep an accurate log of how much bond exposure there currently is and what to expect as far as final bonds.
“I don’t know I need the bond until the last minute, how am I supposed to get it in time?”
We always recommend that a contractor gets pre-qualified or at least gives the agent a heads up of the size of projects they are looking to bid, that way we can make sure that the surety is comfortable providing bonding at those levels and the bid bonds can be turned around quickly.
“The bond is only for a small percentage of the bid amount, why is there so much information required?”
Even though the penalty amount makes the bond seem like it is less serious than a final bond, it is really one in the same since the surety will either have to pay out or provide the final bonds. If the contractor wasn’t actually prepared for the job, it could be a lose/lose situation for the surety – they either pay the difference now or could end up paying when the contractor defaults on the contract. Remember – surety is a “no-loss” industry, so they are only going to agree to a bid bond if they feel comfortable providing the final bonds for a project that the contractor can reasonably complete.
“We know we won’t get all these jobs, why can’t we just bid them all and worry about the final bonds later?”
Just like I mentioned above, sureties write bid bonds assuming that they will be required to write the final bonds if the contractor is awarded the job. If the contractor bid twice as many jobs as they could reasonably complete and ended up getting them all, the surety would be on the hook for that. Again, they’d be faced with the option of taking a loss upfront on the bid bond or writing the final bonds and risking that the contractor defaults, potentially becoming liable for the full contract amount.