What is a bid bond? | Bond investment

When municipalities hire businesses and craftspeople to carry out projects, they need some level of assurance that the work they pay for will be done accordingly. When submitting bids to enthusiastic contractors, organizations can ask for a bid bond to protect themselves.

A bid bond is a type of bond that guarantees payment pending certain stipulations. In the case of large-scale construction projects, the deposit is paid if the contractor does not honor his offer, does not deliver within the agreed parameters or simply does not start the project. These types of surety bonds are very common in commercial construction. In addition, they are mandated for state and federal development projects.

Bid bonds are standard practice for most construction projects, and they are widely applicable anytime there is a project involving qualified contractors. Here’s a closer look at how they’re used, the protections they offer, and the benefits of using them.

Breach of a bid bond

There are three parties involved in a bid bond: the obligee, the principal and the guarantor. All three work together to create an alliance of responsibility before the start of a project:

  • the bond is the owner who will ask for a deposit if the contractor does not deliver.
  • Pmain is the contractor responsible for purchasing the bond as a sign of confidence.
  • gguarantor is the surety company facilitating the issuance of the bond with a premium.

It is preferable to consider the guarantor as an intermediary. The principal works with the guarantor to establish the surety based on its reliability and credit rating. Once issued, the principal gives this surety to the creditor as proof of his credibility. If selected and the principal does not deliver, the creditor files a claim with the surety for the bond.

An example of how bid bonds work

To show the importance of a bid bond in practice, it is best to look at a common example: construction. Large municipal construction projects use bid bonds as a form of bond, and the practice looks like this:

Big Bob’s Builders is bidding $ 10 million for a commercial construction project, with a 10% ($ 1 million) bid bond. If Big Bob’s Builders does not start the project at the agreed amount of $ 10 million, the municipality can raise the claim for a $ 1 million bid bond to cover the cost of the overrun or the cost to have someone else complete the project.

The reason why bid bonds are so prevalent in construction is due to the extremely high costs and schedule of these projects. The owners pay the construction companies as they go, rather than at the end of the project. Bid bonds provide them with some protection against disruptions that may arise during the course of the project.

Requirements

Bid bonds come with a few general stipulations that have become industry standards. Specifically, here’s what to expect with most submission obligations:

  • The bond values ​​are 10% of the contracted amount; 20% for federal projects.
  • Guarantors perform extensive credit and background checks to determine the bond’s premium.
  • Once approved, managers submit bid bonds during the tendering phase of a project.

Ultimately, an offer accompanied by a bond represents a good faith offer on a project. It gives project owners some peace of mind because if you get the contract you will either go through with it or they will receive compensation.

Surety agreement and additional surety bonds

Once a contractor wins a bid, there is a bond agreement. This is a notarized document with the surety company that stipulates the issuance of both a performance bond and a labor / material bond. These bonds have relatively the same objective: to protect the client against failures or overruns.

  • Performance guarantees ensure all work is completed on time, on budget and to specifications.
  • Labor / material obligations ensure that all vendors and workers are paid for their contributions.

Performance bonds and labor / material bonds are secondary to bid bonds, representing the next level of security after the project manager accepts a bid during the call stage offers. The cost of a performance bond is generally very low. This is usually less than 1% of the contract. Labor / material obligations are even lower between 0.25% and 0.5% of the contract price.

How to qualify for bid bonds

Contractors (principals) coordinate with guarantors (surety companies) to qualify for bid bonds. Typically this means two stages of assessment: operations and finances:

  • During the evaluation operations, the bond company will assess the past projects you have completed, the structure of the business, the assets, and your general ability to perform the work you are trying to bid for. The more capable you are, the lower the premium on the bond.
  • Looking at finances, the bond company wants to see healthy cash flow, liquidity, and the ability to cover upfront costs for things like labor and materials. It also includes lines of credit and even personal finances.

Based on these factors, the guarantors will accept or deny the surety request. If accepted, they will assess the premium (cost) of the bond based on the strength of the business.

Non-compliance with obligations

If a contractor does not meet expectations, withdraws from the project, or breaks the agreement in a way that costs the project owner money, they have the right to file a claim against the surety for non-compliance. . In fact, it can mean one of two things. With the first option, the guarantor will pay the full value of the bond to the project owner as compensation. In option two, the guarantor will pay the difference in the deposit between the accepted bid and the next lowest bidder. Nevertheless, the client benefits from the protection he needs.


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