Bid bonds are a subset of the broader category of Contract bonds that must be filed with the project owner or government agency soliciting bids for public or private construction contracts. Bid bonds provide the project owner with security that the winning bidder will sign the contract and meet the requirements of the bid specifications.
Bid bonds must be issued by insurance carriers admitted in the state where the project is to be completed. The insurance carrier issuing any surety bond, such as a bid bond, will also be referred to as the “surety company” or the “bond company”.
Bid bonds protect the requiring project owner by transferring to a surety bond company the cost of ensuring the project owner is compensated for damages resulting from the winning bidder backing out of a project or failing to post a performance bond. The surety company provides the project owner a guarantee (the surety bond) that they will receive payment for financial damages to replace the bidder up to a limit specified in the bond (“penal sum” or “bond amount”). The bond amount required for most bid bonds is between 5-10% of the total bid amount. Ultimately, contractors are responsible for their actions and required by law to reimburse the surety company for any payments made under the bond. Bid bonds refer to the contractor as the Principal, the surety bond company as the Obligor and the project owner as the Obligee.
Bid bond violations triggering a bond payout include a contractor backing out of a contract or failure to furnish payment and performance bonds.
Bid bonds are typically issued without a premium cost. If the contractor is awarded the contract, a performance bond will often be needed with premium due at the time the performance bond is issued.
Credit checks are required for bid bonds. Credit analysis is an important component of bid bond underwriting and is reviewed in addition to business financial statements, personal financial statements, and work in progress schedules. Smaller bond amounts may be eligible for streamlined underwriting programs that allow contractors with excellent credit standing to qualify based on credit alone. Ultimately, the surety insurance company determines how it will underwrite and price a surety bond.
The bond form is a tri-party agreement which defines the rights and obligations of the project owner (obligee), surety company (obligor) and contractor (principal). While many bond forms use similar language, each bond form and bid specifications can be customized by the project owner requiring the specific bond and may contain provisions that increase potential costs for the surety company, which will ultimately be passed on to the contractor via higher bond premiums, stricter underwriting or collateral. The primary text to consider in a bid bond surrounds forfeiture clauses.
Surety bond claims are paid by surety companies to damaged parties to reimburse that party for the financial loss incurred up to the bond penalty amount. Certain bonds contain a clause which requires the surety company to pay the full bond penalty to the damaged party, regardless of the actual damages incurred (“Forfeiture Clause”). Bid bonds with forfeiture clauses tend to be more conservatively underwritten, if provided approval.