What is a Bid Bond in Construction?

A bid bond is a guarantee from a surety company to the project owner that a contractor is able to fulfill the obligations of the contract and provide contract bonds before work begins. A bid bond is a type of bid security that provides assurance to the principal (typically the owner) that the contractor will accept the contract as bid.

How a bid bond works

There are three parties to a bid bond: the principal, the obligee, and the surety. The principal is the contractor purchasing the bond, while the obligee is the project owner or GC protected by the bond. The surety company is the company providing the bid bond.

When a GC needs a bid bond, they secure one from a surety broker for the required percentage of the bid. Generally, this percentage is between 5 and 10%. For example, for a $500,000 bid, the contractor will have to secure a bid bond for $50,000.

That $50,000 serves as a guarantee that the contractor will complete the project for the $500,000 bid value. Should the GC win the bid but not take the project, the owner can file a claim against the $50,000 bond. 

The Miller Act requires contractors on federal projects to post bonds. While payment and performance bonds are the headlining stars of The Miller Act, bid bonds are also a requirement. On Miller Act projects, bid bond amounts can be 5, 10, or  20% of the bid’s value. 

Claims against bid bonds

Usually, the obligee's claim will be in the amount of the difference between the original bid and the next bid the owner accepts. Let's say the winning contractor bid $500,000, but fails to take the job. If the bid from the next contractor was $525,000, the project owner can typically file a claim against the bond for $25,000. 

This dynamic in itself promotes competitive bidding. If a company submits a bid significantly lower than other bidders, the owner might think twice before awarding the project. With a value of 10%, the bid bond might not be enough to cover the difference between the awarded-but-failed contractor and the next competitive bid. This difference can have a significant effect on the project’s financing. 

Other reasons for bid bond claims

There are other scenarios in which an owner can place a claim against a bid bond. If the bid was inaccurate and the contractor needs to bill for more, the bond can serve as an overflow of sorts for the owner.

Paying back a claim

The absconding contractor isn’t off the hook, though — this bond isn’t a standard insurance policy where a claim may or may not increase their monthly premium. Instead, the contractor has to pay the claim amount back to the surety, and the surety establishes the terms.

How to get a bid bond

While the consequences and insurances that a bid bond represents are serious business, securing a bid bond isn’t quite as difficult (or expensive). 

As long as a GC isn’t attempting to take on a project they can’t handle and they keep their finances in order, a bid bond shouldn’t be too difficult to obtain. However, the bond limit available to a contractor will depend on a number of factors, from their financial history to similar projects completed.

Bid bond requirements

Bid bond requirements may differ from job to job. While most federal-funded projects require bid bonds valued at 20% of the bid amount, other projects may require less. Private projects that opt for bid bonds — and public projects at the state and municipality level — often require bid bonds valued at 5 to 10% of the bid.

In general, their subcontractors aren’t expected to post bid bonds.

The application process

Contractors can apply for bid bonds through a surety agency. Establishing a relationship with an agency can help move bid bond applications along.

For smaller projects (let’s use $350,000 as the threshold), many sureties won’t require much more than a bid bond request form. This form will have the information necessary to apply for the bond. It will also allow the surety to check into the GC’s personal finances — the basis used to determine smaller bond eligibility.

However, for larger projects, the contractor might need to supply a bit more information with their application. In this case, the more useful information the contractor can provide, the better.

Breaking down the job costs, supporting bids from subcontractors, and quotes from materials suppliers can help. Also, the company’s financial reports, prepared by a CPA, can go a long way toward securing a bond.

Surety review

Once the surety receives the application, they’ll review it to determine whether the risk is worth the reward.

The first area the surety will look at is the contractor’s ability to complete the project, as that poses the greatest risk for their bond money. The surety will look at current projects, past projects, and the company’s history.

They’ll also take a look at the contractor's financial statements. They may also want to review lines of credit and the contractor's backlog of projects.  

Writing the bid bond

The surety company will write the bond based on both the contractor's financial information and the details in the invitation to bid. Because they are guaranteeing performance based on the bid, they need to be confident that the company actually has the experience and money to follow through.

Why bid bonds are important in construction

Essentially, bid bonds help keep everything fair. They ensure that GCs aren’t submitting frivolous or unbalanced bids that they can’t live up to. Bid bonds protect the project owner from entering into a contract with a company that won’t take that project as-bid. 

They can help keep contractors from exaggerating their capacity or abilities, and stop contractors from changing their mind after entering their bids for a project.

In some ways, bid bonds can also help keep bids competitive — an especially important point when it comes to projects paid for with taxpayer money.

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