Bid Security in Construction: How Project Owners & Contractors Benefit

For project owners, the construction bidding process is a complicated and risky endeavor. They want to select the best GC or construction management firm. But even if they identify the most qualified party — a company that meets or exceeds all of their evaluation criteria — they never have a guarantee that the contractor will actually accept the project. Bid security is often required to ensure that bidders submit serious and legitimate proposals, as well as to protect the project owner or client from potential financial loss in case a bidder withdraws their bid after being awarded the contract. 

As a fundamental piece of the contractor procurement process, bid security helps to maintain a robust construction market and foster a fair and competitive bidding process.

In this article, we will explore bid security, its significance in relation to various laws and regulations, the different types available and how both owners and contractors can leverage bid security to advance their overall objectives. 

What is bid security?

Bid security is a financial guarantee that the contractor or bidder will enter into a contract if selected by the project owner. Bid security serves as a financial assurance for the project owner, ensuring that the selected contractor or bidder will proceed with the contract if selected. It demonstrates the contractor’s commitment and sincerity in participating in the competitive bidding process for a construction project. 

Bid security is most often required on public projects or large or complex private projects. While it is frequently requested from general contractors in an invitation to bid (ITB), GCs also may require bid security from their subcontractors during contractor procurement. 

Even if the contractor submits a bid in good faith, many factors can change between bid and acceptance that preclude their participation. If the winning bidder doesn’t accept the job, the owner has a difficult and sometimes expensive choice to make: Choose another qualified bidder (and hope they haven’t filled their schedule) or put the project back out to bid.  

Bid security protects project owners and mitigates the risk of time loss during procurement, project delays and desertion by ensuring that only serious and genuinely interested bidders compete in the process. Typically, the amount of bid security required is usually a percentage of the bid amount, commonly ranging from 5% to 10%.

Essentially, bid security serves as a mechanism to give the project owner peace of mind that the contractor will enter into the contract if awarded to them. Suppose the bidder is selected but fails to enter into a contract. In that case, the bid security provides compensation for any additional costs incurred in re-bidding or selecting an alternative bidder, up to the amount of the bid security.  

If the bidder enters into the awarded contract, the bid security is generally returned or released back to the bidder after the contract is signed or upon meeting the specific conditions stated in the bidding documents. 

While similar, bid bonds differ from performance bonds or payment bonds (also known as final bonds). After the contract is signed, the contractor may be required to provide a performance bond, which acts as a guarantee that they will complete the project according to the terms and conditions outlined in the contract, including quality standards, timelines and specifications. 

Types of Bid Security

The type of bid security used varies depending on the project,  the contract requirements and the governing laws and regulations. Here are several types of bid security that are commonly used in construction by general and speciality contractors. 

Bid Bond

A bid bond, provided by a surety company, is the most common form of bid security used in construction in the U.S. A bid bond provides assurance to the project owner that if the contractor is chosen, they will accept the contract award. 

Should the contractor fail to proceed with the contract after being selected, the surety will compensate the owner for any financial loss incurred, up to the specified amount stated in the bond. Bid bonds provide both financial and legal protection or recourse for the project owners. 

When public agencies seek contractors or subcontractors for projects, it is common for them to mandate the acquisition of bid bonds.However, bid bonds are commonly utilized by contractors of all sizes, large and small, whether working on public or private projects. Bid bonds provide financial assurance to the owner without impeding a contractor’s liquidity.

Cash or Check

While cash can be used as bid security, it is less common in comparison to other forms. In cases where cash is utilized as bid security, bidders must provide a specific amount of money — essentially, a deposit — to demonstrate their commitment to the bidding process. 

If the bidder is awarded the contract but fails to enter into the contract or fulfill their obligations, the project owner may retain the cash deposit as compensation for their losses. 

For smaller private projects, contractors may opt to use cash for bid security, if allowed. However, in the case of larger and more complex projects, contractors typically require access to substantial capital. Therefore, tying up significant funds as bid security may not always be a viable option, as it hampers their ability to execute other projects in development.

If project owners accept cash as security, they face the responsibility of managing cash deposits diligently. This requires meticulous documentation and procedural measures to ensure transparency and security. Due to the potential risks and administrative complexities associated with cash deposits, project owners often prefer alternative forms of bid security that offer greater reliability, guarantee and protection for all parties involved.

Cashier’s Check or Certified Check

A cashier's check is a type of check issued by a bank or financial institution and guaranteed by their own funds. This is a reliable form of bid security and assures the owner that funds are readily available. 

A certified check is a type of check verified by the bank to be drawn on an account that contains the necessary funds to cover the check amount.Once certified, the bank sets aside the funds, ensuring that the check will not bounce due to insufficient reserves. 

While cashier’s checks are options for contractors of any scale, they are often used for smaller projects or among smaller contractors. This is primarily because the amount required for bid security may not warrant the complexities associated with obtaining a bid bond. Furthermore, these types of checks are frequently utilized in private projects, where there are typically fewer restrictions on the acceptable forms of bid security.

Irrevocable Letter of Credit

An irrevocable letter of credit (ILOC) is a guarantee issued by a bank on behalf of the bidder. It is a binding commitment that assures the project owner that if the bidder is awarded the contract but fails to fulfill their obligations, the bank will pay a specified amount to cover the losses. 

This offers a higher level of assurance and security to the project owner. ILOCs are most often used by established contractors with a strong banking relationship when bidding on larger-scale public and private projects. 

ILOCs are common in international construction outside of the U.S., where the guarantee offered by financial institutions adds an extra layer of assurance.

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The Miller Act & Bid Security on Federal Construction Projects

The development of bid security regulations stemmed from the objective of promoting fairness, transparency and accountability within the procurement process.

Enacted in 1935, the Miller Act standardized the bonding requirements on federal construction projects, increasing contractor accountability, promoting fair competition in bidding and safeguarding public interest.  

The Miller Act significantly impacted the implementation and requirement of bid security in the United States. The enactment of this regulation incorporated a framework of performance and payment bonds into the federal procurement process. For federal contracts on public work exceeding $150,000, general contractors are required to furnish performance bonds to guarantee the fulfillment of their contractual obligations to the project owners as well as payment bonds to serve as a safeguard for subcontractors and suppliers. 

How Contractors Obtain Bid Security

Contractors typically follow several steps to obtain a bid bond. While these steps may vary depending on the specific project and the requirements set by the project owner, here is a high-level overview of the process:

1. Review bid documentation.

First contractors thoroughly examine the bid documents, including the invitation to bid, specifications and contract terms, to gain a comprehensive understanding of the bid security requirements.

2. Negotiate with a surety company.

After gaining a detailed understanding of the bid security requirements, the contractor works with a surety broker, like Procore Risk Advisors, who in turn works with various surety companies. The contractor  partners with their broker to determine available options and to begin the surety submission process for obtaining the required bid security.

3. Submit an application for evaluation.

The contractor completes any necessary application or forms required by the surety company. They may also need to provide various documents such as financial statements, project references, resumes of key personnel and other information required to assess their financial capability and track record of the firm. The surety underwriter will evaluate the contractor’s bondability by assessing a variety of factors. 

Review of Financial Records

To demonstrate a stable net worth and liquidity, the contractor submits key financial documents such as corporate balance sheets, income statements, cash flow statements and tax returns. These documents provide a comprehensive overview of the contractor's financial position and help assess their capacity to meet the bid security requirements.

Past Performance Review

As part of the evaluation process, the surety company conducts a thorough review of the contractor's past performance on previous projects, including whether projects were completed successfully within the specified timeframe and budget. The surety company may also request references from the contractor to verify their work and gather feedback from past clients. This can serve as an important piece in determining the contractor's reliability and ability to fulfill contractual obligations.

Evaluation of Qualifications & Capabilities

The surety company carefully assesses the contractor's industry expertise, the skills and qualifications of their personnel and the effectiveness of their tools, systems and procedures. This helps gauge to determine the contractor's competence and ability to successfully execute the project in accordance with the required goals, standards and specifications.

4. Receive bid security.

The evaluation process above, known as underwriting, establishes the fee or premium the contractor will be charged if the contractor is successful in their bid and requires a performance and payment bond. Generally speaking, sureties do not charge for bid bonds. 

If the contractor meets the surety’s underwriting criteria, the surety company issues the bid bond. This document, signed by the contractor and the surety, guarantees that the contractor will enter into a contract if awarded the project. 

In the event of default, the surety company acts as a financial guarantor and will compensate the owner for any losses incurred, up to the amount of the bid bond. This provides the project owner with confidence in the bidding process.

5. Complete bid submission.

Upon obtaining the bid security, the contractor includes it along with their bid and submits all the required documentation to the project owner. This ensures that the bid is complete and includes the necessary assurance of bid security as per the owner's requirements. 

Once the bid is submitted, the surety company assumes the role of a neutral third party guarantor that reimburse the project owner for any financial losses up to the bond value if the contractor does not proceed with entering into the contract. 

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Bid Security as a Financial Risk Mitigation Tool

Bid security plays a vital role in the construction industry, providing financial protection and risk mitigation for project owners. By requiring bid security, project owners ensure the commitment of contractors, safeguard against non-performance or default and promote fair competition in bidding, ultimately contributing to the overall successful execution of construction projects. 

Bid security also helps contractors establish credibility, build trust with owners and demonstrate their commitment to the project. When utilized effectively, contractors can demonstrate their dependability and reliability, positioning themselves as trustworthy and capable partners for project owners to choose for their construction projects.. 

By upholding the principles of transparency, fairness and accountability, bid security contributes to the overall stability and health of the market and fosters a healthy and competitive bidding environment, ultimately benefiting the entire construction industry as a whole.

With advancements in technology and globalization, bid security practices have continued to adapt to new challenges and opportunities. Electronic bidding systems and online platforms have streamlined the submission and management of bid security documents, further enhancing efficiency and transparency. Bid security continues to serve as the ongoing effort to enhance the integrity of the procurement process and create an environment that encourages genuine and qualified bidders to participate. 

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