There are two types of bonds that an estimator must understand. First, there is a bid bond also called a bid security or bid guaranty. Second, there is a performance bond. Let’s take a look at the difference between these two bonds and how they should be addressed in an estimate.
Defining the bid bond
The surety company of the contractor issues a bid bond. Sometimes a bid bond is issued in the form of a check made payable to the project owner. It may also be issued as a bond by the surety company in the amount or percentage stated in the instructions to bidders of the project specifications.
If the contractor is the certified low bidder and fails to enter into a contract to perform the project, the owner has the right to hold the bid bond. For example, if a contractor submits a bid of $100,000 — and the bid bond is issued in the amount of 10% of the bid price — the owner would be entitled to $10,000 in compensation from the surety company due to the low bidder’s failure to sign a contract with the owner.
The reason owners use bid bonds is because it will usually guarantee them quality bids submitted by qualified contractors. This process will typically eliminate contractors with poor performance records and poor reputations.
Here is an excerpt from a specification of a public works project in New York.
Bid guaranty or bid security
- Where applicably indicated, each Proposal must be accompanied by a bid guaranty which shall not be less than ten percent (10%) of the total base bid amount. When specified in The Notice to Contractors, the guaranty may be a certified check, bank draft, or standard form Irrevocable Letter of Credit. If the specified form of bid guaranty is a Bid Bond, such Bond shall be secured by a guaranty or surety company authorized to do business in the State of New York as a surety. Proposals received without the specified guaranty may be deemed nonresponsive. Certified check or bank draft must be payable to the order of “Chautauqua County Director of Finance.” Cash deposits will not be accepted. The bid guaranty shall insure the execution of the Agreement and the furnishing of the surety bond or bonds and insurance by the successful Contractor, all as required by the Contract Documents.
- Bid guaranties in the form of certified check, bank draft or letter of credit will be returned to bidders other than the successful Contractor within ten (10) days after the contract is awarded. The bid guaranty of the successful Contractor will be returned upon execution of the Contract and submission of required bonds and insurance.
The estimator does not need to include any costs in the estimate for a bid guaranty. The costs for this service from the contractor’s bonding company are included in their annual costs.
The performance bond
Performance bonds are provided by the contractor before a project begins and offer a guarantee to the project owner that the contract obligations will be fulfilled. The contractor secures performance bonds through their insurance company or surety company. The costs for this bond must be included in the estimate.
Here is the typical wording from a selected project specification.
Performance bond: Bidder agrees, if awarded contract, to furnish and deliver to Owner, through Architect, at time as stipulated in “Instructions to Bidders,” satisfactory performance bond and labor & material payment bond in amount equal to one hundred percent (100%) of contract sum. Approval by Owner and/or Owner’s legal counsel shall be obtained as a condition prior to issuance of bonds. Cost of bonds shall be borne by undersigned. Furnish to Architect a copy of “release” request normally sent to Owner by surety upon acceptance of job by Owner.
The purpose of the performance bond is to assure the owner that the project will be completed at the contract price. This bond protects the owner’s project in the event the contractor files for bankruptcy. When this happens, the owner has the performance bond to guarantee that the project will be completed for the contracted amount. When bankruptcy occurs, the bonding company will locate a contractor that is willing to complete the project according to the contract. Typically, when this happens, the costs to complete the project increase substantially. However, these costs are borne by the bonding company, not the owner.
The performance bond costs are based on the contract amount, and these costs must be included in the proposal. These bond costs are typically based on progressive ranges of the contract value. For example, a contractor’s bonding rates might be something like this: The first $400,000 at 2%, from $400,000 to $1,000,000 at 1.50%, and $1,000,000 to $5,000,000 at 1.00%.
Key takeaways
Bid bond or bid security
- The bid bond is submitted with the bid proposal.
- No costs are added to the proposal.
- The costs for bid bonds are included in the contractor’s annual premiums with their security company.
- If the contractor is not the low bidder, the bid bond is void.
- It eliminates contractors with a poor performance record or those without the capital to complete the project.
- It gives the owner some assurance that he or she will receive quality bids from quality contractors.
- Bid bonds are a percentage of the contractor’s bid amount.
- If the contractor is the low bidder and does not enter into a contract with the owner, the contractor’s bonding company will pay the owner the value of the bid security.
Performance bond or material and labor bond
- The performance bond is provided to the owner upon signing a contract.
- Costs for this bond must be included in the contractor’s bid proposal.
- This bond guarantees the owner that their project will be completed at the contract price if the contractor files for bankruptcy and can’t complete the work.
- The bonding or surety company will hire another contractor to complete the project when the original contractor can’t meet their contractual obligations.
- Rates for this bond will depend on the contractor’s financial wellness and capital assets.
- Performance bonds provide 100% insurance for both labor and materials to complete the project according to the contract documents.
