A bid bond is required of a contractor by a project owner as a guarantee that the bidder will enter into the contract if awarded the job. In addition, the bid bond stipulates that the contractor will procure performance and payment bonds in support of the contract to ensure its satisfactory completion.
On average, the bid bond penalty amount is 10% of the estimated project value. Some municipalities allow for a 5% bid bond. Federal construction projects require the bid bond to be issued at 20% of the contract value.
A bid bond or other bid security is required on most public work projects. The Miller Act of 1932 mandates bonding on all Federal construction projects. Most States have adopted “Little Miller Act” statutes on projects funded by City, County, State or other municipalities. In addition, a growing number of General Contractors and Construction Managers require bid bonds from subcontractors to ensure they are qualified to bid a particular job.
In the unfortunate event a contractor fails to enter into a contract and/or provide the required performance and payment bonds, the project owner is entitled to claim rights against the bid bond. The monetary value of the bid bond claim can be either the difference between the contractors bid price and the next lowest bid amount or the full penal sum of the bid bond (5-20% of the contractors bid amount).
A cash deposit, certified check, cashier’s check or money order may be substituted for posting a bid bond, in some cases. Nonetheless, it is not a recommended business practice.
Bid bonds are executed through a licensed surety insurance company. The bonding company acts as an independent third party. As with any dispute, not all bid bond claims mandate a bond payout. If a contractor were to file cash, a certified check, cashier’s check or money order, there is no third party intermediary to review and mitigate a wrongful claim. Moreover, posting cash encumbers a contractor’s valuable cash resources unnecessarily.
Frequently, project owners have their own bid bond form they require to be executed by the bonding company and contractor. A contractor’s bid may be rejected should the bid bond not be issued on a mandated form and/or there being a mistake made in the execution of a bid bond Such cases can also result in a bid bond claim and the project being awarded to the next lowest responsive bidder.
A contractor’s ability to provide a bid bond reflects their positive qualification through a bonding company’s underwriting process. Both project owners and general contractors are familiar with the general underwriting guidelines a bonding company utilizes for granting surety support. Bonding capabilities provide a contractor a broader avenue to pursue projects.
Performance bonds are required by law on most public works projects. These jobs are contracted through various federal, state, county and local municipalities. Nonetheless, there are a growing number of private entities requiring performance bonds including lenders, developers and commercial property owners. Performance bonds on private projects protect the company, their shareholders and investors from the costs that may be incurred due to contractor failure.
In some cases, performance bonds are required by contractors of their subcontractors. This condition may be mandated by the general contractor’s bonding company and/or the project owner. Requiring performance bonds from subcontractors, especially those with larger stakes in a project, is considered a wise business practice of the general contractor.
Generally, projects are sublet to bid and are awarded to the lowest, responsive, contractor. A bid bond is typically required during the bid process as security to the project owner that the contractor will enter into contract and procure the required performance and payment bonds in support of the job. Upon the award of a contract, a performance bond, in conjunction with a payment bond, is typically mandatory to be filed with the obligee in the face value or penal sum of the contract. In some rare cases, performance bonds are accepted at a percentage of the projects value.
There is no question that construction is a risky enterprise. Performance bonds transfer the cost of this risk from the project owner to the surety company. In the event of contractor failure on a project, the performance bond stipulates the surety’s responsibility in remedying the default. In other words, it becomes the surety’s responsibility to ensure the project is completed. The amount of liability under a performance bond is determined on a case by case basis and entails the review of the bond terminology, as well as the contract terms and conditions. Note, that the contractor and the surety are both liable under the bond, jointly and severally. The obligee will be entitled to monetary payout under the performance bond for damages sustained due to the contractors default. Except in limited circumstances, the maximum value under which and obligee can collect under the performance bond is the penal sum or penalty amount under which the bond was executed.
A payment bond is generally required to be executed by the surety in an amount equal to the contract price. Note that, on a rare occasion, the penal sum of a payment bond amount may be less than the contract value if stipulated in the agreement terms. However, the payment bond amount cannot be less than the penal sum of the performance bond.
Payment bonds are required by law on most public works projects. Subcontractors and suppliers are the primary beneficiary to a payment bond. On a typical basis, payment bonds provide protection to all first and second tier subcontractors, laborers and suppliers. Third-tier subcontractors, laborers and suppliers are not protected by nor do they claim rights under the payment bond.
The process by which a subcontractor, laborer or supplier would qualify to place a claim for monetary damages against the payment bond would require them to establish that they furnished labor or material that was utilized in the prosecution of work for that particular project. In most states, preliminary notices are required by the project owner from all subcontractors and suppliers. They serve as notice of labor, materials or equipment being furnished on the job.
Secondary to payment bonds, subcontractors, laborers and suppliers have two additional options to remedy a payment issue. The first would be the filing of a mechanic’s lien. In most cases, mechanic’s liens are not a remedy on public works projects, but are on many private works jobs. A mechanic’s lien is defined as a “security interest in the title to the property” and can serve as a remedy for non-payment.
The second potential payment remedy for a subcontractor, laborer or supplier would be to file a stop notice against the project. Stop notices require the project owner to withhold funds from the contractor until payment is made to the claimant and/or the payment dispute is resolved. With regard to public works, the general contractor has the option to file a release of stop notice bond. The release bond supersedes the stop notice bond. It allows for the release of any withheld funds under the stop notice. Should a payment bond be held on a project in which a release of stop notice bond is filed, it is generally required that the payment bond and release of stop notice bond be issued through unrelated surety companies. Stop notices on private works projects are not as largely useful unless there is a construction lender involved. A bonded stop notice served to a lender on a private works project is the only manner in which to guarantee the withholding of funds from the contractor.