When there is a major construction project being planned, the work to be done will be bid out to various contractors. During the bidding process, interested parties will submit their offers to the developer or the project owner. The contract is normally awarded to the one who has the lowest price.
Along with the bid, contractors are also asked to submit a construction bid bond. This guarantees the developer that the contractor will not back out from the project if they get awarded the contract. It also means they will finish the work for the exact amount that they submitted. Bid bonds for construction have the backing of insurance and financial brokers, and contractors pay a small amount equivalent to a percentage of the full amount of the contract.
How They Work
Contractors estimate how much they need to complete the job. This is the price they will submit to the developer as their bid. This should include the material costs, the manpower and subcontractors as needed, and their profit. Should they back out because of a mistake with the bid or simply refuse to sign the contract, the broker that provided the bond may sue the contractor to recover their costs, but this will depend on what is stated in the bond’s terms and conditions.
The bid bond exists to minimize the risks for the developer. This will make sure contractors do not put in fake bids because they either fulfill their obligation to finish the job if they win, or they will have to pay the bond. Construction bid bonds are also a way to make sure bidders are financially capable to see the project through because the bid brokers do a review of their financial standing and credit scores before issuing these bonds. If they are not financially sound, they will not get the bond and will not be able to participate in the bidding process.
In the late 19th Century, construction bonds started to be adopted by the federal government because lots of contractors would go bankrupt before the project was finished. The Heard Act, passed by Congress in 1894, allowed the use of bid bonds on federal construction projects. Updated in 1935, the Miller Act requires all bidders to submit bonds to take part in a federal project. Private developers have also copied this step to reduce risks during the bidding process.
Bid bonds are a way to classify contractors based on their financial and credit standing, as well as their previous completed projects. This is because the companies that issue these bonds rate the contractor’s so-called “bonding capacity.” A contractor has to be careful about its bonding capacity when choosing projects to bid on and avoid bidding on too many jobs as they cannot provide the bonds for all of them.
Newer contractors might find it difficult to obtain a bid bond because they simply do not have any work experience yet. However, the Miller Act helps these companies gain when they cannot find a bond issuer to back them, instead, they are allowed to make a cash deposit of 20% of the bid instead of a bid bond. These cash deposits and bid bonds are given back after a contract gets signed.
Besides construction bid bonds, there are also other types of construction bonds that many might interchange. In the Miller Act, contractors who are bidding on or are awarded the job are required to submit bid bonds, performance bonds, and payment bonds. Private developers have also copied this practice and ask for these same three bonds from contractors bidding for their projects.
The first, the bid bond, will guarantee that the contractor will sign the work contract, but not necessarily that they will finish the project. The second, performance bonds, will assure the developers that the contractor will execute it to the end, using the materials, timelines, and methods agreed upon by the developers and contractors.
Lastly, payment bonds serve to protect both the developer and the subcontractors. In the case that the contractor hires other workers as subcontractors, payment bonds secure their rights to get paid, even if the contractor drops out of the job or files for bankruptcy. It also protects the owner from lawsuits in case the contractor fails. Whether for federal construction projects or for private ones, these bonds are important mechanisms to ensure construction works are finished with as little risk for all parties involved as possible.