Originally posted 2010-07-23 09:00:11.
For this week’s Guest Post Friday, Construction Law Musings welcomes Danielle Rodabaugh. Danielle is a principal for Surety Bonds.com, an agency that issues surety bonds to individuals and businesses across the nation. She writes articles to clarify bonding rules and regulations for those who have a stake in the surety bond industry–from contractors to telemarketers, and every professional in between.
In construction we often value performance and payment bonds when considering how to protect the financial investments put into a project. We do so because these bonds provide a legal financial guarantee that the selected contractor will fulfill the contract. However, a third, equally protective kind of construction bond is often overlooked.
Before an official contract has been agreed to and successfully executed, bid bonds guarantee that the selected low-bidder will officially enter into the contract at a later date. Bidders must submit a bid bond with their bid. Without doing so, the bidder becomes non-responsive–or an invalid candidate. Sometimes we overlook the benefits provided by this kind of Virginia surety bond, and yet they frequently act as the only legal protection for a project prior to groundbreaking.
The purpose of bid bonds
The primary purpose of a bid bond is to assure the client funding the project that the low bidder will enter into a contract for the price quoted in its bid. This has two major benefits:
- The low bidder is now unable to increase its bid on the project.
- If the contractor refuses to enter into the official contract with the client at a later time, the bond allows the client to recover the difference between the accepted bid and the next-lowest bid.
Bid bonds also mandate that the bidder will secure other required performance and payment bonds as necessary, reaffirming that the contractor will fulfill its duties to the developer.
Bid bond forfeiture
If the principal should decide to opt out of the contract, then the entity will be held accountable for paying reparation in the amount of:
- the difference between the amount of the faulty bidder’s bid and the next-lowest bid or, if a lesser sum:
- the face value of the bond
If a principal breaks the contract, the obligee usually collects damages in the amount of how much more they now have to pay to contract the next-lowest bidder for the project. In such collection cases it’s not unusual for courts to base their decisions on precendent rather than legal stipulations, as regulations in the bonding industry are constantly evolving.
Bid bond costs
If you’re a bidder, you need to check to see whether a bid bond is needed before you start preparing a bid so that you can estimate what the approximate penal sum will be. As with other construction bonds, all publicly-funded projects in Virginia that exceed $100,000 require a bid bond. A bond’s penal sum varies for many reasons, including:
- the project’s total projected cost
- contract terms
- the area in which the contract is executed
Depending on the jurisdiction, the principal usually needs to provide between 5 and 10 percent of the bid upfront to guarantee its accountability to the client. Federally-funded projects usually set a higher standard of 20 percent. For example, if a contractor bids $100,000 on a project, the entity will need to provide a $5,000 to $10,000 (or $20,000 for a federally-funded project) bid bond prior to beginning work. This cost is calculated to protect the owner in case the low-bidder opts out of the contract, and the surety will not pay more than this amount if the principal defaults on the bond’s payment.
For construction professionals working on a smaller scale, the U.S. Small Business Administration offers a surety program for small businesses. The SBA can also guarantee bonds for contracts up to $2 million for riskier principals. Small and emerging contractors who cannot obtain surety bonds through regular commercial channels can take advantage of the SBA to back their bid, performance, and payment bonds.
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