What is the Function of a Bid Bond?

Even though bid bonds are required by law for construction projects that are funded by tax dollars, it’s still important to understand why it is necessary and how it works. Anything you’re obligated to use should be understood as much as knowing why it’s important and how it can benefit your contractor business, and to that point- what is the function of a bid bond?

How Bid Bonds Work

Part of understanding the function of a bid bond is knowing how bid bonds work. To start, let’s look at the three parties involved with a bid bond:

  • The obligee: the owner of the job or general contractor who is requiring the bond.
  • The surety: the bond company providing the bid bond
  • The principal: the contractor or subcontractor who needs to provide the bond for their bid

The bid bond behaves as a pre-qualification tool, demonstrating to the owner of a project that the contractor has been vetted by the surety company.  By approving the bid bond, the surety is confirming their belief that the contractor has the means and capability to complete the project. The bond essentially acts as an assurance to the project owner, that the contractor has been prequalified by a surety company and has both the financial capabilities and resources to finish the job. In addition to being a prequalification tool, it is a type of surety bond that provides a guarantee to the project owner that the contractor with the low bid will enter into the contract and provide the required performance and/or payment bonds.  If they don’t, the owner can claim on the bond and will be financially compensated. 

Applying for a Bid Bond

To apply for a bid bond, the surety company will review specific documents and kinds of information to ensure you qualify for the bond. Some of this documentation and details include:

  • The contractor’s personal credit score
  • The bid date and scope of the project‘s work
  • The length of time the contractor’s construction company has been operating
  • Depending on the size of the bid for the project, financial information might be needed from the contractor’s business.
  • The contractor’s track record of profitable projects completed that are similar to the current project
  • The labor and equipment that is available to the contractor for finishing the construction project.

The process to get a bid bond is fairly similar to applying for a bank line of credit, because if a claim is made on the bond and the surety company pays out, the surety will go back to the contractor and expect to be reimbursed. The size of the bid bond needed is where contractors can run into trouble if their bonding capacity is not sufficient. If the contractor is unable to secure a bid bond of the right size, then they won’t be able to win the contract, as their bid will be deemed non-responsive

If you feel that your bonding capacity may be an issue when applying for a bid bond, we strongly recommend reading here:

3 Things Contractors Can Do to Increase Bond Capacity Immediately – CSBA

Where to Get a Bid Bond

Part of understanding how a bid bond works is knowing where to get one. A contractor has two choices, a surety agent or an insurance agent. While both are able to help a contractor secure a bid bond, there are several differences that should be understood:

  • An insurance agent lacks the professional expertise in surety bonds, which means they’d lack the connections or in-depth experience to help the contractor get the size of the bond they need or pair them with an appropriate surety company.
  • A surety agent, due to their professional exclusivity, is equipped to help a contractor get set up with the right surety, secure lower premium rates and guide them in steps towards growing their bonding capacity on top of helping them secure the bid bond

Where you get a bond from in general is an important decision to make. If you’re considering using an insurance agent to apply for a surety bond of any sort, we strongly encourage you to read here:

The Difference Between a Surety Specialist and an Insurance Agent

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How Much Do Bid Bonds Cost

Sureties do not charge a premium for the bid bond, but before you’re tempted to think it’s free, keep in mind that the bid bond is providing assurance to the owner that you will provide a performance and/or payment bond if you are awarded the contract. Therefore, it’s important to understand how much premium you will pay for the performance and payment bonds, to factor the cost into your bid.  Also, while there may not be a premium associated with the specific bid bond, some insurance agents and surety agents might charge an annual fee to issue bid bonds. This depends on several factors and depends on the insurance or surety agency you’re working with.

Why a Bid Bond is Required

The Miller Act was enacted in 1935 and requires all projects over $100,000 that are funded by tax dollars to be bonded. This means contractors bidding on public works projects must be able to provide performance and payment bonds, and to ensure the contractor is able to provide the required performance and payment bonds prior to the contract award process, the bid bond is required at the time of the bid. Before the Miller Act was passed, the cost burden fell upon the taxpayers if a contractor backed out of a project at the last minute or left the project unfinished. In addition, requiring a bid bond could also act as a way to dissuade contractors from bidding on projects they can’t handle, which is a perk that has led to many private companies requiring bid bonds as well. Due to the growing popularity of requiring bid bonds in the private sector and the legality of needing one for public projects, having the right agent to guide you through the bonding process is essential.

We at CSBA are committed to bringing our 225 years of combined experience to the benefit of California contractors, which is why we regularly publish these articles. We’re committed to helping contractors grow their bonding capacity, gain the surety bonds they need, and reach new levels of success by guiding them through the bonding process and the opportunities it presents.

Now that you know how a bid bond functions, it’s time to connect with a surety specialist to help you get it.

Shaunna Ostrom.
About The Author

Shaunna Ostrom

Senior Underwriter

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