Previously we discussed the fact that bonds are guarantees of something, and the first question we ask ourselves is, “a guarantee of what?” Requirements for Bid Bonds, Performance Bonds and Payment Bonds are usually found in construction specifications and they are all closely related to one another. In construction, an Owner wants to be assured that only the most qualified contractors submit bids for a proposed project. This is especially true in publicly funded construction, where taxpayer dollars are at risk due to a contractor’s potential failure. Publicly funded includes Federal, State, Municipal, local government, etc. In virtually all cases, the lowest responsible bidder is the one who is offered a contract. Requirements for bid, performance, and payment bonds are found in the construction project’s specifications.
Requirements for bid, performance and payment bonds can also be found in a General Contractor’s solicitations for subcontractor bids, so all subcontractors need to be aware of these, as well.
A bid bond is a guarantee that if an Owner accepts a contractor’s bid, the contractor will agree to execute the contract and, if required, provide performance and payments bonds, as well (more on
performance and payment bonds to follow).
Bid bonds can be viewed as a means of pre-qualifying a contractor for a particular project, as a bonding company will generally not issue a bid bond if the
underwriters do not feel the applicant-contractor is up to the tasks of the contract, both operationally, as well as financially. Requirements for bid bonds are found in the contract’s specifications and are issued in an amount that usually equals a percentage of the contract’s value, usually anywhere from 5% to 20% of the estimated contract.
If the applicant fails to enter into the contract that is offered, the bid bond penalty is intended as a financial guarantee to reimburse the Owner (or General Contractor) for the additional expense of re-letting the project or awarding to the second bidder, whose bid is obviously higher. In almost all cases, the difference in the first and second bidder’s price is what becomes payable under a bid bond claim, or the face amount of the bond, whichever is less. Bonding companies do not generally charge for bid bonds, though this is not always true.
Performance bonds guarantee provisions of a contract- in other words, that the contractor will perform each and every requirement of that contract. The Owner, who is paying for the work to be performed, and therefore is the primary beneficiary of the bond, wants an assurance that the correct contractor has been selected, and the performance bond does just that. If the contractor fails or is unable to properly complete the contract, the company that issues the performance bond is required to respond. Performance bonds are generally issued in an amount that equals the contract’s value (100%) but this is not always the case. In reviewing a potential customer application for a performance bond, the bonding company underwriters look at the history and experience of the company itself, as well as the background and experience of the company’s owners and key people. A company experienced in concrete construction would not necessarily be approved for a bond that covers mostly electrical work. Close attention is paid to previous project size experience as well as complexity. The bonding company wants to be sure that the likelihood of successful completion by the applicant is very high. Additionally, bond company underwriters look very closely at contract provisions to make sure they are achievable. Some of these include (but are not limited to) completion time, liquidated damages, insurance requirements and warranty provisions.
Payment bonds are guarantees that all labor and job-related bills are paid in accordance with the bonded contractor’s obligations to subcontractors and suppliers- in other words, that all job-related bills are paid. This bond differs from the performance bond in that the potential beneficiaries (or claimants) are those that supply the contract. Payment bonds are often issued in tandem with performance bonds and are also issued in an amount that equals the contract’s value (100%). Accordingly, the bond underwriters look very closely at an applicant’s credit history, both personal as well as business, as an indication of the ability to meet financial obligations. Since performance and payment bonds are often issued simultaneously, it’s important to keep in mind that each benefits a separate and distinct beneficiary. However, since the bonds are issued together, an application for a performance and payment bond involves a close review of experience and credit history together. Some applicants may receive high ratings for the experience but be declined in an application due to poor credit history. Fees for performance and payment bonds vary, based on the type of construction, the financial capability of the client, the number of bonds used and other factors. More on bond fees in a later issue.
Have any questions regarding bid, performance or payment bonds? Need a bid, performance or payment bond? Contact the experts at KOG International, Inc! www.kogbonds.com (610) 399-4080 PA
Office (302) 382-7489 DE Office (717) 732-9066 Central PA Office