Bid Bond

Article byPrakhar Gajendrakar
Edited byRaisa Ali
Reviewed byDheeraj Vaidya, CFA, FRM

What is a Bid Bond?

A bid bond refers to an agreement guaranteeing the owner that the bidder will enter into the contract if he wins the bid and ensures compensation if the bidder fails to accept the contract. It is a type of surety bond involving three parties: the principal, obligee, and surety.

The project owner is the obligee to whom the principal or contractor obliges to accept the contract and undertake the project. The surety company is the guarantor underwriting the bond. The bond binds the owner and the bidder in financial and legal recourse. It also reflects that the bidder is qualified to provide the price quoted for the project bid and is in its entirety to complete the project.

Key Takeaways

  • Bid bonds guarantee the project owner that the bidder will enter the contract and undertake the project according to the bid’s terms and conditions.
  • It’s a three-party agreement common in the construction industry involving the principal (contractor), the obligee (the project owner), and the surety (surety company or bank).
  • Performance bonds differ from it. It is another example of a surety bond assuring the completion of the work as per the contract.
Financial Modeling & Valuation Courses Bundle (25+ Hours Video Series)

–>> If you want to learn Financial Modeling & Valuation professionally , then do check this ​Financial Modeling & Valuation Course Bundle​ (25+ hours of video tutorials with step by step McDonald’s Financial Model). Unlock the art of financial modeling and valuation with a comprehensive course covering McDonald’s forecast methodologies, advanced valuation techniques, and financial statements.

Bid Bond Explained

A bid bond is a construction bond. Purchasing this benefits the contractor or construction business to win a project or permit and convey protection to the owner. In a construction bidding, process bidders submit the bids, the competent bidder quoting the lowest bid will win and gets the contract. If a dispute occurs between the contractor and the project owner, the surety or bid guarantee comes into the limelight. It is because it possesses the potential to resolve conflicts.

Bid Bond

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Bid Bond (wallstreetmojo.com)

This bid guarantees the signing of the contract to perform the work but does not promise the completion of the work or the payment like labors and material suppliers bills. Obligations like these are guaranteed by other surety bondsSurety BondsSurety Bond is a contract made between 3 parties where the guarantor (surety) guarantees to fulfill the particular task or provide the required sum to the creditor (obligee) in case the debtor (principal) can't meet the obligation or debt. This protects the creditor from the loss of non-performance or non-payment. read more like performance, payment, and ancillary bonds. Usually, the bid winner has to submit a different type of surety bond based on the federal, state, and local laws and the project owner’s requirements. For instance, as per the Miller Act, all bidders must submit a bid guarantee on any federal project.

The surety entity issues this bond to the principal and charges a fixed price or premium amount. The premium charges vary with project characteristics. Its coverage is known as the penal sum, and it indicates the maximum amount of damages that the guarantor will pay with the bondBondBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period.read more. It is represented as a percentage of the winning bid value, like 5%, 10%, or 20% of the bid value.

Example

Imagine construction company ABC bidding for a project of client XYZ. The bidding process mandates a bid bond because the client XYZ wants bidders to guarantee their capacity to fulfill the contract requirements and ability to furnish other surety bonds like performance & payment bonds in the upcoming levels.

ABC won the bid by quoting the lowest amount, $200,000 but unfortunately backed out from signing the contract. Therefore, XYZ can file a claim against ABC and its surety company. The ABC company will be liable to pay the difference between the winning bid amount and the next lowest bid amount of $220,000, and it is equal to 10% of the winning bid amount. Hence, the difference is $20,000. Furthermore, the ABC company has to pay the surety company fees.

In another scenario, if the ABC company decides to raise the price after signing the contract. Then, the XYZ company can cancel the contract and look for a new contractor. The aptest choice here shall be the next reasonable bidder and get compensated from the ABC company.

Bid Bond vs. Performance Bond

Risk factors are not uncommon in construction projects. Hence, different surety bonds form an integral part of most construction projects. Let’s briefly portray the differences between bid bonds and performance bondsPerformance BondsPerformance bonds are financial instruments used by the investor to have guaranteed the contractor's successful execution of a contract. Financial institutions, such as insurance companies and banks, are the issuers of these types of bonds.read more.

SectionsBid BondPerformance Bond
SubmissionIt is submitted first, and all competing contractors offer it.After the bid winner and the project owner enter the contract, it replaces the bid guarantee. Hence, only the winning contractor submits it.
RolePortrays a guarantee to the project owner. It helps the owner to choose the contractor. Presenting a well-functional bid helps the contractor to win the bid.It ensures successful project completion. It is only initiated after the contractor is chosen to monitor, control and complete the project.
AssureQuality, professionalism of the bidder, and signing of the contract.Project completion in compliance with terms and conditions agreed.
Penalty sum or financial protection in case of defaultUsually, the percentage of contract amount like 10% of bid value and in line with the difference between the winning bid amount and the next lowest bid amount.Usually, 100% of the contract amount.

Frequently Asked Questions (FAQs)

What is bid bond meaning?

It is an integral element in a construction bidding process where the competing bidders submit it to the project owner. The bond forms a guarantee between the owner (obligee), contractor (principal), and surety. It guarantees the project owner that the bidder will sign the contract to perform the work in accordance with the bid.

How do bid bonds work?

Suppose the contractor or construction company back out from accepting the project or violates the terms and conditions after winning the bid. In that case, they have to pay the compensation or penal sum in line with the percentage denoted in the bid guarantee or the difference between the winning bid amount and the next lowest bid. The owner then finds a new contractor, presumably the next reasonable bidder with low prices.

Who provides a bid bond?

It’s a three-party agreement involving the bidder, surety company, and the owner. First, a guarantor or surety company issues it to the bidders and charges a fixed sum or premium. Then bidder will submit it to the project owner.

This article has been a Guide to What is Bid Bond & its definition. We explain the meaning of a bid bond as a guarantee and how it differs from a performance bond. You can learn more from the following articles –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *