HOW DOES A BID BOND WORK?

COUNT ON STOKES SURETY BONDS

contractor holding his bid documents for tender date

Brief

It cannot be stressed enough the importance of surety bonds. Each bond is unique in its own way with various purposes. Most contractors obtain a surety bond to improve their odds of scoring more jobs. Many consumers would not even consider hiring a contractor who is not bonded. In fact, many Texas consumers view these contractors as “high-risk.” 

Regardless of how long you have been in business, without a bid bond, your odds of winning a bid contract are very low. With this in mind, you need to know how a bid bond works before tackling the application process. In the article below, you will find more information about bid bonds and how they work.

TOO LONG; DIDN’T READ (TL;DR)

Ideally, bid bonds are used to provide fraud protection to the obligee if the contractor submits frivolous bids (low bids) to enable them to win the project. As such, if the contractor can’t complete the project at the stated price, the obligee will be required to find the next lowest bidder. The bid bond helps compensate for the difference between the fraudulent contractor’s bid and the next lowest bid. 

FRAUD PROTECTION

As a project manager, you must have full fraud protection in place before running bids. One of the best ways to protect your investment is with a bid bond. This type of construction surety bond is utilized during bidding processes. Require all contractors to be bonded before bidding on your construction or development projects. This will help weed out the bad contractors while protecting yourself from becoming a victim of fraud.

Project owners can protect their investments by requiring all bids to include a bid bond, which is not much different from surety bonds. The purpose of bid bonds is to generally utilize this as a form of guarantee against fraud.

The construction industry is running rampant with fraudulent contractors. While your odds of coming into contact with one of these contractors are low, there is always a possibility of it happening. To ease your mind and protect your investment, you must require that every contractor obtain bid bonds before bidding.

FRADULENT CONTRACTORS DOING WHAT THEY DO BEST

It is not as easy as looking at a contractor to determine his/her legitimacy. There is much more to it than just a quick viewing. All contractors share some of the same qualities, but only a few have fraud on their mind when bidding on construction projects. These are the contractors you will need to avoid at all costs. How is these even remotely possible? Well, you can start with bid bonds. Demand that all contractors be covered under bid bonds before placing bids on your development projects.

Ruling out fraudulent contractors is as simple as dealing with only those who are bonded. These contractors have one goal in mind. This goal is to defraud as many project owners as possible by submitting frivolous bids.

WHAT IS A PENAL SUM?

Every project owner know the penal sum upfront as this is the full amount covered under a bid bond. When a contractor applies for a bid bond, he sets the price upfront. 

The penal sum must be high enough to cover any damage as the result of a breach of contract. To determine the value of your bid bond, you need to know exactly how much the project will cost when it is fully complete. You will need to divide this number by 5, 10, 15, or 20 percent to get the penal sum.

It is rare for a contractor to underbid on a construction project without being aware of the risks. The bid is the predicted total amount of the project. Project owners need to have this number in mind when choosing the winning bid. Remember, the lowest bid is not always the best bid because some contractors will do whatever is necessary to win a construction project. If this means an abnormally low bid, it means an abnormally low bid.

Keeping this value in mind will ensure you avoid any potential frivolous bids.

WHAT ROLE DOES THE SURETY PLAY IN A BID BOND?

Other than being the party responsible for the principal’s performance of a construction project, a surety can also become the mediator in some situations. Unforeseen circumstances cannot be prevented, but they can be resolved in a timely manner if all three parties work together.

Surety companies do not recommend claim initiation. Instead, they recommend a timely resolution. For example, a contractor loses an expensive excavator in an accident where the operator was not injured. A replacement will not be available for several weeks. The contractor updates the project owner who is unwilling to accept any delays. In response to the damaged excavator, the project owner reaches out to the surety. What will happen next?

The surety will immediately encourage both parties to work out their differences. The surety’s main goal here is to discourage the obligee from filing a claim against the principal’s bid bond. The underwriter will sit down with the two parties to encourage a resolution. 

If at all possible, the contractor should avoid any potential downtime. The surety will encourage the contractor to focus on tasks that do not require an excavator. Continuing forward will help eliminate downtime and possibly a breach of contract. If all parties work together, the project will move forward without the need for a deadline extension.

BREACH OF CONTRACT IN THE CONSTRUCTION INDUSTRY

Nothing is a simple as it may seem when it comes to a breach of contract. There are three parties involved right from the beginning. These include the principal or contractor, the obligee (the project owner), and the surety (underwriter), and they remain the same across all construction surety bonds.

No contract wants to be blamed for a breach of contract. And, no obligee wants to be left dealing with a breach of contract. Both parties need to be reasonable and willing to work with the surety to resolve the issues at hand. The surety acts as a mediator between the parties in an attempt to resolve issues responsible for preventing the completion of the project.

It is very unusual for an obligee to not be willing to work things out with the principal. But, again, anything is a possibility in the construction industry.

To learn more about contractual agreements for different types of construction bonds in detail, please take a look at performance bonds in a contract.

BID BONDS AND THE CONSTRUCTION INDUSTRY

As mentioned previously, bid bonds are utilized more in construction than in any other industry. Even government entities are turning to bid bonds to protect taxpayer money when bidding out construction projects. 

A bid bond was specifically developed to protect project owners during the bidding process. When it comes to dealing with construction service providers, there are a lot of risks involved. These risks range from poor workmanship to a breach of contract. When a bonded principal (the contractor) breaches a contract, it is up to the obligee (the project owner) to take action.

BID BOND CLAIMS PROCESS

Even though bid bonds are utilized during construction bidding processes, you rarely see them in action. Most contractors are in it for the long haul. They are well aware of the risks involved in taking on construction projects. Regardless of the type of project, being the main contractor is a lot of responsibility. 

Again, there are no guarantees when it comes to construction contracts. Unless the winning bidder is covered under a bid bond, the project owner’s investment is at risk. Of course, some contractors are always looking for vulnerable project owners. But, the majority of contractors are reliable and trustworthy. With this said, the contractor cannot promise the project owner that the job will be done right or before the deadline. 

An unexpected mishap can result in a tragic ending for both the principal and the obligee. When this happens, a claim will be filed against the principal’s bid bond.

The bid bond claim process is complex, resulting in an extensive investigation by the surety company. The investigation will help the underwriter determine which party is responsible for the breach of contract. While the principal may be the responsible party, it very well could be the obligee who breached the contract. There is no way to really determine which party is at fault without a thorough claim investigation.

Finally, the claims process is not limited solely to bid bonds, it can extend to other types of construction surety bonds as well. To learn about this in more detail, please take a look at a performance bond being called.

ENHANCED PROTECTION FOR OWNERS

There are a lot of risks involved in construction projects. Like the above scenario, unexpected mishaps can easily lead to a breach of contract. When you approach a construction project, you must be open-minded. Know and accept your risks to be prepared for the inevitable. 

Some project owners take things a step further than the bid bond. By combining the protection of a bid bond with the protection of a performance bond, project owners know their investments are fully protected. 

While it is the surety companies responsibility to ensure the contractor is financially stable, project owners are responsible for protecting their investments. Combining the protection offered by multiple bonds will not only give you peace of mind but ensure your entire investment is protected from frivolous bids.

GET APPROVED FOR A BID BOND BEFORE THE CUTOFF DATE!

Every bidding process has a cutoff date or deadline. All bids must be submitted on or before the cutoff date. To avoid the deadline, you will need to apply for a bid bond in advance. Stokes Surety Bonds utilizes a simple bid bond application combined with a complex pre-approval process to ensure project owners that bidding contractors are financially stable. If you have any questions, please feel free to contact one of our Texas bid bond experts. We can guide you through the application process to ensure the timeliest submission.

To learn about this in more detail, please take a look at how to obtain bid bonds and their  turnaround time for bid bonds.

NEED A CONSTRUCTION SURETY BOND FOR A JOB? COUNT ON STOKES SURETY BONDS