What are Performance Bonds and Bid Bonds?
If you are in the construction industry and are bidding larger projects, you likely have already run into a “bond” requirement. Bid Bonds and Performance Bonds are just two types of bonds that are commonly referred to as Surety Bonds or Construction Bonds. Surety bonds are used primarily in the construction industry. These bonds protect the owner from financial loss in the event that the contractor fails to fulfill the terms and conditions of their contract.
What are Performance Bonds?
A Performance Bond guarantees that the contractor will perform its obligations to the owner according to the terms and conditions of the contract. The basic function of a performance bond is to provide financial protection to the project owner in the event of default on the part of the contractor.
Performance bonds are required for many different types of construction and service contracts. The majority of bond requirements are found on government contracts but bonds are sometimes requested by private owners.
Performance Bonds provide security to the owner that should the contractor fail to perform their obligation under the contract; the bond company will assume the responsibilities of the contract as per the terms and conditions of the contract. In the event of a default, the bond company may:
- Complete the contract involving the original contractor by providing any required financial, management or technical support.
- Re-tender to a new contractor and pay for the cost of completion in excess of the contract price.
- Compensate the owner up to the total amount of the bond.
Given the inherent risk in construction, it is easy to see why project owners would want the kind of assurance provided by a performance bond. For the contractor, a performance bond is considered credit and it should be kept in mind that contrary to insurance, the surety company is not anticipating a loss and will look to the contractor for recovery of its claim under the indemnity agreement.
What are Bid Bonds?
A bid bond is the most commonly used risk management tool used by project owners at the tender stage. It is a legal instrument, enforceable by law. A Bid Bond, typically in the amount of 10% of the tender price, provides assurance to the project owner that the bidder is not only qualified, but will take their tender seriously and follow through on their bid.
If the contractor is awarded a job where a bid bond has been submitted and decides not to enter into the contract, the owner can make a claim against the full amount of the bid bond.
The claim amount typically covers the difference in price between the first and second bidder. In the event of a claim, the bond company will look to the contractor for recovery of its loss in a claim situation under the indemnity agreement.
Obtaining Performance Bonds and Bid Bonds
In order to get performance and bid bonds on specific contracts, a contractor must establish what is known as a Surety Bond Facility. A Surety Bond Facility allows a contractor to bid on jobs that require bid bonds and performance bonds throughout the year. This Bond Facility is established with job size limits under which the bond company will supply the bonds required by the owner.
All Surety Bond Company’s use the same 3 Criteria to determine whether a contractor qualifies for Bid and Performance Bonds. These include:
1. Character: Does the contractor have a good track record, good references and integrity?
2. Capacity: Does the contractor have the skill, experience and knowledge necessary to perform the contract? Have they successfully completed projects of similar size and scope?
3. Capital: Does the contractor have the net worth position and working capital necessary to complete the project and support the various other projects they are undertaking?
Basic Surety Bond underwriting requirements to assess these criteria are as follows:
- Good personal credit
- 3 years experience in this field
- The project requiring bonds is within the normal size and scope that the contractor has completed or supervised in the past.
- Corporate financial statements meet a minimum financial threshold.
Information required to submit for a bid bond and performance bond application is as follows:
- Complete and Sign the Contractor’s Questionnaire
- Bond Request along with the contract documents.
- Most recent business financial statements.
- Current Personal Financial Statement.
Bid and Performance Bonds for Emerging Contractors
Are you an emerging contractor looking for your first bond facility? Have you experienced issues qualifying for a traditional bond facility or have been deterred because of the complexity of the applications and paperwork required to submit an application? Were you unimpressed by your current insurance broker’s ability to help you navigate the process of applying for a bond?
If so, this is not uncommon. At FCA, we have developed a system called First Bond that simplifies the process for modest bond requirements. The financial requirements are much easier to achieve and the paperwork required to apply is simplified.