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Bid Bonds How They Work - The banner shows a contractor as a bidder.

Bid Bonds: How They Work

In order to have a better understanding of what bid bonds are, it is first important to have an understanding of what surety means.  In the bidding process (particularly in the construction industry) not only in government or federal projects but in big budgeted projects as well, the surety (normally an insurance company or a bank), sets up a guarantee that the obligations set forth in the contract for which a bid was placed, will be done.

Also known as a bid security or bid guaranty, a bid bond is the specific part of the process of bidding that assures the project owner that the winning bid will be honored.  When dealing with huge amounts of money, bid bonds facilitate in making the process proceed in a smooth manner. Without the bond, the owner will have no idea as to who the bidders are, and whether or not they are financially solvent.

How to Use a Bid Bond

Every bidder is required to put up a (usually) small percentage of the specified contract amount in order to qualify for bidding. The rate typically ranges between 1 and 3%. When there is no cap in place for a particular project being bid on, the base amount can be an amount agreed upon. The surety will hold the money for safekeeping until the winning bid is announced.  The bid losers will then be refunded for the bond that they put up.

On the other hand, the winning bidder will be required to put up a performance bond that will assure the owner that the job will be completed in a timely manner as specified in the contract. This is normally 10% of the total budget for the project.  The bid bond is usually not refunded and just rolled into the new bond if handled by the same surety company.

In case the winning bidder does not deliver on their obligations, the surety will pay the project owner the difference between the amount of the awarded bid and the net best bid amount, but this should not exceed the bid bond total.  This is known as liquidated damages.  The surety company will hold on to the winning bond, and will use it instead to help defray the cost of damages.

Legal Relationships

A bid bond is a legal document that binds the signer to a specific part of the bidding process.  Bid, payment, and performance bonds are all included in the bids and awards process, depending on the discretion of the project owner.  Ultimately, it is the owner that will be responsible to pay for all funds required for the project. But since he is not the one handling the procurement of the materials and the hiring of the required labor, the owner would naturally require assurance that the money to be paid to the contractors will be appropriately handled.

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