Bid Bonds

What a bid bond is

A bid bond is a three-party surety instrument furnished by a bidder on a construction or service contract, guaranteeing that if the bidder is awarded the contract, the bidder will (a) enter into the contract on the terms bid, and (b) furnish the required performance and payment bonds. If the bidder is awarded the contract and refuses to sign, or is unable to obtain the required final bonds, the surety pays the difference between the low bid and the next-lowest bid that the obligee is willing to accept, up to the penal sum of the bid bond.

The economic purpose is straightforward. Public procurement, and much sophisticated private procurement, depends on the willingness of bidders to stand behind their proposals. Absent a bid bond or equivalent bid security, a bidder could tie up a procurement with a low bid, then withdraw after opening upon discovering an error or a change in circumstances. The bid bond backs the seriousness of the proposal with a solvent surety.

Penal sums—5%, 10%, 20%

Bid bond penal sums are generally expressed as a percentage of the bid amount. Federal work uses a twenty percent penal sum by regulation. State and local work varies: five percent and ten percent are the most common, with some jurisdictions specifying a fixed dollar amount rather than a percentage. Occasionally an obligee will require a bid bond with a penal sum equal to 100% of the bid; this is unusual and typically indicates a poorly drafted request-for-proposal.

When a bid bond is forfeited

A bid bond is forfeited in one of two scenarios. First, if the bidder is awarded the contract and refuses to sign the contract as bid. Second, if the bidder is awarded the contract and cannot furnish the required final bonds. In either case, the obligee's damages are measured by the difference between the defaulting bidder's bid and the next bid the obligee ultimately accepts, up to the penal sum of the bid bond.

Forfeiture is not automatic. The obligee must actually award the next-lowest bid, or otherwise re-procure, in order to establish damages. Where the obligee simply cancels the procurement, no damages arise and the bid bond is not forfeited notwithstanding the bidder's withdrawal.

Federal bid bond requirements

Under the Federal Acquisition Regulations, federal construction contracts requiring performance and payment bonds under the Miller Act generally also require a bid bond at 20% of the bid amount, subject to a cap of three million dollars. The bid bond form is Standard Form 24. Alternatives to the bid bond—Treasury securities, certified checks, cashier's checks—are permitted at the bidder's option, but the surety bid bond is by far the most common form.

State and local bid bond requirements

State transportation, general services, and university procurement statutes almost universally require bid bonding on projects above defined thresholds. Percentages vary; the most common are 5% and 10% of the bid. Municipal work is governed by local ordinances, which likewise vary widely. On virtually all public work above modest thresholds, some form of bid security is required.

Do bid bonds cost anything?

Bid bonds carry no premium of their own on standard contract surety accounts. The premium ultimately charged at final bond issuance is treated as compensation for both the bid bond exposure and the final bonds. Where a bid bond is issued and the contract is not awarded to the bidder, no premium is charged.

The economics reflect a specific reality: on any given competitive procurement, only one bidder will be awarded the work. If the surety charged premium on every bid bond, contractors would bear cost on many bids that never materialized into contracts. The industry convention—no charge on bid bonds—concentrates the premium at the point of final bond execution.

The underwriting behind a bid bond

A bid bond is not underwritten as a discrete transaction. It is underwritten as an incident of the underlying account. When a surety agrees to support a contractor with an established bond program, the bid bonds up to the approved single-project limit are effectively pre-approved; the underwriter reviews the specific opportunity for anything unusual—foreign obligee, unusual work type, penal sum approaching the limit—but does not re-underwrite the account for each bid.

For contractors without an established program, a first bid bond requires the same underwriting that would be applied to a final bond—financial review, work-in-progress schedule, personal indemnity, references. Once the account is established, subsequent bid bonds within the approved limits flow within hours.

Bid bonds vs. cashier's checks and LOCs

Public procurement statutes generally list a menu of acceptable bid security forms: surety bid bond, cashier's check, certified check, Treasury securities, and (sometimes) irrevocable letter of credit. Each has distinct economics.

A cashier's check ties up the full penal amount of the bidder's cash from the moment of bid submission until the bid is either accepted or rejected. On any active bidder submitting multiple bids, the working-capital drag becomes substantial quickly.

An irrevocable letter of credit ties up the same amount against the bidder's bank credit line rather than cash. It is generally worse than cash from the bidder's perspective; the LOC counts dollar-for-dollar against borrowing capacity.

A surety bid bond ties up nothing—no cash, no bank credit line, no premium. It is the cheapest bid security available and, for any active bidder, is the only economically rational choice.

How to obtain a bid bond

For established accounts, request the bid bond with as much specification as the request-for-proposal provides: obligee name and address, project description, bid opening date and time, penal sum required, and the bid bond form required by the RFP if one is specified. Bid bonds are typically issued same-day for approved accounts.

For first-time submissions, expect a two-to-five-business-day underwriting cycle on ordinary submissions, longer on complex accounts or unusual work. Start early. For a related pre-award instrument that requires less specific project information, consider a statement of bondability.

See also: performance bonds, payment bonds, the Miller Act.