corporate surety

Secrets of Bonding #21: Church Projects

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Think about it – what could be better than writing a bond to build a church?  What could possibly go wrong?

The sad truth is that these projects can be high risk for the contractor and surety.

Here’s why:

Unique Risk #1

Church construction contracts include obligations for both parties.  The builder must perform the construction correctly, on time, and for the agreed price.  The church (the “owner”) must pay for the work as it progresses.  When compared to public work such as for the city or state, church work (and other non-profits) can be more hazardous if the owner does not have all the funding in place.

Suppose they are depending on a successful fund drive?  If the contractor performs work, incurs costs, and is then not properly paid it could be detrimental to both the contractor and surety.

Unique Risk #2

An additional threat arises from the design and administration of the contract.  If there is no architect, or if the architect is terminated or withdraws during the project, the contractor may be answering to the church building committee.  This is likely to be a loosely organized group of non-professionals with no construction design experience, each with their own ideas on how to proceed – bad for the contractor!

Summary

To assure a reasonable level of professionalism and predictability on church work, it is important to confirm full funding in advance (prudent on ALL private contracts).  This could be in the form of an approved building loan or funds on deposit in an escrow account.

It is also necessary to have an architect engaged throughout the process.  Note: Design / Build contracts present more risk, not less. (Projects where the contractor is responsible for both design and construction.)

Church projects can be a heavenly experience if the proper safeguards are followed.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

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Secrets of Bonding #20: Subordination Agreements

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“Instant Net Worth!”

Here is another gem for your tool box.  A Subordination Agreement can solve a Net Worth deficiency problem easily – in some cases.

Why is Net Worth (NW) Important?

Net Worth is the value of the company if all its bills are paid and it is liquidated.  It is a measure of strength and staying power, and therefore is relevant to surety bond underwriters.

In a corporation, NW (aka Stockholders Equity) is typically comprised of the money initially put in to start the company (Capital Stock) plus all the net profits earned over its lifetime and retained in the company.

Sometimes the NW is insufficient to support the current bonding needs.  This problem cannot be fixed by instantly earning more net profits.  It could be addressed by adding additional capital stock, but this is heavily taxed (capital gains) upon withdrawal – so this may not be a good solution, especially if the need is viewed as temporary.  So in comes our Subordination Agreement.

Here’s how it works:

Let’s assume that an owner who originally put money into the company by purchasing capital stock has now loaned funds to the corporation.  Both are debts of the company. Here is the important difference: Capital Stock is considered Equity, and a permanent debt (because of the tax penalty assessed upon withdrawal) whereas a loan is called a Liability and is temporary since it may have periodic payback terms and there is no capital gains tax assessed.

When making bonding decisions, does an underwriter consider loaned money as valuable as capital stock?  Is money the company has temporarily as valuable as funds it holds permanently? No, of course not. The purpose of the Subordination Agreement is to make the loaned funds just as valuable, by allowing them to be viewed as permanent.  From an analysis viewpoint, this moves the loaned money from debt to equity.

The Subordination Agreement is executed by the creditor (lender of the money) for the benefit of the Surety.  It states that the creditor will not demand payment without the written consent of the surety in advance. It locks the money in.  Having this degree of control can allow a surety to treat the subordinated loan as Instant Net Worth!

Two words of caution:

  • Not all sureties are willing to rely on this strategy or may not do so for a major portion of the total NW.  We will!
  • Also, it is important to inform the CPA regarding the subordination so it can be memorialized in the financial statement notes.  The subordination only works if the creditor remembers to observe it.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

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Secrets of Bonding #17: Dual Obligees & Additional Insureds

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Contractors are often required to name an architect, building owner or lender as an additional insured on their insurance.  The insurer will do so, and assume the additional risk for a minimal or no charge.  While there are some potential consequences for the contractor, most favor this extension of coverage without hesitation.  Why shouldn’t they? After all, the point of the insurance is to transfer risk away from the insured.

With a Performance Bond, there is a similar situation with the Dual Obligee rider.  This rider modifies the bond to include a party that was not named on the contract.  An example of such a party is a lender to a borrower who owns property. The borrower has hired a contractor to work on the property.  The Performance Bond that guarantees the contract has the property owner as the natural Obligee (the “owner” on the contract).  The lender has an interest in the project and may therefore ask to be named as a Dual Obligee.  Sureties will normally do this (and for no additional charge), but it is not without consequences for the contractor.

The Dual Obligee rider enables the lender to make a performance bond claim directly against the Surety – and thus creates additional risk for a potential loss on the bond. So why should the contractor care?  (See Secret #1)  Bonds are not insurance.

A surety relationship is more like banking than insurance.  Like a lender not expecting a loan to result in a loss, a surety does not expect any bond claims or losses.  Similar to a bank’s promissory note, a surety requires a General Indemnity Agreement (GIA) which is a hold harmless intended to prevent any financial loss to the surety if a claim occurs.  Read this as “no risk transfer.”

So let’s go back to the Dual Obligee rider.  All contractors are required to provide a GIA for their surety.  So if the bond is extended to include the lender, and the risk for a bond claim or loss in increased, who assumes this risk?  The answer, of course, is the surety plus the contractor.  The nature of a Performance Bond is that the contractor, the “Principal,” always shares in the bond risk – both in their company and personally.

Summary: Adding additional insureds may seem like a freebie, but contractors should be cautious when adding Dual Obligees to a bond.  Each obligee is another master they must please on their contract.  Each one is a risk and a financial threat.  Some entities must be added when requested such as a lender, the city or other entitled parties.  Other times there is a feeding frenzy: “Let’s add everybody.” 

If the surety fails to object or at least ask for justification as to why such parties must be added, the contractor should… because unlike insurance, on a bond the contractor assumes risk.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

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Secrets of Bonding #16: Bid Spreads

Steve Golia1 Comment

They can be full of fat or skinny. Sometimes they’re yummy, but they never go on crackers.

Spread

A Bid Spread is important to contractors and their surety.  Let’s find out why.

What is bid spread? 

When a contractor is pursuing a new project, they may be required to submit a written proposal which the project owner then compares to offers made by other firms.  It is a competition based on capabilities, credentials and price.  In the case of public projects such as federal, state or municipal, the bid results are normally published – meaning everyone gets to see the full list of bidders and their amounts.  These dollar figures are the prices the contractors will charge to perform the work.

The bid spread is the difference in dollars and percentage between two of the bidders.  The “apparent low bidder” is the company with the least expensive price on bid day.  The bid spread for the low bid is based on the difference between bids # 1 and 2.  It is an evaluation of the potential inadequacy of the low bid amount.  

How to calculate the bid spread

Suppose the low bid is $100,000 and the second bid is $150,000. In this case it may be obvious that the low bid is 33.3% below the second.  But what is the calculation method?  You subtract the difference between the bids and divide the number into the second bid:

150,000 – 100,000 = 50,000

50,000 / 150,000 = 33.3%

Therefore the bid spread is 33.3%.  (The difference in bids equals 33.3% of the second bid amount.)

Another way of calculating is to divide the 1st bid into the second, such as 100,000 / 150,000 = .66 or 66%. This indicates that the first bid is 66% of the second, and therefore the second is 33% larger.

What does the bid spread tell us?

The purpose of determining the bid spread is to evaluate the potential inadequacy of the low bid.  For example, if the 2nd, 3rd and 4th bids are all clustered together with the 1st bid far below, one may conclude that the low bid is inadequate.  Maybe they left out an element, misread the plans or miscalculated.  All the bidders wanted the work, so how could one be significantly less?

For the low bidder, a large bid spread demands an immediate review.  If an error or omission is found, usually the bid can be withdrawn with no penalty if acted upon promptly.

For the surety, there is a reluctance to bond an inadequately priced project.  The absence of profit could cause the contractor to abandon the work or they could be forced into default by the financial pressure – with the surety left to complete the project.  They may be tempted to cut corners resulting in a performance claim.  Slow payments to subs and suppliers could result in payment claims.

The only thing worse than a bond claim is a defaulted project requiring completion by the surety where the remaining funds are insufficient to complete the work.

How low is too low?

The rule of thumb is 10%.  If the low bid is $100,000 and the second is more than $111,000, the spread is over 10% and warrants evaluation before a performance bond is issued. ($11,000 / 110,000 = 10%)

The surety will ask if the bid estimate has been double checked.  What was included for profit and overhead? Are subcontractors dependable at their prices – and bonded? Did the low bidder have some advantage over the other contractors that enables them to perform the work profitably for a lower price?

Alternative calculation method

When faced with a spread of more than 10%, analysts will also calculate the bid spread to the average of the second and third.  In this case they hope to find a spread not in excess of 15%.

Try the analysis on these numbers: 1st: $100,000, 2nd: $112,000, 3rd: $114,000.

(Answer: 11.5%)

Other facts about bid spreads

In most cases, the surety that provides a bid bond is not obligated to provide the Performance and Payment bond.  An exception to this would be situations in which a Consent of Surety was required with the bid bond.  Such consent does promise to issue the P&P bond.

With no consent in play, a large bid spread could cause the surety to refuse the P&P bond, even though it could result in a bid bond claim – if the contractor cannot quickly locate a replacement surety or withdraw the bid.  (Refer to Secrets #8: Bid Bonds).  A bid bond claim is a much smaller problem to deal with than a defaulted contract.

A new surety that is offered the P&P bond will naturally ask for details if they know a bid phase was involved.  They know the incumbent surety must have had good reason to forego the P&P premium and face a possible bid bond claim. Producers can expect this to be a difficult placement.

Bid spreads are revealing! A tight bid spread validates the low bidder’s amount.  Large spreads require further scrutiny.

In cases where bid results and bid spreads are not known, such as on private contracts (or in cases where the contract amount is negotiated) it makes approval of the P&P bond a bit harder for the surety.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

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Secrets of Bonding #15: How to Submit a Contractor’s Bond Account

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In this post we will talk about the key elements when sending a contractors account to the surety for evaluation.

Think of the underwriters mind as a blank canvas.  (Some more blank than others!)  Presenting a bond account is an opportunity to paint the picture.  The underwriter knows no more than you tell them. It is up to the sender to describe the key points and explain why the account deserves support.

Let’s go over the primary elements:

Introductory Letter: This letter should state how well the applicant is known.  Can the sender vouch for the applicant’s honesty, good character and capabilities?  The letter (which is typically just an email) should describe what’s needed – if it is a bonding program and / or a specific bond.  There should also be comments about any significant underwriting points such as “The account has been declined elsewhere because…” or “The incumbent surety cannot provide the bond in question because…”

The author may also talk about any known underwriting issues and how they may be effectively addressed.

Contractors Questionnaire: All sureties have some version of this form which asks all the basic questions such as “Who owns the company?” “What kind of work do you do?” “What are the largest projects completed in the past?”

This document should be filled out completely, signed by the applicant and dated. If there is uncertainty on how to answer, don’t leave a blank.  It gives the reader an uncertain feeling – which is not the picture you want to paint.

Financial Statements: These are needed for the company and its owners and should be provided in a complete form. Underwriters normally want to see 3 fiscal year-end company financials plus a current interim FS if the recent year-end is more than 6 months ago. If CPA prepared financials are not available, provide whatever info is.  It may be financials prepared by a bookkeeping service or just produced from QuickBooks.  Some companies only have tax returns if they have never pursued bonding in the past.

The personal financial statements are less formal.  Most underwriters will accept self-prepared financial states if well-presented, signed and dated by the owners and spouses.  Note: Typically, spouses are included in everything when it comes to bonds.  Their names appear on the Questionnaire and personal financial statements, and they sign the General Indemnity Agreement (hold harmless for the surety) even if they are not active in the business.  Underwriters take this approach because the company is jointly owned marital property.

Work In Process Schedule: Referred to as a “WIP Schedule,” this describes the financial condition of their uncompleted contracts.  It indicates how much work the company has on hand and if it will be profitable.  Other important info is gleaned from this document so treat it with care!  CPAs normally do a good job presenting such data. But if it is being prepared by the contractor, be careful to follow the exact meaning of the column headings and fill out the form completely.

Specific Bond Needed: Provide a Bond Request Form.  This document tells key details about the project and bond needed.  Fill out completely and include attachments as indicated.

Optional: Include other info that may help paint the picture such as a company brochure, web site link, reference letters and resumes of key people.

When submitting an account, keep the underwriters point of view in mind.  Sureties only provide bonds for applicants that present no likelihood of claim or default.  It is important to show the company’s expertise, capabilities and financial strength.

Once the paperwork is moving, an “in person” meeting with the underwriter is always beneficial.  Contract surety bonds have a human element that is not part of the paperwork. The underwriter must be personally convinced that the account deserves support.

If a real meeting is not possible, consider a teleconference such as Skype or Go To Meeting, or even send jpg pictures of the people, premises and some key projects.

Seize the opportunity to paint a convincing picture and gain the enthusiastic support of your surety underwriters.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)

Secrets of Bonding #13: Release of Lien Bonds

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“For the want of a nail…”

This often quoted proverb reminds us that if left unresolved, small problems may become catastrophes.  Construction liens fall into this category.

If you are a contractor or insurance agent with construction clients, this is a subject worth knowing about.

It all starts with a small problem: A money dispute.  It could be a performance issue a general contractor (GC) has with their subcontractor or defective materials received from a supplier.  This could happen on ANY project. The sub or supplier files a lien against the property to protect their interests until the matter is decided.

A Release of Lien Bond removes effect of the lien and restores the property owner’s right to sell or deal with the property as they wish.  It does so by acting as the replacement security to assure the lien claimant will receive any payment that is eventually due them.

That’s all pretty simple.  There is a money dispute and the Release of Lien Bond becomes the replacement security for the claimant until there is an actual decision in the matter.

Here’s where it gets exciting. Assume the project is not bonded.  If there WAS, the claimant could have gone against the Payment Bond – then there would be no lien.  Also assume the GC’s contract requires that they protect the owner from liens, which is a common requirement.  Owners want to avoid having to pay twice if they pay the GC but the money doesn’t flow down to suppliers and subcontractors. So the GC (or prime contractor) may be charged with the task of removing the lien against the owner’s property.

From the surety’s side, a release of lien bond is difficult; it is a financial guarantee.  It promises that money will be paid at a future date.  Because of the immediacy of claim payment (if the matter is decided in favor of the plaintiff), the surety needs funds (collateral) in hand.  This means the GC (bond applicant) has to come up with cash for possibly twice the lien amount, because that’s how the bond amounts are set.

It gets worse: The GC faces three bad options.

  1. Pay the claimant just to settle the dispute (and thus release the lien)
  2. Put up collateral (2x?) and pay for a Release of Lien Bond for the privilege of fighting the claim in court
  3. Ignore the lien and risk being in default of their contract or at the minimum, have contract funds withheld by the owner

We think the P&P bond is just for the protection of the owner, but the GC would have benefited if the project was bonded.  There would have been a Payment Bond claim.  With their sureties support the GC would deal with the matter and not involve the owner.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

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Secrets of Bonding #11: Payment Bonds

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You’ve heard of “Performance and Payment.” In this article let’s discuss the Payment part because this obligation affects more people and is the most frequent area of claim for sureties.

The old fashioned name for these is a “Labor and Materialmen’s Payment Bond.”  The name says it all: These bonds guarantee that suppliers of labor and material will receive their proper payment. We know labor and material suppliers want to be paid, but why are these bonds required on public work and other contracts?

Why Obligees Require Payment Bonds

Scenario: A company is building a new office facility and hires a general contractor.  The GC then hires a paving subcontractor to put in the parking lot.  If the paver is not properly paid, they may be entitled to file a Mechanics Lien against the property.  He can’t take back his labor and paving material, so the court allows the lien to be filed to protect his interests until there is a legal resolution.

The problem with liens is that the company may have paid the GC properly. It could be the GCs fault that the paver isn’t paid, yet the company is being penalized.  With the lien in place, the company no longer has a clear title. If they want to sell the property, they may have to pay the paver directly even though they already paid the GC!  The payment bond is a source of financial recovery for the paver so there is no need to file the lien and therefore it protects the interests of the obligee as well.

Who Are Payment Bond Claimants?

As the name says, potential claimants are “suppliers of labor and material.”  Other parties that have a direct interest in the contract are also included.

Let’s use our GC and paver situation as an example.  The GC obtains the Performance and Payment Bond.  The paver is a subcontractor to the GC and would be entitled to make a bond claim. The paver’s asphalt supplier is directly supplying materials and can also make a claim.

If the paver hires a striping contract to mark up the parking lot, they are covered. However the paint supplier to the striping contractor is not, legally they are too far removed from the prime contract.  They are working for the sub-subcontractor and are three steps down.  Here’s the flow:

  1. Owner
  2. GC (Prime contractor with owner)
  3. Paver (Subcontractor)
  4. Striping contractor (Sub-subcontractor)
  5. Paint supplier (supplier to Sub-subcontractor)

Remember that the payment bond does not protect parties that are more than two steps down.

Other key points needed for a valid claim:

  • To be covered, materials must have actually gone into the project, not just be delivered to the site.
  • There is a time limit for after which claims cannot be filed.
  • The form and proof of claim must be correct.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site Bonds since 1979 – we’re good at it!  Call us with your next one, Bid and Performance bonds, too.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)

Secrets of Bonding #10: Site / Subdivision

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Site / Subdivision: Oh what a tangled web we weave…

Feel like you’re not an expert on these?  You’re not alone!  In this article we’ll cover the basics as well as some of the tricky stuff.

Site and Subdivision (Sub-D) Bonds are both similar for the surety.  A Site Bond is needed when a business expands their facilities whereas Sub-D arises on residential development projects.

In both cases, the property owner or developer has obtained zoning board approval to proceed, but is required to build certain elements the township wants such as sidewalks, roads or lighting.  Contractors call this “site work,” thus the name Site Bond.  Site bonds do not concern the construction of the buildings.  “Improved Lots” are property where such elements have been completed.

This required work is collectively called the Public Improvements.  A township engineer will prepare an “Engineers Estimate” with an estimated current cost for each item.  The bond amount is the sum of these costs plus an added cushion in case the bond is called at a future date when construction costs are higher.

The purpose of all Site and Sub-D Bonds is to guarantee that public improvements will be built at the developer or surety’s expense, not the taxpayers.  For example, if the developer fails to topcoat the road, the township makes a bond claim and the surety must complete the work.

How Site & Sub-D differs from Performance Bonds:

  • There is no contract with the obligee (township)
  • The obligee is not paying for the work.  It is self-funded by the principal (property owner)
  • There is no definite completion date

FIRST TANGLED WEB: Since the work is self-funded, the property owner must either have cash on hand or arrange for a construction loan. If the latter, it is likely that the property in question will be collateral for the lender. This means in the event of the principals failure (such as bankruptcy), the bank becomes the new property owner but the surety remains obligated to the township.

In the borrowers absence the bank has no obligation to disburse the remainder of the loan (the purpose of which was to improve and increase the value of property THE BANK NOW OWNS) – but the surety is still required to complete the work.

Untangle this by obtaining a “Set Aside Letter” from the lender prior to issuing the bond.  This requires the bank to continue disbursing funds to the surety in the event of the borrower’s failure – with no pay back required.  In this manner, the work can be completed as intended.

SECOND TANGLED WEB: When the property owner hires a contractor to build the public improvements, it is not uncommon to require the construction firm to obtain the Site / Sub-D bond.  After all, the contractor may already have a surety relationship.  Problem: In the event of the property owner’s default, the construction contract is terminated however the Site / Sub-D bond obligation remains in force.  No more money is coming to the contractor to complete the work. The contractor is now solely responsible to the township and the surety and must self-fund the completion of improvements for property they do not own.

Untangle this one by a) requiring the developer, not the contractor, to be the bond applicant, or b) at least get the financial statements and indemnity of the developer so the contractor is not solely obligated to the surety and township, and c) a set-aside letter or escrow account (for funding by cash) could still be required.

Summary: Key questions are:

  • Who will build the public improvements?
  • If built under a construction contract, is it bonded to the developer? (Performance and Payment Bond)
  • How will the work be paid for?
  • How will the surety be funded in the event of failure by the property owner?

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site Bonds since 1979 – we’re good at it!  Call us with your next one, Bid and Performance bonds, too.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)

Secrets of Bonding #9: Capacity – Cure or Lure?

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Bonding Capacity is a key point for many contractors along with rate (the cost of the Performance & Payment Bonds) and the approval terms.   Capacity is the amount of bonding the surety will provide, both the “per job” limit, and the total amount.  Let’s look at how all this works. 

Traditionally, the capacity amount is defined as Single and Aggregate.  The Single is the per job amount for any one contract and bond, which is the way bonds are actually issued.

The Aggregate is the maximum at any one time, comprised of:

  • The remaining “costs to complete” on started projects
  • The full amount of all awarded, signed but unstarted contracts
  • The full contract amount for low (winning) and undecided bids

Typically, the Single is no more than half the Aggregate. It is also common for the Aggregate to include all contracts, both bonded and unbonded.  The Aggregate is not just an expression of how much the surety will provide.  It is also an indication of how much work they feel the contractor can undertake without being overextended.

Here are some underwriting elements surety underwriters may review when making a capacity determination:

  • Working Capital (WC) and Net Worth (NW) of the company – The benchmark is for each of these to not be less than 10% of the Aggregate.  i.e. $100,000 WC could support $1 million Agg.
  • Secondary Financial Resources – Available bank credit, personal financial strength, affiliate companies and strong credit reports could help justify support.
  • Prior Experience – The Single is normally not more than 100% greater than the largest similar single contract successfully completed. Company longevity and expertise of key individuals is also considered.
  • Current Work On Hand – Even if the applicant has a good financial condition, underwriters may be unwilling to add to their workload if company resources appear to be fully utilized or if exisiting contracts have problems.

There needs to be balance between the elements.  For example, support will be withheld from an applicant who has good prior experience but no financial resources.

Bottom line is that bonding capacity is important.  It influences which projects the contractor will pursue and directly affects their annual revenues and profits.  Having adequate capacity can be the Cure for construction companies seeking better financial performance and market penetration.  It also Cures the bond agents need for increased commission income.

Capacity can also be a Lure. The promise of increased capacity can be a hook to draw in a contractor’s account.  Lines of bond capacity are always conditional.  Any bond can be declined for various reasons – meaning: “We’ll actually give you the capacity if we feel like it.”

It’s best to look at the credibility, reputation and stability of the provider of the line. Make sure the capacity you rely on is a Cure, not a Lure.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site Bonds since 1979 – we’re good at it!  Call us with your next one, Bid and Performance bonds, too.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)

Secrets of Bonding #8: Bid Bonds

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“It’s only a Bid Bond.  If you can issue it now, we’ll complete the underwriting later.”

Unfortunately it doesn’t work that way.  In this article we’ll talk about the purpose of Bid Bonds and how to deal with them effectively.

Every surety bond contains a promise that something will happen.  For example, a Performance Bond guarantees the correct performance of a written contract.

A Bid Bond is often required to guarantee the bidder’s sincerity on projects funded with tax dollars (public work such as federal, state, and municipal projects.)

The promise contained in the bid bond is that one of two things will happen.

  1. If the bidder receives a contract award, they will sign the contract, produce the required Performance and Payment (P&P) Bond and commence with the work.  Or in the alternative…
  2. Pay the difference between their bid and next higher proposal.

For the benefit of the taxpayers, this assures that if the low bidder does not proceed, the work will still be performed for their price – which was the lowest price bid.

Bid Bonds are part of construction bonding or what we call “Contract Surety,” but they are really Financial Guarantee Bonds.  Sureties are always careful when issuing these.  So you can throw away the “It’s only a bid bond” comment.  Sureties view Bid Bonds as part of the acquisition process for Performance Bonds.  If the underwriting is not resolved for the P&P bond, the surety has no motivation to issue a financial guarantee/bid bond.

Other points worth knowing:

  • When ordering a bid bond, the underwriter does not want to know the actual bid price so the confidentiality is protected.  Just round up the number.
  • Award of the contract based on a bid bond indicates the obligees approval of the surety – which presumably is then transferred to the upcoming P&P bond.
  • Bids that are more than 10% below the next bidder will require a written explanation (prior to the P&P bond) to assure there are no calculation errors and an adequate profit margin.
  • Bid bonds are sometimes capped, meaning the bond will not support a bid higher than the bid estimate the underwriter approved. In such cases, it is important to use an ample figure on the Bid Bond Request form.  If there is a last minute bid increase, such as a subcontractor or supplier coming in higher than expected, the bidder will not be able to bid a dollar more than the pre-approved figure.  Remember, there is no downside to bidding less than indicated.
  • Postponements – when bid dates are rescheduled, the obligee may permit the original bids bonds to be used even though the stated bid date will now be incorrect.  Check with the obligee to see if you must re-issue the bid bond to show the new date.
  • When a bid is outstanding (undecided), the contract amount is considered “in use” in regard to their available capacity.  Therefore, “not low” bids should be reported promptly to the surety.
  • Bid Bonds are considered terminated upon issuance of the P&P bond, or after 90 days.
  • The bid security of the low three bidders is usually held until the contract is signed and bonded by the low bidder (see our following comment about using a check!)

One last word of caution: A check may be accepted as an alternative to a bid bond.  However, it is subject to forfeiture if the bidder receives an award but cannot produce the P&P bond.  Always use a Bid Bond if possible!

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site Bonds since 1979 – we’re good at it!  Call us with your next one, Bid and Performance bonds, too.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

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