In a typical situation, there can be up to three different bonds that are required in a construction contract. First, there is a bid bond, which provides that if a company wins the contract that they will go ahead and sign the construction contract. Second there is the contract bond (also known as a construction bond) that guarantees the performance of the agreement pursuant to the terms in the agreement. Finally, there can be a maintenance bond, which guarantees that the work will hold up over time.
Strangely, many companies have traditionally thought that a bid bond is a just a formality in the bidding process. Further, they believe that there is no liability whatsoever. It is treated that, if they win the bid and do not want the work, they can simply decline. But this is not how it works.
When your company enters into a bid bond agreement, it agrees that it will sign the contract if it wins the bid. Further, it agrees that if it chooses not to go through with the work and perform according to the terms of the agreement, then it will pay the difference between its bid amount and the next lowest bidder’s amount. Thus, the owner of the project will not have to pay any more than what your company bid. What is worse, though, is if the process is re-bid and the second round of bids are substantially higher than the first round. This bid could, then, be a very expensive process for your company.
That is not to say that it may not be in your best interests to decline a project just because of the bid bond rejection amount. We have worked with several companies that have received much better projects than anticipated and, when that happens, happily pay the bid bond amount and go on with a project that has much higher margins.
Process in underwriting
Given that there is real liability on the part of the surety, then care must be given to providing a bid bond. The information that is normally obtained includes the last few years of financial information so that the surety bond company can be assured of repayment in case of default. Further, they can dig in a bit to make sure that they will write a final bond (i.e., a construction contract bond) for the company once it actually does win the job.
Further, these bid bonds have a tendency to provide a fixed limit of liability on the part of the surety (this was a direct result of the re-bid process when the bids would come in much higher). Thus, some sort of agreed-upon damages would be a part of this agreement (known as liquidated damages).
A construction contract typically has three bonds: 1) a bid bond; 2) a contract bond; and 3) a maintenance bond. The bid bond process should not be seen as a mere formality, but really as the beginning of a relationship. Thus, the normal underwriting process should be upheld.