Bid Bond VS. Performance Bond: What Do They Mean?

As a construction worker, you need to make sure that the project is finalized without financial losses, which isn’t easy. A surety bond can help you reduce financial risks. Surety bonds are a type of contract bond that contractors purchase when bidding on or entering into a contract to perform work for a project owner. There are different types of surety bonds for different purposes. Two common types that are usually mixed with one another are bid bonds and performance bonds.

Understanding those types is important for contractors who want to purchase a construction bond. In this blog, we explain the two types and what makes them different.

What is a Bid Bond?

First, we need to explain the meaning of bid bonds. Bid surety bonds are often used for construction jobs or other projects with similar bid-based selection processes. The function having bid bond insurance is to provide a guarantee to the project owner that the bidder will sign the contract if selected in a bidding process. If the bidder fails to meet their obligations, bid bonds provide financial compensation to the project owner.

Bid bonds help clients avoid frivolous bids, which saves time when analyzing and choosing contractors. Most public construction contracts require contractors or subcontractors to secure their bids by providing bonds for legal and financial protection to the client.

How Does a Bid Bond Work in Canada?

Bid bonds are typically submitted during the tender phase for public or private projects. If a contractor wins the bid but decides not to execute the contract, the client can claim the full or partial amount of the bid bond.

Once a project successfully begins, the bid bond amount is returned to the bidder. They are typically valid for a specified period, typically 60 to 90 days, from the bid submission date. The bid bond amount is required as a percentage, most commonly between 5% and 10% of the bid amount. Federally funded projects require 20% of the bid.

Writing a Bid Bond

A bid bond is written by a third-party guarantor, who can be a surety company or insurance company, stating that the guarantor will pay the debt if the contractor fails to do so. The written guarantee is submitted to the client or project owner. It affirms that the contractor has enough funds to do the construction project.

Who Are the Parties Involved in Bid Bonding?

Generally, when it comes to surety bonds, three parties are involved.

The principal: The contractor working on the project. In bid bonding, they are a person or company looking to secure a bid.
The obligee: The project owner or client requiring a bond. They solicit the bid and require the bid bond to guarantee that the principal will sign the contract and fulfill their obligations.
The surety: The bonding company, which is either a surety company, bank, or insurance company. They assess the financial status of the principal and charge a premium.

What Are the Benefits of a Bid Bond?

Bid bonds protect projects and ensure their completion. Here is why the construction industry may benefit from them.

They ensure that the contractor is capable of seeing the project through, on the financial and operational levels.
They reassure the project owner that their money is not going to be wasted if the contractor bails.
They prevent contractors from bidding frivolously and then withdrawing from the bid.
Without bid bonds, the project may end up unfinished because of insufficient funds.
They help maintain a competitive bidding environment with honest pricing.

What Are the Risks Associated with Bid Bonds?

A bid bond protects, but it still has some drawbacks.

The risks for contractors:

Failing to fulfill the bid contract may harm your credibility and ruin your reputation in the market.
If you fail to fulfil the terms of the bid bond, you will have to compensate the project owner.
Getting a bond requires paying a cost, providing a personal guarantee, and a strong financial statement. If you fail to provide that, you will not meet the bid bond requirements.
Once you submit the bid, you are required to fulfill it, even if the market costs or input costs change. You may end up forced to honor a bid that is not profitable.
You must comply with the terms of the bond and ensure all required bonds and documents are submitted on time. Missing deadlines or documentation can lead to forfeiture.

The risks for project owners:

It amounts to a small percentage of the bid, typically 10% only, which isn’t enough to cover the full cost difference. The project owner may have to pay more than planned if they award the contract ot a significantly higher second bidder.
When the winning contractor defaults on their bid, it causes the project to stop until they find and award a different contractor, which also increases the overall project cost.

How is a Bid Bond Terminated?

A bid bond is terminated and returned to the bidder after the bidding process is concluded unless the bidder has defaulted. That means that the bid bond is terminated after the bidder or contractor enters the contract, and then it is replaced by performance and payment bonds because it has served its purpose.

The bid bond is always void if the project owner decides to award the contract to another bidder, as it means the original bond didn’t result in a contract.

Moreover, the bid bond expires after some time, usually 30-90 days, depending on the agreement. If the time passes and the contract isn’t signed, the bid bond is automatically terminated.

If the bid is withdrawn in accordance with the tender’s rules within the time allowed, the bid is terminated. The obligee or project owner may call on the bond if withdrawal is deemed improper.

Lastly, a bid bond is terminated after it is enforced if the principal refuses to sign the contract and the surety company pays the obligee.

What Happens When the Contractor Fails to Meet Obligations?

Both the principal/contractor and the surety company are held jointly and severally liable if the contractor fails to meet the obligations. The client will be forced to award the contract to the second-lowest bid if the contractor decides not to sign for any reason. Since the first contractor was the lowest bidder, that means the client will have to pay more than the initial price. For that reason, the client or project owner can claim the full or partial amount of the bid bond.

The surety company pays for the bid amount, and depending on the contract, they can sue the contractor to reclaim the amount they paid. The bid amount usually covers the difference between the lowest and second-lowest bids.

How Much Does a Bid Bond Cost?

Bid bond premiums commonly cost 0.5% to 10% of the contractor’s bid amount. The difference between a 0.5% premium and a 10% premium is the contractor’s profile. A contractor with good credit and a solid track record pays 0.5% to 3%, while one who has a weak financial status and less experience can pay up to 10% of the bid amount.

What Are the Factors that Affect the Cost of Bid Bonds?

Financial strength: A contractor with good credit, stable finances, good working capital, and a clean bonding history gets a lower price as they are seen as less risky by the surety.
Size of the bid: Larger projects with higher values get a lower percentage because the fixed underwriting costs are spread over a larger base. Conversely, smaller projects get higher rates or are forced to pay a minimum fee.
Complexity of project: Complex projects that are seen as high-risk have increased premiums, especially those with tight deadlines and difficult site conditions.
Contractor’s experience: A proven track record and prior successful execution of bonded contracts help. Past claims, weak financial statements, or a small track record can increase cost.
Brokerage fees: Some Canadian brokerages or surety providers require a bonding facility or annual underwriting fee.

What is the Claims Process for Bid Bonds?

Here is what happens when a contractor refuses to sign a contract:

The obligee/project owner informs the surety company and the principal/contractor that they wish to claim the bid bond.
They provide proof that they awarded the contractor, that the contractor defaulted, and that it caused financial loss.
The surety investigates to ensure that the default is valid and that the procedural requirements have been met.
If the claim is accepted, the surety pays the claim to the obligee, up to the bond amount. Then, they may seek indemnification from the principal.
Once the claim is resolved, the bond is discharged.

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Bid Bond VS. Performance Bond: What is the Difference?

The main difference between a bid or tender bond and a performance bond is the purpose or function of the bond. A bid bond, like we’ve mentioned before, ensures that the contractor signs the contract after they are chosen in a bidding process.

As for the performance bond, it ensures that the contractor actually finishes the job according to the standard and specifications agreed on in the contract. In other words, they ensure the contractor fulfills their contractual obligations.

The bid bond comes before the performance bond, as it is bought during the bidding stage. After the winning bidder enters the contract, the project owner buys the performance bond to ensure project completion.

The bid bond usually covers only 5-10% of the bid amount. On the other hand, the performance bond covers up to the contract value or enough to allow the project owner to complete the work if the contractor bails.

Finally, another major difference between bid bonds and performance bonds is that bid bonds last for 30-90 days until they expire, while performance bonds last longer. A performance bond has no expiration date and is valid until the project is completed.

In short, choosing to get a bid or performance bond depends on the stage you’re in and your goal. While bid bonds guarantee bid security, performance bonds guarantee contract fulfillment. Both are risk management tools that work together to secure your financial stability.

What is the Meaning of a Performance Bond?

A performance bond is a contractual agreement that a contractor or construction company will finish a project. It is a guarantee that the contractor will finalize the project, following the terms agreed upon. The bond is an agreement between three parties: the contractor (principal), the project owner (obligee), and the surety company, bank, or insurance company.

In the case of a performance bond, for example, if the contractor defaults at any point, the surety will step in to help the project owner by providing financial protection, finding a new contractor, or paying the owner for losses up to the bond’s value.

What Are the Benefits of a Performance Bond?

Here is why obtaining a performance bond is beneficial for everyone.

Contractors who obtain performance bonds are seen as more credible, which is extremely helpful in a competitive bidding environment.
Performance bonds reassure project owners that the work will adhere to contract specifications, standards, and schedules.
They also incentivize contractors to give their best performance to avoid claims.
Without a performance bond, the contractor may be ineligible for some government projects.
They minimize the risk of insolvency; if the contractor goes bankrupt for any reason, the bond can provide funds to compensate or finalize the project.
Performance bonds give the project owners recourse if the contractor fails to finish the project.

What Are the Risks Associated with Performance Bonds?

For contractors:

If the contract defaults, they will be liable to pay for the costs of fixing, completing, or replacing work, which is often required to reimburse the surety.
It is hard and demanding for a bond. A contractor is required to have strong financial guarantees, a track record, and collateral.
If the terms are unclear or unfavourable, they can expose you to more liability than expected.

For project owners:

If the project owner misunderstands what the bond covers, it may lead to disappointment and legal disputes. For example, the performance bond doesn’t delay damages, loss of income, or warranty work.
If the owner fails to give the surety proper notice of default or waits too long, it can void the bond or reduce enforceability.
A weak or insolvent surety bond may not provide full protection.

When is a Performance Bond Terminated?

The performance bond may be terminated in these cases:

The contractual agreement was fulfilled.
The longstop date agreed on was reached.
The obligee agrees to formally release the bond.
The final payment was made to subcontractors and suppliers, and any potential claims have been resolved.

What is the Claims Process for Performance Bonds?

When the contractor fails deadlines, fails to meet contract scope/quality, abandons the project, or becomes insolvent, the project owner can file a claim. Here are the steps:

The project owner notifies the contractor that they are in default and may need to cure if the contract allows.
Then, the project owner sends notice to the surety under the performance, providing supporting documents, explaining the default and what remedial work is required, or the cost to complete.
The surety starts to investigate, verifying the fact, and getting the contractor’s input.
If the contract allows, the surety might arrange for the contractor to cure the default. If that fails, the surety may take over completion of the project by hiring a replacement contractor or reimbursing the obligee to do so.
The surety pays up to the bond amount.
The surety typically has an indemnification agreement with the contractor, so after paying, the surety will seek recovery of losses from them.
Once the performance obligation is fulfilled, the bond is closed.

How Much Does the Performance Bond Cost?

For most contractors, the cost of a performance bond is about 0.5% to 5% of the contract value. A low-risk contractor may get to pay 1% to 3%, while a high-risk contractor may have to pay 4% to 5% of the contract value.

Factors that Influence the Cost of Performance Bond

Contractor’s financial health and track record.
The size of the contract and bond amount. Bigger contracts may get better rates per dollar.
Project complexity. If it’s long and unfamiliar, the contractor may pay higher costs.
Duration of the bond and the warranty period.
Whether it is a standalone performance bond or paired with a payment bond.

What Are the Bid and Performance Bonds Submission Requirements?

To apply for a bid bond or performance bond, you need to:

Complete a contractor’s questionnaire, then sign it.
Make a bond request and provide contract documents.
Provide the most recent business financial statements.
Provide the most recent personal financial statement.

Gain Your Client’s Trust with Surety Bonds

Both bid and performance bonds are crucial for any contractor who wants to establish their name in the market. With St. Andrews, you can get surety from a company that cares, with experienced brokers who can give you guidance and set you up for success.

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Bid Bond Vs. Performance Bond FAQs

How long does a bid bond last?

Bid bonds are valid for a limited time, usually 60-90 days from the date of issuance.

How to calculate the value of a bid bond

Depending on the contractor’s profile, a bid bond premium costs anywhere between 0.5% and 10%.

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