Welcome to the first in a three-part series on surety bonds in Illinois compliments of guest author Danielle Rodabaugh. Danielle is a principal for SuretyBonds.com and will be discussing the three basic types of construction bonds:
- Bid bonds
- Performance bonds
- Payment bonds
Today we’re starting with bid bonds.
Surety Bond Basics
Illinois state law requires most public construction contracts to incorporate bonding in one way or another because bonds provide legal and financial protection. Various state-mandated regulations outline a need for different kinds of bond protection depending on the specific project and those involved. Consequently, Illinois surety bond agencies issue a number of different construction bonds for large projects that involve in-depth, provisional contracts. Like other surety bonds, securing a bid bond involves three parties:
- Obligee–the developer who seeks the financial protection of a bond to guarantee that their project is completed by the contractor or construction company for their proposed low bid
- Principal–the contractor who secures a bond to ensure that they will fulfill the contract for the amount proposed in his low bid
- Surety–the agency who issues the bond to the principal, thus holding the entity accountable for completing the contracted work for the amount proposed in the low bid
How Bid Bonds Work
The primary purpose of a bid bond is to assure the developer that the low-bidding contractor will enter into a contract for the price quoted in his bid. This keeps the contractor from increasing the bid on the project after entering into a contract with the developer. Bid bonds also stipulate that the contractor will secure other necessary performance and payment bonds required throughout the project, as to further guarantee his work and protect the developer. If the contractor breaks the contract, generally the bond allows the developer to collect damages in the amount of how much more he has to pay to contract the next-lowest bidder for the project. If the contractor cannot cover the cost, the surety will be held accountable for paying reparation up to the bond’s full face value. Court rulings in such collection cases are frequently based on precedent rather than legal stipulations, as regulations in the bonding industry are constantly evolving.
Regulations Affecting Bid Bonds
Most bonding regulations require a contractor to provide between 5% and 10% of the bid upfront as a penal sum. However, federally-funded projects usually require the penal sum to be 20% of the bid. For example, if a contractor bids $100,000 to complete a construction project, the company will need to provide a $5,000 to $10,000 (or $20,000 for a federally-funded project) bond along with the bid. This cost is calculated to protect the developer should the low-bidding contractor opt out of the contract, forcing the developer to pay more to contract the second-lowest bidder for the project. In Illinois the Capital Development Board uses the 10% standard when distributing grants for public construction projects. Projects managed by the Federal Acquisitions Regulations–or FAR– require 20% of the total bid to be included in the bond.
Cost: Bid Bond Premiums
Contractors pay surety agencies a premium to secure a bid bond. Bid bond costs vary greatly due to a number of factors, such as the bid amount, contract terms, and the jurisdiction in which the contract is executed. Typically bid bond premiums are between 1% and 5% of the penal sum. Before you start preparing a bid, check to see whether a bid bond is required, and if so, what the approximate penal sum is going to be. This will help you determine the fee you will pay to secure the bid bond.
Up Next in Construction Bonds
Next Danielle will explain what performance bonds are and how they work.