Bid Bonds, Performance Bonds, Payment Bonds, and Warranty Bonds
If you are a contractor or subcontractor (or an insurance agent that represents one of them) that is considering bidding on or have been awarded a contract that has bond requirements, you're on the right page. Here are the common bond types you may see in your RFP/Bid Invitation packet and/or contract:
- Bid Bonds are required to be turned in with your bid. The hiring party (known as the obligee in my world) may require this type of bond as bid security. Generally this bond gives a guarantee to the obligee that you will enter into the contract if you are the low bidder. If you are the low bidder and choose not to enter into the contract, you lose your bid security, or in our case they would claim on your bond.
- Performance Bonds are required to be turned in once you are awarded the contract. These bonds give a guarantee to the obligee that you will complete the contract according to specifications and generally adhere to the agreement. It covers things such as your workmanship, adherence to completion schedule, proper materials used, etc.
- Payment Bonds aka Labor and Material Bonds are also required to be turned in once you are awarded the contract. These bonds guarantee that you pay your subcontractors and suppliers. It protects the obligee from liens placed on the property due to unpaid subcontractors and suppliers.
- Warranty Bonds aka Maintenance Bonds are bonds that would be required once the job is 100% complete and accepted by the obligee. They guarantee that you will honor your workmanship warranty. This bond type is often considered redundant because performance bonds also cover the workmanship period since it is part of the contract language. Still, some obligees feel more comfortable if they have a separate bond to cover your warranty period.
- Bid Bonds - These bonds are often provided as a gratuity. Yes, that means exactly what you think it does - they are often free. Even when they're not free, they are pretty inexpensive. Some surety companies charge processing fees. I've seen these processing fees range from $50 - $150 per bid bond, to $100 - $350 annually for an unlimited number of bid bonds in a year.
- Performance and Payment Bonds - I lumped these together because they are priced together. It won't cost you anything different if you need one, the other, or both. Premium for these bonds generally range from 1 - 5% of the contract price, depending on your qualifications, contract amounts, length of contract, scope of the work, and length of workmanship warranty.
- Warranty Bonds - These bonds can vary in price, generally between 0.25% and 3% of the bond amount. Notice I said bond amount vs. contract amount for this one. Warranty bond penalties (the bond amount) are usually only a percentage of the contract amount.
What to Expect
There are a lot of moving parts when it comes to contract bonding. For that reason, this section is going to focus on larger contracts ($350,000 and larger) for simplicity. If you want to learn about smaller contract bonds, visit one of these pages - Small Contract Performance Bonds and Payment Bonds - Good Credit or Small Contract Performance Bonds and Payment Bonds - Bad Credit.
Paperwork requirements for these bonds are fairly extensive. In addition to a 10 - 12 page application which I would send to you, general requirements are as follows:
- Business financial statements (P & L and Balance sheet) for previous 3 years ended, and current year-to-date - CPA prepared is preferable, but not required
- Personal financial statements for all owners
- Copy of the job contract OR complete bid invitation packet , depending on what stage of the process you are at
- Bond form(s) required by obligee
- Bid Tabulation (if project has already bid) - list of bidders and amounts bid for your scope of work
- Liquidated Damages should not be excessive - we generally want to see them at $2,000 per day or less. Anything more would need to be approved on an exception basis.
- Workmanship Warranty Period shouldn't exceed 2 years. The performance bond covers the first year without an extra fee. The 2nd year of warranty is allowed, but at an extra cost, usually around 0.25% in addition to the base fee. Longer warranties would require an exception.
- Current Bank/Brokerage statements to verify cash in business accounts
- Current Bank/Brokerage statements to verify cash in personal accounts of each owner
- Bank/Brokerage statements or bank letter showing information on existing line(s) of credit - should show limit, balance and maturity date
Once a submission is received, we would determine which market best fits you and what terms we could offer. The process usually takes at least a week and can take longer depending on your organizational skills as well as the process of the surety that best fits you. Another factor that could contribute to an increase in processing time would be the requirement of specialty conditions.
Not all bonds require specialty conditions, but if the underwriter feels it necessary in a borderline situation, specialty conditions may be introduced as an option to write a bond when otherwise it would have been declined. Here are some examples of specialty conditions that could be introduced:
- Collateral may be required to secure a bond. Forms of collateral accepted by surety companies are either a cashier's check or an irrevocable letter of credit (ILOC) from a bank acceptable to the surety company. The amount of collateral required is determined on a case by case basis but on average is between 30% - 50% of the contract amount. Collateral is NOT a fee. It is held by the surety company for the duration of the contract as an extra security measure and is returned to you once the job is done. Typical hold period is 90 days past the acceptance of the work by the obligee.
- Funds Administration is another condition that could come in to play to make the surety company comfortable. In this case, the surety company would require that draws are directed to their funds control department. The surety company would then manage payments to subcontractors, suppliers, and to you. There is usually a fee involved for this ranging from 0.5% - 1% of the contract amount. Funds administration greatly reduces the potential for claims on your payment bond.
- Subcontractor Bond-Back may be required if you have subcontractors that are performing large portions of the contract. What this means, is the surety company may require you to demand performance and payment bonds from your subs. This helps to protect both you and the surety company from failure of any of your subs.
- SBA Bond Guarantee - The Small Business Administration offers a program to small business contractors that may have difficulty qualifying for bonds. They work with surety companies to back bonds with Federal money. I am a registered SBA Bond Guarantee agent and can assist with this program if it is a good fit for you. If you're interested in learning more about this program, visit this page: http://www.sba.gov/content/contractors
Note: If someone has asked you to provide a "performance bond" and it doesn't fit what you've read here, what you need probably isn't a true performance bond, and least not what the bond industry considers one to be. If that's you, send me a message. I'll help you down the path to get you what you need.
By: Cynthia Baldonado