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Bid security is a form of risk insurance used in the construction industry. By submitting a bid bond along with a construction bid, a contractor is providing a legal guarantee that he will sign a contract if it is awarded to him. If a bonded contractor does not sign the contract when offered, he faces both financial and civil penalties.
These bonds are designed to protect the owner or developer of a project. An owner may be a developer, private company or government agency. Bid security helps to minimize frivolous bids and wasted time for the owner. Because bonds are issued by private surety companies, an owner can feel confident that all bidders have been thoroughly investigated and pre-qualified by their respective bonding agent. This helps to weed out bidders with a history of poor performance, as well as those who lack the funds to complete the project successfully.
When a job is issued for bids, the owner will specify whether bid bonds are required. Bid security typically represents a percentage of the total bid, and will vary widely depending on the requirements of the project. Contractors will request bid bonds in this amount from their bonding agents, who will issue a bond directly to the contractor. The contractor will then submit both his bid and the bid bond to the project owner.
All bidders who are not awarded the project will have their bonds returned to them once the bidding process is complete. The contractor who wins the job will also receive his bond back once he signs a contract for the job. In effect, the contract now takes the place of the bid bond in protecting the owner from risk. If the contractor decides not to sign the contract, the surety company will reimburse the owner for any losses incurred. This is usually equal to the price difference between the lowest bidder and the bidder who is eventually awarded the job.
In the United States, bid security is required on all government projects valued over $100,000 US Dollars (USD). The bond must be valued at twenty percent of the bid price up to a maximum of $3 million USD. Because it can sometimes be difficult for smaller contractors to obtain bonds this large, they are permitted to provide bid security in the form of cash or cashier's checks instead. Bonding requirements on US government projects are defined under the Miller Act, which was first passed nearly a century ago. Many states have their own bonding laws known as “Little Miller Acts.”
It is important to understand that bid security is not the only type of bonding instrument used on most projects. An owner that requires contractors to provide a bid bond will usually also require payment and performance bonds. Once the contract is signed, a payment bond protects the owner if the contractor fails to pay his suppliers and subcontractors. A performance bond is more comprehensive, and protects the owner if the contractor fails to complete the job due to poor performance, financial troubles or bankruptcy.
You are right, Telesyst, that smaller contractors have a disadvantage. That is why it is so difficult to make a good living as a small, independent contractor.
However, in most cases it is not true that a small-time contractor would be able to afford the personnel and equipment needed to do the large-scale projects for which a bid bond is usually required.
Although the bid bond is eventually returned to the contractor, the up-front cost of securing a bid often keeps smaller contractors from bidding on and getting larger jobs.
Just because a contractor does not work for a large construction company does not mean they do not have the skills, experience or equipment to do a job well.