The difference between bid bonds and payment bonds

Construction can be a risk-filled business even in the best of times, with one in three contractors folding before their fifth anniversary, according to U.S. Census Bureau data. That’s one reason why many private projects now require contract surety bonds for protection. 

Contract bonds, sometimes referred to as construction bonds, ensure that the obligations of a construction contract are met, from starting work as promised (bid bonds) to completing the project per specifications and on time (performance bonds) to paying their subcontractors and suppliers for the project (payment bonds). Each one provides protection on a construction project, but they function in different ways and serve different people. 

Before you start your next project, let’s talk about the difference between bid and performance and payment bonds. 

What is a bid bond? 

A bid bond is given as an assurance to the project owner, or obligee, that if selected as the low bidder, they will have the means to fulfill the job at the cost that was outlined in the bid. Bid bonds are presented by a contractor to the project owner as part of the bidding process. 

They help prevent contractors from submitting low bids and then raising the price before work begins, or delaying the start of work. They also weed out unqualified bidders as part of the surety review process, including those that may not have the cash flow or experience to finish a specific project. Bid bonds are one of the most common types of contract bonds issued by surety companies like UFG Surety, often at no charge. 

What is a performance & payment bond? 

A performance and payment bond guarantees that the obligee will be indemnified for losses that result from the contractor, or principal, not performing the work as specified in the contract. If the contractor defaults on their contractual obligations, the surety company promises to step in and potentially pay the affected parties, while attempting to collect damages from the contractor. 

Performance and payment bond premiums generally range from 3% of the total contract amount for new contractors or higher-risk projects, to 1% for more established companies. They are priced based on the value of a project contract (not necessarily the size of the bond), meaning that changes in the contract amount may require premium adjustments. 

If a bonded contractor fails to follow the terms of their contract, an obligee can declare the contractor to be in “default.” The surety company will then investigate and may take action to remedy the situation. The following may be considered: 

• Re-bidding the job.
• Replacing the contractor to complete the project. 
• Helping the winning bidder meet their contractual obligations in the event of financing or cash flow issues.
• Paying compensation to the bond owner. 

What’s the difference between bid bonds and payment bonds? 

If you’re new to the world of contract surety bonds, you might be confused by their different applications and costs. Here’s a quick rundown of how bid and payment bonds differ: 

• Protections: Bid bonds and payment bonds are both obtained by a project contractor, but protect different groups. Bid bonds provide legal and financial protection for project owners against changing terms, while payment bonds provide financial protection to the workers and suppliers on a project. 
• Bond claims: A bid bond claim is made by the project owner (obligee) when a contractor defaults on their obligations at the start of a project. Payment bond claims are made by subcontractors or suppliers that have not been paid for that specific project.
• Cost: Bid bonds are generally issued by a surety company to a contractor at no charge. Performance & payment bonds are paid for by the contractor, with bond premiums generally ranging from 1% - 3% of the total contract value. 

In either case, the surety company must be satisfied with the capabilities and financial stability of the contractor applying for a bond. It pays for contractors to build strong relationships with their surety company, as it can streamline the bond underwriting process and help them qualify for larger contracts. 

When you’re ready to explore contract surety bonds for your next construction project, UFG Surety is ready to help. Find an agent near you today for help finding the right solution to fit your needs.