Construction of any building takes a lot of resources. When someone plans to construct a building, they invest a considerable sum of money. Thus the building owner needs an assurance that the contractor will appropriately enter into the contract as per their bid submission once the contract has been awarded. The bid bond provides such confirmation. There can be an additional sense of financial security if the owner knows what is a bid bond and how they can benefit from it.
The bid bond may also be an offer fulfillment agreement, managed by a third party, usually a bank or an insurance company, and assures that the contractor has an excellent financial background. It ensures that the contract will be entered into as per the parties’ agreed terms. If the contractor does not fulfill the conditions, they will pay a certain sum to the owner.
As per the agreement, the contractor will be termed as the “principal,” the owner will be termed as the “obligee,” and the insurance company/ bank will be referred to as the “surety.”
The document has to be purchased by the owner; the owner will explain the maximum coverage provided by the surety if the contingent event happens. This coverage sum will be technically referred to as the “penal sum.” Usually, the penal sum will be calculated up to 20% of the amount bid on the project.
THE FUNCTIONALITY OF BID BONDS
Every bond functions in three steps.
- The first step is the guarantee step. The financial institution/ insurance company meets the project owner in this step. The overall sum of the project, the penalty sum, and the contingent event(s) that trigger the contract clauses will be finalized.
- The second step is verification. The project owner runs a background check on the financial soundness of various bidders. Potential bidders are shortlisted and finalized requirements of the owners. Owners seek to avoid frivolous bids. A frivolous offer is a type of bid that would appear cost-efficient on paper only and has aftermath due to poor materials.
- The third step involved in understanding what is a bid bond is the triggering of the clause(s).
OTHER USE OF BID BOND
Apart from the general usage of bid bonds in contractual building projects, they are utilized in federal jobs too. In federal employment, offer fulfillment agreement clauses are triggered when the bidding candidate refuses to forego the job. In this case, the surety company/ organization would have to provide relevant proof of sound financial background.
HOW IS AN OFFER FULFILMENT AGREEMENT CALCULATED
Commonly, the bond is a certain percentage of the project sum. However, there are certainly other factors that influence the agreement.
The project’s approved location will be checked. The location plays a significant factor in prospects such as rent and revenue. Thus, this becomes an essential factor in the calculation.
The financial strength of the owner is crucial. If the owner was involved in any past contractual building projects/ is actively engaged in any other such project(s), it will be factored in.
The calculated sum may happen to change along with the project’s development. Based on such changes, the sum will be altered accordingly. For, the initial sum is an approximate budget only.
HOW TO PURCHASE A BID BOND?
The first step is to establish the project owner’s search for a contractual builder. There are several forums available to post such requirements. Owners also tend to approach independent builders based on the contractor’s popularity.
While the owners receive bids, the owner can simultaneously approach an agent specialized in fulfillment agreements. The owner’s meeting with the agent will involve filling in several relevant questionnaires, which play a role in determining the agreement sum. If the owner is new to the bid bond concept, it is advisable to have a trustworthy advocate present by the side to understand the process.
Following the questionnaire, the owner will be explained the concepts, terms and conditions such as underwriting. This step is crucial for the agent and the owner to reach a common understanding. The owner will then be required to fill out a bond request form.
Following the bond request approval, the owner can utilize the copy of it to discuss terms with the shortlisted contractors.
While visiting the agent, it is advised that the owners have the relevant document handy such as the financial statements. Such action will quicken the analysis by the agent. Often, the agent will assist the owner in such analysis and reach a reasonable consensus on the sum of the offer fulfillment agreement. Some agents will provide in-depth insights into how the owner can improve their financial credentials.
Bid bonds offer the financial safety net for the project owners who invest time and energy into the projects. The offer fulfillment agreements/bid bonds happen when any bond clause is being triggered due to one or more contingent activities. Thus, the owner will recover the financial status to a certain extent.