Tishk International University

Faculty of Engineering
Civil Engineering department

Bid Bond, performance Bond and Payment Bond

Course Instructor: Mr. Haval M. Salih

Course Title: Construction Management
Student name: Laween Kakil Hamad
Student ID:121119011
Stage: 3rd
Submission date:15/10/2021
Fall semester – 2021
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Table of Contents
1. Types of bonds................................................................................................................................................ 3
1.1. Bid Bonds................................................................................................................................................ 3
1.1.1.How Bid Bonds Work?.................................................................................................................... 3
1.2. Performance Bond................................................................................................................................... 4
1.2.1.How Does a Performance Bond Work?........................................................................................... 4
1.3. Payment bond.......................................................................................................................................... 5
1.3.1.What Is the Difference Between Payment Bonds vs Performance Bonds? ...................................... 5
2. Cost of bonds.................................................................................................................................................. 6
2.1. Cost of bid bonds..................................................................................................................................... 6
2.2. Cost of performance bond....................................................................................................................... 6
2.3. Payment cost........................................................................................................................................... 6

Table of figures
Figure 1 performance bond................................................................................................................................... 5

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 Introduction

A construction bond is a type of surety bond used by investors in construction projects. Construction
bonds are a type of surety bond that protects against disruptions or financial loss due to a contractor's
failure to complete a project or failure to meet contract specifications. These bonds ensure a construction
project’s bills will get paid. Construction bond, also known as a contractor license bond, is a required
bond for a construction project. A contractor is required to have construction bonds for nearly all

government and public works projects. A contractor vying for a construction job is generally required to
put up a contract bond or construction bond.

The construction bond provides assurance to the project owner that the contractor will perform

according to the terms stated in the agreement. Construction bonds may come in two parts on larger

projects: One to protect against overall job incompletion, and the other to protect against non-payment
of materials from suppliers and labour from subcontractors.

here are generally three parties involved in a construction bond:

-The investor/project owners, also known as the obligeee.

- The party or parties building the project.

- The surety company that backs the bond.

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The project owner or investor is typically a government agency that lists a contractual job it wants to be
done. To reduce the likelihood of a financial loss, the obligeee requires all contractors to put up a bond.
The contractor selected for the job is usually the one with the lowest bid price since investors want to
pay the lowest amount possible for any contract.

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Types of bonds
Bid Bonds
A bid bond is a type of construction bond that protects the owner or developer in a construction
bidding process. It is a guarantee that you, as the bidder, provide to the project owner to ensure that if
you fail to honour the terms of the bid, the owner will be compensated. A bid bond is typically
obtained through a surety agency, such as an insurance company or bank, and it helps guarantee that a
contractor is financially stable and has the necessary resources to take on a project. Bid bonds are
commonly required on projects that also involve performance bids and payment bonds.

A bid bond typically involves three parties: the obligee, the principal, and the surety. The obligee is the
owner or developer of the construction project under bid. The principal is the bidder or proposed
contractor. The surety is the agency that issues the bid bond to the principal. The principal purchases
the bid bond from the surety for a set price, much like a premium for an insurance policy. The
coverage value of the bond is called the penal sum and represents the maximum amount of damages
the surety will cover with the bond.

How Bid Bonds Work?

Bid bonds help to prevent contractors from submitting frivolous or inappropriately low bids to win a
contract. During a construction bidding process, various contractors (principals) estimate what the job
will cost to complete, and they submit their price to the owner (the obligee) in the form of a bid. The
contractor who wins the bid is given a contract for the project.

A bid bond serves as a guarantee that the contractor who wins the bid will honour the terms of the bid
after the contract is signed. If the contractor fails to honour the terms of the bid—for example, he
raises his price for the job after the contract is signed—the contract may be broken and the owner will
have to find another contractor for the project, presumably the next-lowest bidder. A bid bond
compensates the owner for the cost difference between the initial contractor's bid and the next-lowest
bid. Sometimes, the surety agency sues the contractor to recover these costs, depending on the terms of
the bond.

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Performance Bond

A performance bond is a type of contract bond that guarantees a contractor will complete a project

according to the terms outlined in a contract by the project owner, also called the obligee. The obligee
can be a city, state, or local government, as well as the federal government or a private developer. One
reason these bonds are often required for public projects is to ensure hired contractors are financially
and professionally capable of completing the projects they bid on. Surety bond companies that are
willing to bond a particular company for a project are, in essence, vetting the contractor’s capability of
completing the specified project on behalf of the project owner.

A performance bond is required on federal government construction projects exceeding $100,000 as a

result of the Miller Act of 1934. Prior to this, it was common for contractors to intentionally underbid
government contracts in order to be awarded projects with the intent of not completing the work unless
the contract price was increased after the fact. Since there were no bond penalties in place to prevent
this, obligeer’s were essentially held at ransom. They could pay the increased financial demand or fire
the contractor and rebid the project, only to have the same problem repeat with the new company.

Performance bonds solve this issue.

How Does a Performance Bond Work?

If a contractor (the principal) fails to meet the terms outlined in the contract, the project owner

(obligee) can make a claim against the contractor’s bond seeking to recover financial damages. If a
claim is valid, the surety will compensate the obligee on behalf of the principal up to the bond amount.
It’s important for contractors to know that performance bonds are fully indemnified, so in the event of
a claim, the contractor is responsible for repaying the surety the amount of the claim plus expenses. In
some instances, a surety may work with a project owner following a claim to hire a new contractor in
lieu of providing a cash settlement to the project owner.

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Figure 1 performance bond

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Payment bond
A payment bond is a surety bond issued to contractors that guarantees that the contractor will pay
their subcontractors, material suppliers, and laborers in a timely fashion.

Payment bonds are usually obtained by contractors or subcontractors prior to the commencement
of a construction project. Their function is to guarantee that the labour and materials provided by
subcontractors and suppliers to a general contractor will be paid for in due time and in compliance
with the contract. These bonds also guarantee that payments for labour and material will comply
with state and federal laws and regulations. Payment bonds serve as protection for subcontractors,
and offer them legal recourse against contractors who do not fulfill their side of the contract terms.
If a contractor has failed to pay subcontractors, suppliers and laborers can file a claim against the
payment bond within a certain period of time, and receive compensation by the surety.

When do you need a payment bond?

Payment bonds are typically used in conjunction with performance bonds and are oftentimes even
on the same bond form. Contractors purchase payment bonds when negotiating a construction
contract to reassure those working with them that they will be paid appropriately and on time.

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Differences between the bonds

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Cost Of Bonds (Your Guide to Payment Bonds,
n.d.)
Cost of bid bonds

The cost of a bid bond—the premium paid by the contractor to the surety—is based on several factors,
including the cost of the project (bid cost), the location of the project, the owner, and the financial
history of the contractor. For small projects, bid bond premiums may be a flat fee, such as $100 or
$200. For larger projects, the bid bond premium usually is based on a percentage of the total project
cost and the penal sum of the bid bond.
The standard penal sum for non-federal projects ranges between 5 and 10 percent of the total project
cost. The penal sum for federally funded projects is mandated at 20 percent of the project cost. Bond
premiums typically range from 1 to 5 percent of the penal sum. For example, if the project cost is
$500,000, and the penal sum is $50,000, the contractor's cost for the bond may be $500 to $2,500.

Cost of performance bond

The cost of a given bond will fluctuate greatly based on several factors. The two primary criteria
commonly used by sureties when determining how much to charge for a performance bond is the
amount of the bond in addition to the overall strength (experience, credit, liquid assets, etc.) of an
applicant. Rates most commonly fluctuate between 1.5% and 3.5% of the project amount.
Performance bonds are generally a small percentage of the bond amount, given an applicant is
financially strong, though not all contractors will qualify for a bond at any price. Because they are
fully indemnified, a surety looks for an applicant that is financially sound enough to repay the surety in
the event of a claim. Otherwise, they will not issue a bond. The larger the bond amount being
requested, the more difficult it will be for a contractor to qualify because the risk to the surety
increases proportionally. Often, the cost of a bond is included in a contractor’s bid, effectively passing
the cost onto the project owner as an itemized project expense.

Cost of payment bond

Payment bond costs can vary but are often around 3% of the contract amount assuming the applicant
has sound financials. For example, if your bond requirement is for $200,000, then a 3% premium
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would translate to a $6,000 bond cost. Payment bond costs will depend on several factors including the
financial strength, credit score and experience of the contractor requesting the bond.

Conclusion

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References

(What Is a Performance Bond?, n.d.)

(What Is a Bid Bond?, n.d.)
(Payment Bond, n.d.)
(Your Guide to Payment Bonds, n.d.)
(Understanding Bid Bonds and Performance and
Payment Bonds: The Complete Guide for
Insurance Agents, n.d.)

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https://www.californiacontractorbonds.com/
contract-bonds/performance-bond/

https://www.thebalancesmb.com/what-is-a-bid-
bond-844376

https://www.suretybonds.org/contract-bonds/
payment-bonds

https://www.suretybonds.com/payment-bonds.html

https://www.bondexchange.com/understanding-
bid-bonds-and-performance-and-payment-bonds/

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