If you’re a contractor requiring a bid bond for your next project, or what you hope is your next construction project, there’s not a lot to learn about bid bonds, which is the good news, however the bad news for most contractors is that the process isn’t as easy as they think.
It’s understandable why so many of my contractors think buying a bid and or performance bond is easy. First, I generally make buying business insurance, including general liability and commercial auto coverage relatively easy, and the “balance of contractual power” is squarely with the contractor looking for other insurance coverage. The same isn’t necessarily true for contractors wanting a bid and/or a performance bond, especially newer and smaller contractors.
The reason why is because unlike a general liability policy, where the risk is relatively small the policy will pay out, the odds of paying out is much greater for a performance bond. Let’s examine why, using the comparison of a general liability policy.
Most contractors try very hard not to become negligent to another party while performing their work. Negligence means the contractor owed a duty to another party (this other party could be a home owner, business owner, employee, or some other person on the job site), the contractor breached their duty to the other party (breach in this context means they did something, or failed to do something that a reasonable contractor would do in the situation (for example, a roofer knows the building they are working on to replace the roof has people entering and exiting the building at the same time. A reasonable roofer would make sure to never toss old roofing material from the roof to the ground where people are entering or exiting, however, if they did do so, it would be a breach of the duty they owe to the people entering or exiting because those people could get hurt).
And if the contractor breaches the duty, and as a result of the breach, someone gets hurt, boom, you likely have negligence that the general liability policy may have to pay out on. To be sure, there’s a whole lot more to negligence then this quick over simplistic explanation, albeit the point here is to discuss performance bonds, and not the nuances of general liability nuances. That said, feel free to give us a call if you want to discuss this further.
Now, comparing the likelihood of paying out on a commercial general liability policy we have a performance bond risk assessment made by insurance companies. An insurance company writing a performance bond agrees to pay out if the contractor doesn’t perform as agreed. And as you can quickly imagine, this includes much more than a contractor not showing up to do the work at all. The contractor may fail to perform in a reasonable workmanlike fashion. Or may perform 70% of the contract and run out of money and walk away. There are LOTS of possibilities where a performance bond company may have to pay out.
Akin to most small business startups, the odds of success are much lower than an operation with years of business reputation built up. For that reason (along with others) the odds and likelihood of a performance failure claim being made are much higher with new contractors, and by new, I also mean contractors that are stepping up above what they have done in the past. A good example of this is a contractor that historically has worked with homeowners for $15,000-$30,000 home improvement projects, and then wants to bid on a government contract worth $300,000. Any objective third-party (think performance bond company here) will ask the question of “what’s the capacity of this business to move up to a project worth 10 times their normal size?”
At this point, you’re now probably starting to think the bonding process and risk assessment is much like extending a line of credit or unsecured credit card limit and if so, you’re absolutely correct. The bonding companies view the approval of a bid bond and performance bond a lot like extending credit, because if the contractor doesn’t deliver, the bonding company must step up and pay the difference what was paid out, and/or the bid amount and the cost of hiring another contractor to finish the job. This can be extremely costly, especially if the first company isn’t finishing the job because they underestimated the cost of performance.
Thus, the bond company will look at a contractor’s credit and business history, look at other bids (ie is your bid WAYYY under the second and third lowest bid), your overall credit experience, and your current staffing vis-a-vis the staffing required for the subject project/contract.
All of this takes time, and there lies the motivation to write this article. Most (almost all) first-time performance bond buying contractors underestimate the amount of time to secure a bond, and unfortunately some performance bonds are simply out of reach for some contractors. In either case, this can become a real problem for contractors that don’t know the process. This is why it is essential that if you’re thinking of bidding on a government contract or any project that requires a performance bond that you allow your business to have plenty of time to secure the bond well before it’s required.
How long is plenty of time? This really depends on the size and scope of work in relation to your current operations, albeit a good rule of thumb is to allow at least two weeks from the time you’re able to supply required financial information (ie potentially tax returns, balance sheet, profit and loss statements etc…) and the time your bid needs to be submitted. I would say that having the pre-approval is vital because otherwise you face all the work, time, and effort of calculating your bid without knowing if you can even get the bond.