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Requiring Bid Bonds from Subcontractors

With subcontract failures on the rise and jobs going to contractors bidding work with little profit, there is no room for a bid or execution error these days. The impact of these errors can vary widely depending on the financial strength of a firm and whether it is an isolated problem or a systemic issue.

A lot of construction jobs—both publicly and privately funded—require the general contractors procuring the work to post performance and payment bonds. In turn, many of those general contractors require their subcontractors to post performance and payment bonds. This is prudent in today’s business climate, as it’s not always obvious if a firm is doing well or struggling. Longstanding companies in the industry are having issues just like lesser known firms. An unfortunate trend that is picking up steam is subcontractors failing or pulling off work before they sign subcontract agreements or post the required performance and payment bonds. This can lead to severe negative repercussions for the general contractor. Replacement subcontractors may come in at a more expensive price, putting additional pressure on already tight construction budgets. Schedules also can be impacted depending on how long it takes to find a qualified replacement contractor.

Though risks rarely can be eliminated entirely, a possible remedy is requiring subcontractors to post bid bonds.

General Contractors Should Require Bid Bonds
Historically, general contractors send a prequalification package to interested subcontractors on an annual basis. In today’s volatile environment, a yearly review of qualifications is simply too long of a time period. In addition, the simple form many general contractors provide to bond agents, sureties or subcontractors to ask about bonding abilities are not binding commitments.

For example, the following wording that appears in nearly all surety letters makes surety prequalification letters non-obligatory:

“The agreement for bid bonds or performance and payment bonds is a matter between the contractor and the surety company. XYZ Surety Company assumes no liability as to third parties or to others, if for any reason, we do not execute said bond(s).”

By requiring subcontractors to post bid bonds, general contractors stand a much better chance of getting a higher quality subcontractor. In addition, the general contractor would know a surety guarantee is behind the bid and that they are aware of the project at bid time, not just when the subcontractor requests a performance and payment bond they hope to secure.

Additionally, the general contractor can indicate acceptable surety parameters in the request for bids and then review the bid bonds that come in prior to committing to a subcontractor. To determine surety acceptability, general contractors usually require an A-rated surety company as determined by AM Best. They also routinely confirm the surety’s U.S. Treasury Department listing is greater than the value of the bond being issued for the subcontractor.

The general contractor also would have recourse against a subcontractor and surety company if a selected subcontractor does not enter into a subcontract. While it is hopeful the requirement of bid bonds would nullify the risk of a subcontractor not entering into a subcontract, that is not always the case. However, the risk should be significantly less than if a bid bond was not required.

This risk mitigation tool applies to federal, commercial and public works construction projects. On federal jobs, in which general contractors depend on teaming partners to win the contract and successfully perform the work, it is crucial to ensure they actually enter into the subcontract. In addition, it is not unusual for a surety company to require a large teaming partner to bond back to the prime contractor. Requiring a bid bond when the teaming partner submits a proposal will enhance the chances the firm will fulfill its pre-award obligation and enter into a subcontract.

General contractors that plan on requiring subcontractor bid bonds should be prepared for the subcontractor’s surety to request some basic information to underwrite the request; for example, copies of all potential bond forms that may be required (bid, performance, payment), an explanation of project financing, if the general contractor will be bonding the project and a sample subcontract agreement.

Subcontractors Should Endorse Bid Bond Requirements
Subcontractors that qualify for bonding should consider bid bond requirements a good thing. These requirements should help reduce the amount of competition on a bid by removing less qualified firms that cannot get a surety to guarantee their work from the pool of bidders.

Subcontractors can learn valuable information from their surety partner. Information the surety should review and provide input on includes the bid bond, performance bond, and payment bond form’s terms and conditions. These can vary widely and, from time to time, be very onerous on the subcontractor and surety.

In addition, the surety can review the scope of work, workmanship guarantees, efficiency guarantees, liquidated damage provisions and indemnity provisions. This is a more advantageous time to negotiate onerous terms and conditions than when it comes time to sign the contract. If terms are not negotiable, the subcontractor and surety can make an informed business decision before wasting a lot of time, energy and money putting together a bid.

Just like prime contractors, subcontractors still can pull out of bids that require bid bonds. It’s important not to feel boxed into taking a job if a legitimate bid error occurred.

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