Bid Bonds and Performance Bonds: What a Sub Needs to Know

Why this matters

The first time a general contractor or a public owner asks you to be bonded, the vocabulary alone can cost you a job you were qualified to do. Bonds are not insurance and they do not work like insurance, and a sub who treats them the same signs promises they do not understand. Knowing what each bond guarantees, who is actually protected, and what you are on the hook for turns a bonding requirement from a wall into a normal cost of commercial work.

A bond is a three-party promise, not a two-party policy

Insurance protects you. A surety bond protects someone else from you.

• Principal: you, the contractor doing the work.
• Obligee: the party the bond protects (the project owner, or the GC when you are their sub).
• Surety: the company that guarantees to the obligee that you will perform, and pays the obligee if you do not.

Here is the part that trips up everyone: when the surety pays, it comes after you to get its money back, because you signed an indemnity agreement promising exactly that. So a bond is the surety extending you credit and vouching for you, not covering your losses. Insurance absorbs a loss; a bond you ultimately repay.

The three bonds you will meet

Bid bond. Guarantees that if you win, you actually enter the contract at your bid. If you back out, or your number was a mistake you will not honor, the surety covers the gap between your bid and the next one, up to the bond amount, which is often set as a percentage of the bid, commonly up to around ten percent, with the exact figure stated in the bid instructions. It exists to keep bidders honest.

Performance bond. The big one. Guarantees you will finish the job to the contract. If you default, the surety can pay to complete it, hire a replacement, or finance you through, then bill you. Performance bonds are typically written at the full contract value, so the guarantee, and your indemnity exposure, is the whole job, not a slice.

Payment bond. Guarantees your subs and suppliers get paid. It matters most on public work, where a mechanic's lien cannot attach to public property, so the payment bond is the downstream parties' only security. If you are the sub, the GC's payment bond is often your backstop when the GC does not pay.

What the surety underwrites: the three Cs

A surety is betting you will finish, so it underwrites you like a lender. The trade shorthand is the three Cs:

• Capital: your financial strength, working capital, and balance sheet. Can you fund the job through slow payments and retainage (the percentage of each payment held back until the job is substantially complete)?
• Capacity: can you actually do this work, at this size, with your people and equipment? Your track record on similar jobs.
• Character: your reputation, references, credit history, and how you have handled trouble before.

Strong Cs earn a higher bonding line at a better rate. Weak Cs mean more collateral, a lower limit, or a decline.

Bonding capacity: single and aggregate limits

Your surety approves two numbers.

• Single-job limit: the largest one project it will bond.
• Aggregate limit: the total bonded work it will carry across all your open jobs at once.

A job that fits your single-job limit can still be declined because your aggregate is full of other open work. Manage your bonded backlog the way you manage cash. A full aggregate is a bidding freeze until something closes out.

Cost and the indemnity you sign

The premium for a bond is a modest percentage of the contract value, often in the low single digits and driven by your three Cs, so better financials and a clean record lower it. Keep two things straight:

• The premium buys the guarantee for the obligee, not protection for you. You still owe the surety back for any loss it pays.
• The indemnity agreement is usually personal, and often spousal, so a bond claim can reach personal assets, not just the company. Read it before you sign. It is the real document, and it outlives the job.

References

• The Surety and Fidelity Association of America, bond-type and underwriting fundamentals
• U.S. Small Business Administration (SBA) Surety Bond Guarantee Program
• Miller Act and state "Little Miller Act" payment and performance bond requirements on public projects (thresholds vary by jurisdiction)
• See related: Bond This Job or Walk Away (decision tree); Getting on an Approved-Vendor List