Bid Bond: How a Tender Guarantee Works

Running a tender costs the owner time and money, and the prices it receives are only useful if the bidders stand behind them. A bidder that withdraws once it has seen the others' prices, or that wins and then walks away, leaves the owner to re-tender or to accept the next, higher bid. The bid bond gives the owner a sum it can claim when that happens, and gives every bidder a reason to price carefully.

Its life is short and its triggers are few. It is lodged with the bid and must stay valid for the bid validity period plus a margin; the World Bank's procurement regulations, for projects it finances, put that margin at generally four weeks. It can be claimed if the bidder withdraws or modifies its bid during validity, or wins and fails to sign or to provide the performance security on time. It falls away once the winner has signed and posted that security; unsuccessful bidders' bonds are released once the contract is signed with the winner. Some owners ask for a bid-securing declaration instead, under which a defaulting bidder is barred from that owner's tenders for a period rather than paying money.

The tender states the amount, as a fixed sum or a percentage of the bid, and it is usually small against the contract price. Banks commonly issue bid bonds as demand guarantees: the owner presents a demand, commonly with a statement of what the bidder failed to do, such as signing within the stated period after award, which URDG 758 requires unless the guarantee excludes it, and the bank pays on a complying demand without deciding whether the owner was right. Insurers and sureties also write them, and some of their forms are conditional, paying only the owner's actual loss, such as the gap between the defaulting bid and the next, up to the bond amount.

Tenders run late, and owners ask bidders to extend their bids, and with them the bonds. Where the bond is subject to URDG 758, an owner can present an extend-or-pay demand near expiry; the bank may suspend payment for up to 30 days while its customer decides whether to extend, and pays if no extension is agreed.

A pipeline contractor, constructed for this page, has a US$3.0m guarantee line with its bank, of which US$1.6m is used by performance and retention bonds on current jobs. It bids for four contracts priced at US$6m, US$9m, US$14m and US$20m. Each tender asks for a bid bond of 2% and, on award, a performance bond of 10%. Every figure is the example's.

While the bids are open, the bonds fit with room to spare. The day two of them win, the contractor needs a line two-thirds larger, and probably more working capital to mobilise two jobs at once. If the bank declines to issue the performance bonds and the contractor cannot find another issuer, such as a surety, in time, it cannot post them, and failing to post them is itself a trigger: both owners can call the bid bonds, US$680,000 in all, which the bank pays and debits to its customer. By issuing the bid bonds, the bank took on most of the decision about the performance bonds months before anyone asked for them.

The two follow each other. A bid bond covers the stretch from submission to signing and is called if the bidder refuses to enter the contract. A performance bond covers the contract itself, from signing through completion and often into the defects period, and is called if the contractor fails under it. The performance bond is larger, lasts longer and is the owner's main security; the bid bond exists largely to make sure the performance bond arrives. A contract that also pays an advance adds a third instrument, the advance payment guarantee, at the same moment.

Some tenders make the link explicit, asking the bidder's bank for a letter committing it to issue the performance security if the bid succeeds. That turns the bank's implicit undertaking into a written one, and the credit officer approves it as such.

DEFINED IN ONE PARAGRAPH → · PRODUCT FILE: BANK GUARANTEE → · THE ON-DEMAND GUARANTEE →

A contractor's bank reads the bid pipeline, not the bonds. Which tenders is the business likely to win, and could it carry two or three of them together? What is its record of wins against bids, and of finishing what it won at the margin it priced? A bank that approves a guarantee line without asking has approved the performance bonds by default, because refusing them later costs its customer the bid bonds and the jobs together.

The bond also says something when it is called. A bidder that would rather lose its bid bond than sign has often found an error in its own price, and a contractor whose estimates are wrong enough to walk away from one job may have the same error in the jobs it is already building. A credit officer who sees a bid bond called reads the contractor's other contracts next.

HOW BANKS READ A WORKING CAPITAL REQUEST → · PROGRESS CLAIMS → · CASH COVER →