Bonding basics

Q: What are bonds and when are they required?

According to the Federal Acquisition Regulations (FAR), a bond is a written document between a bidder or contractor (the principal) and a second party (the surety) to ensure fulfillment of the principal’s obligations to a third party (the obligee or government) identified in the bond. If the principal’s obligations are not met, the bond ensures payment, to the extent stipulated, of any loss sustained by the obligee. Put simply, bonding protects the government from financial losses.

The bonding process

Contractors seeking bonding must be prepared to prove to a surety that their company has the capacity, character and capital to perform the project(s) on which they are seeking to be bonded. Sureties want to be sure that entering into a bond relationship with a contractor is a good business decision. Prior to issuing a bond, a surety will analyze a contractor’s capacity to perform (necessary equipment), financial strength (good credit history and line of credit), past performance in similar contracts and organizational structure.

Types of bonds

In construction projects, it is typical for the federal government to require bid, performance and payment bonds.

A bid bond provides financial assurance to the government that a contractor has submitted the bid in good faith, that the contractor will not withdraw a bid and that if awarded the contract, the contractor intends to enter into the contract at the bid price. A bid bond also ensures that the contractor will provide the required performance and payment bonds.

A performance bond protects the government from financial loss should the contractor fail to perform the contract in accordance with the terms and conditions of the contract documents.

A payment bond guarantees the contractor will make payments to all subcontractors supplying labor and material in performing the government contract.

An ancillary bond guarantees other factors incidental but often essential to perform a contract.

When are bonds necessary?

Unless waived, bid bonds are only required when performance bonds or performance and payment bonds are required. In such cases, all bidders must submit a bid bond with the offer. The bid bond amount shall be at least 20 percent of the bid price but shall not exceed $3 million.

The Miller Act requires a successful bidder to submit performance and payment bonds for any construction contract exceeding $100,000. This requirement may be waived in limited circumstances. Unless the contracting officer determines that a lesser amount is adequate for the protection of the government, performance and payment bonds shall be 100 percent of the original contract price. If the contract price increases, the performance and payment bonds must also increase by the same amount.

For any construction contract between $25,000 and $100,000, the government contracting officer shall require two or more of the following payment protections from the successful bidder:

  • A payment bond
  • An irrevocable letter of credit, a written commitment by a federally insured bank to pay a stated amount until the expiration date of the letter
  • A tripartite escrow agreement, in which the government makes payments to the contractor’s escrow account, and the escrow agent distributes the payments to the contractor’s suppliers of labor and material
  • A certificate of deposit from a federally insured financial institution, executable by the contracting officer
  • A deposit of the amount of the bond in U.S. bonds or notes, certified or cashier’s checks, bank drafts, postal money orders or currency

Generally, federal government agencies do not require performance and payment bonds for contracts other than construction contracts. However, they may require performance bonds when a contract exceeds the simplified acquisition threshold ($100,000) and government property/funds are provided to the contractor for use in performing the contract; when substantial progress payments are made to the contractor; or if the contract is for dismantling, demolition or removal of improvements. A payment bond is only required when a performance bond is required and if its use is in the government’s interest. Annual bid bonds and annual performance bonds might be used in lieu of individual bonds for each project.

Reference the FAR Part 28 Bonds and Insurance for further guidelines on bonding for federal government contracts. State and local government agencies may also use bonds for their financial protection. However, they may use them in different contracting situations and with different dollar values.

For more information on bonding, consult your local Missouri Procurement Technical Assistance Center (MO PTAC).

– Donna (Leonard) Porch, former program director for MO PTAC-Kansas City. Article used with permission from the Kansas City Small Business Monthly.