For construction companies that perform public contracts, such as for a township, state or the federal government, Bid Bonds are a fact of life.  These contracts are often awarded through a competitive bidding system in which proposals are submitted by interested contractors.  A review of the proposals in made, and the work is awarded to the “lowest responsible bidder.”  This is intended to assure that taxpayer dollars are spent efficiently, and a quality contractor is engaged.

The contractors need the participation of a surety company, such as an Individual Surety or a corporate firm.  Both are equally accepted by the federal government and many other public and private entities.  The Individual Surety will issue a Bid Bond to accompany the contract proposal and a Performance and Payment Bond when the construction contract is executed.

The decision to issue the bid bond is made when the Individual Surety completes their review of the contractor’s qualifications to perform the contract in question.  This evaluation is performed in advance since the contractor has not yet won the project

After the bids have been submitted, the details of the individual proposals become a matter of public record.  When the successful contractor needs the Performance and Payment Bond, the surety will review the bid results.  The surety underwriter wishes to calculate the bid spread in order to determine if the low bid they are bonding is “in line,” meaning not excessively low.

The magic number is 10%.  Bids more than 10% below the second bidder or more than 15% below the average of the second and the third will require a written explanation.  This explanation must assure that the bid estimate was reviewed and is correct, and that the contractor anticipates a reasonable profit and wishes for the bond to be issued.

Here is how the calculation is performed. 

In this example there were three bids.  The low bid was $100,000.  Second bidder was $112,000 and the third bidder was $114,000.  First, find the difference between the second and low bids. $112,000 – $100,000 = $12,000.  Next divide this by the low bid.  $12,000/100,000 = .12.  This means the low bidder is 12% below the second. 

Since this is more than 10%, let’s try the second analysis. 

$112,000 + $114,000 = 226,000/2 = $113,000.  Now run the analysis on the low bid again: $113,000 – $100,000 = $13,000/100,000 = .13 or 13%.  So the low bid is more than 10% below the second (it was 12% below), but not more than 15% below the average of the second and the third (it’s 13% below). 

Therefore this bid might not require any special explanation and the performance and payment bond would be issued by the Individual Surety.