Tender security and bid bonds hold immense importance in construction and procurement because they help protect the integrity of competitive tendering. These financial instruments protect the buyer and the bidder in the competitive tendering process and secure both parties from the risk of nonperformance or fraudulent bidding.
Although these words are sometimes used in the same context, they are terms with distinct definitions and purposes that every contractor or supplier needs to know.
Through this blog, let's dig into the meaning and relevance of tender security and bid bonds.
What is Tender Security?
Tender security, also known as bid security, is a form of financial guarantee that is submitted together with the bid by the bidder as part of the tendering process.
Purpose:
- The principle of tender security arises to protect the project owner or issuer of the tender from any loss or delay caused by unqualified or non-committed bidders.
- Bid security ensures that only qualified and committed bidders are involved in the process, and the tendering system becomes more effective in integrity and fairness.
Types of Tender Security:
1. Cash or Bank Guarantees: Tender security can take the form of a cash deposit or bank guarantee. In case a bidder fails to honor their commitment, the project owner can call upon the guarantee to recover any financial loss incurred from the bidder's withdrawal.
2. Insurance-Backed Securities: Some bidders may give insurance-backed guarantees. Such policies are issued by insurance companies to guarantee the commitment of the bidder, if winning, to adhere to the terms of the tender.
Tender security is generally required when the bid amount is significant or when there's a risk of the bidder withdrawing after the contract is awarded. The sum of bid security is always the percentage of the bid estimate and usually ranges between 1% and 5%.
What is a Bid Bond?
A bid bond is a form of tender security usually given by an insurance company or a surety bond provider. A bid bond ensures payment in the event the winning bidder fails to sign the contract or abide by the terms and conditions outlined in the tender document.
- Objective: The purpose of a bid bond is to ensure that the successful bidder accepts the contract and performs the work as provided in the tender. Any failure by the selected bidder may result in project owners recovering their losses or costs through claims from the bond.
- Usage at Large: Bid bonds are commonly used in construction contracts, particularly in big projects. High-value projects, such as infrastructure, real estate development, or public works, carry a higher non-performance risk. Generally, these are ensured with the help of the continuity of projects in the case of such risks by the use of bid bonds.
Bid bonds typically range between 5% and 10% of the contract value.
What is EMD?
Like tender security and bid bonds, earnest money deposit (EMD) ensure the bidder will honor the terms and conditions of their bid. Earnest money deposits (EMD) are refundable deposits returned if the bidder fulfills their obligations. The primary distinction is in the role and application: EMD is usually applied as a cash deposit. Tender security and bid bonds may be composed of third-party guarantees or bonds.
Tender Security vs. Bid Bond: What's the Difference?
Tender security and bid bonds are often confused or used interchangeably; however, there are some fine differences between them. Here's a breakdown:
Nature of the Guarantee:
- Tender Security: This is a general term referring to any kind of financial security - usually cash deposit, bank guarantee, or bond-that needs to support a bid.
- Bid Bond: It is a bid security in particular but offered as an insurance or surety bond; it is often issued by an independent third-party surety company.
Issuer:
- Tender Security: This can be provided by sources such as a bank, a financial institution, or as a direct cash deposit.
- Bid Bond: Underwritten by a surety company or insurance provider, who insures the risk of ensuring the bidder's performance.
Purpose:
- Tender Security: This secures the bidding process by ensuring the bidder will undertake the terms and stipulations of the contract once awarded.
- Bid Bond: This specifically guarantees that the successful bidder will execute the contract and furnish the required performance security when awarded the contract. If the bidder defaults, the bid bond compensates the project owner.
Refundability:
- Tender Security: This may be refundable if the tendered bidder is not awarded the contract, depending on the terms of the tender.
- Bid Bond: Usually non-refundable, as this is an advance paid to a third-party surety company.
Why Tender Security and Bid Bonds Matter?
- Bidder Default Protection: Project owners are protected by tender security and bid bonds. In the event of a failure to sign or withdraw by a successful bidder, the project owner can claim compensation from the bond or security. Bid security reduces the impacts of delays or a re-bid of the project.
- Promotes Serious Bidding: The cash guarantees ensure that only the serious and capable bidders participate in the bid. It reduces the risk of low-ball bids from incompetent or uncommitted contractors who have no intention of resources for completion.
- Enhances Credibility for Bidders: For contractors, providing a bid bond or bid security demonstrates financial responsibility and professionalism. It signals to project owners that the bidder has the means and intention to deliver the project. This strengthens their reputation and increases future opportunities.
- Avoids Unfair Practices: Pre-tender security and bid bonds prevent fraudulent or irresponsible bidding, created by fake or overly aggressive bids. This situation tends to create a more transparent environment among all bidders.
- Reduces Legal Risks: These guarantees ensure legal and financial risks are minimized since both parties are committed to the contract. In cases of default, legal and financial recourse could easily be processed, thus making things clearer instead of disputes.
- Enhances Confidence in Completing the Project: The existence of tender security and bid bonds increases the chances of a project's completion on time. With specifications agreed upon between the project owner and the bidder, the confidence of both parties increases.
How to Secure a Bid Bond or Tender Security?
Working with Surety Companies:
- Obtaining a bid bond is essentially teamwork with a surety company that will stand as a guarantee to ensure that the contractor will perform his part of the terms for the particular tender.
- Contractors usually seek a surety company by presenting an application that contains the financial status of the company, project descriptions, and previous experience.
- The surety then checks the capacity of the contractor to undertake the project. Being aware of the terms and conditions of this bond, such as premium cost, length, or exclusions/limitations of coverage is significant.
Common Requirements for Obtaining Tender Security:
- To secure tender security or a bid bond, contractors must show good financial standing, creditworthiness, and sound company background.
- Surety companies and financial institutions evaluate these factors for their risk. Some of the fundamental requisites may be in terms of providing financial statements, a history of completing projects successfully, and evidence showing insurance coverage.
- Sureties and financial institutions each play a crucial role in the offering and underwriting of tender securities to ensure project owners are protected in case the contractor fails.
Conclusion
Tender security and bid bonds are important instruments assuring the integrity and success of the competitive bidding process. These financial guarantees protect both the project owners and the bidders against other serious participants and reduce the risks of defaults.
They enhance the credibility of the contractors and ensure the timely completion of the project by protecting it against non-performance and fraudulent bids.
For an easier management of your bidding process from the securing of bid security to the tracking of EMD, turn to Tender Grid, the best e-procurement platform designed for streamlining and safeguarding your tendering experience.
