Why are Contract Bonds Required for Public Construction Projects?

Practically all of the public construction jobs in America are done by private sector firms. The jobs are typically rewarded to the lowest reactive bidder through the open competitive sealed bid system. Bid bonds play a crucial role in making this system work.

A bid bond is in place to keep irresponsible bidders out of the bidding process by guaranteeing that the lowest bidder will enter into a contract and supply the required performance and payment bonds. If the lowest bidder fails to follow through with these commitments, the owner is protected, up to the amount of the bid bond, typically for the difference between the low bid and the next higher responsive bid.

A performance bond backs up the contractor’s guarantee to perform the job description according to the contract’s terms and conditions, final price, and within the allotted time frame. This type of bond protects specific workers, material suppliers, and subcontractors against nonpayment. Since mechanic’s liens cannot be placed against any public property, the payment bond may be the only protection these claimants have if they are not paid for the goods and services that they provide to the project.

In the majority of cases, contract bonds are required by law for public construction projects. Many bonds are required by a township, borough, or municipality. Since these laws have been in existence for many years, few contractors give much thought as to why such laws are even in place. Some contractors who are unable to obtain the required bonds argue that the laws are unfair because they are denied when applying for types of contract bonds. Let’s take a look at what gave rise to these laws that require contractors to obtain bid or performance/payment bonds in order to perform public construction projects.

More than 100 years ago, the federal government became nervous regarding the high failure rate among the private firms it was using to perform public contract jobs. It uncovered the fact that the private contractor often was in debt when the jobs were awarded, or got into debt before the job was finished. As a result, the government was repeatedly left with unfinished projects, and taxpayers were obligated to cover the additional costs resulting from the contractor’s default. Since government property is not subject to mechanic’s liens, the workers, material suppliers and subcontractors were without a solution if they were not paid for their services. To protect itself and those who worked on the projects, the government attempted to use individuals to serve as sureties. However, most of the individual sureties failed to follow through with their commitments, many times because they did not have the financial resources to cover their obligations. So, in 1894, Congress passed the “Heard Act� to allow the use of corporate surety bonds to protect privately performed federal construction contracts. In 1935, the Heard Act was replaced by the “Miller Act�, which is the current law that requires performance and payment bonds on federal construction projects.

It is imperative to note that contract bonds are not intended to protect the contractors that are required to obtain them. These bonds are in place to protect the owner (or obligee) of the construction project against contractor failure and to protect workers, material suppliers, and subcontractors against nonpayment.