Project Management

& Engineering Cases

CEE 3348a
Bidding Law and
Bonds
Lesson 3
Lecturer: Kevin McGuire P. Eng., M. Eng., PMP

11/25/2022
Bidding Law and Bonds
 Bidding Law
– Traditional Law of Bidding
– Ron Engineering
 Bonds

– Construction surety bonds

– Types of bonds
• Bid Bond
• Performance Bond
• Other Bonds
General Contract Law
 IfA offers to sell B a car for $2000 and B
says “I accept”, there is a contract
 There is no enforceable contract without

consideration (something of value)

• A’s consideration is the money
• B’s consideration is the car
 A can withdraw its offer at any time before

B accepts it
General Contract Law
 Counteroffer:
• If B says “I accept your offer, but will only pay
$1800 for the car” there is no contract
• B has made a counteroffer and the bargaining
process starts from scratch

 Mistake:
• If A’s offer contains a mistake that affects a
fundamental term such as price, and if that
mistake is known to B, B cannot “snap up the
offer” and form a valid contract
• Where there is no agreement as to terms, there
can be no contract
Traditional Law of Bidding
 Calling for bids used to be considered an invitation
to submit offers – a contract would be formed when
the owner accepted a bid; then all the principles of
contract law would apply. This used to be so, and
this is still the law in all other common-law countries
(2000) – but not in Canada
Traditional Law of Bidding -
Application
 Belle River Community Arena Inc. v
W.J.C. Kaufman Co. Ltd.; Ontario
Court of Appeal; June 1978

 In 1972 Town of Belle River sent out

an invitation to bid on the proposed
construction of a community arena

 Bid bond $40,000, bid to remain open

for acceptance for a period of 60 days
Traditional Law of Bidding -
Application
 W.J.C. Kaufman Company, Ltd. put in
bid for the job including the $40,000
bid bond

 Bids opened January 11, 1973 and

Kaufman’s bid was the lowest of 9
bids by just over $15,000

 The owner did not accept the bid that

day
Traditional Law of Bidding -
Application
 Next morning Kaufman sent a telegram to
the architects informing them that Kaufman
wished to withdraw the bid because it
contained a serious error – the bid had left
out a summary sheet – such that the
submitted bid was substantially lower than
intended

 One month later the owner instructed its

solicitors to advise Kaufman that its bid had
been accepted
Traditional Law of Bidding -
Application
 Solicitors for Kaufman reiterated that
their client had made a mistake and
had withdrawn their bid before
acceptance

 Owner never submitted a formal

contract to Kaufman but entered into a
contract with the next lowest bidder
and sued Kaufman for the difference
between the two bids
Traditional Law of Bidding -
Application
 Trial judge dismissed the owner’s
claim because Kaufman had not
formally refused to enter into a
contract before the expiration of the
period during which all bids were
open for acceptance

 Belle River appealed the ruling, but

the Ontario Court of appeal dismissed
the appeal
Traditional Law of Bidding -
Application

 Principle – offeree cannot accept an

offer which he knows has been made
by mistake even if there is a provision
binding the offer or to keep the offer
open for acceptance for a given
period
Traditional Law of Bidding -
Application
In this case, no contract came into
existence:

• If Kaufman’s bid could be withdrawn

before acceptance, then it was
withdrawn, and no contract came into
existence
• If it could not be withdrawn for 60 days,
it nevertheless could not be accepted
because the owner knew of the mistake
Revolution in the law of
Bidding
 Ron Engineering vs Government of
Ontario, Supreme Court of Canada,
January 1981

 Problem: Bidder’s freedom to withdraw bid up to

the moment the owner accepted one
sometimes created problems
Revolution in the law of
Bidding
 Kaufman – it seemed unfair that a
contractor could submit an irrevocable
bid with bid security and walk away
unbound and unscathed by simply
calling “mistake”

 No discussion of competitive bidding

since then can take place without the
name of Ron Engineering being
mentioned
Ron Engineering
 The contractor Ron Engineering and
Construction (Eastern) Ltd. submitted a bid
along with a cheque for $150,000 to the

Ontario Government for a construction project

 Employee discovered that Ron’s bid

($2,748,000) was low bid by $600,000

 Employee immediately informed the contractor

that it was apparent that there was an error in
the bid
Ron Engineering
 Contractor sent a telex within 1 hour of bid
opening to the owner notifying of its error,
requesting to withdraw the bid without
Penalty

 Owner submitted to the contractor the

construction contract, which the contractor
refused to sign – held to position that since it
had notified the owner of the error prior to
accepting the bid that the bid could not be
accepted
Ron Engineering
 Because of contractor’s refusal the
Owner felt entitled to retain the bid
Deposit

 Owner accepted second lowest bid

 Contractor sued to recover the money

 Owner counterclaimed for damages

caused by having to accept a higher bid
Ron Engineering
 Trial judge ruled in favor of the owner – that
he was entitled to retain the deposit

 Contractor appealed the decision

 Court of Appeal sided with the contractor –

when a mistake is proven with reasonable
evidence, the person to whom the tender is
made is not in a position to accept the
tender or to seek the forfeiture of the bid
deposit
Ron Engineering
Owner then appealed to the Supreme
Court of Canada

 Justice Estey, who wrote the decision for

the court, found that the process of
bidding involves two contracts, which he
called Contract A and Contract B
The Two-contract System
The Two-contract System
 Contract A (or Bidding Contract) arises
between the contractor and the owner
immediately when the bid is submitted,
and without further formalities (unilateral
contract)

 From the moment the bids are made the

owner and each of the bidders are locked
in a bidding contract
The Two-contract System
 The bidding contract contains another
term where the bidder will enter into a
formal construction contract (Contract B)
if the owner awards it to him

 A principle of Contract A (bidding

contract) is the irrevocability of the bid, if
that is what the bid documents require
Ron Engineering
 Estey ruled that under Contract A
(bidding contract) that Ron Engineering
could not withdraw its bid for the period
specified in the bid documents

 The bid deposit in the court’s view was

there to ensure that the bidder performed
its obligations under Contract A, the only
contract in existence at that time
Ron Engineering
 Neither Ron engineering nor the owner were
aware of any mistake up to the moment the
bid was submitted and Contract A came into
existence. The contractor intended to and did
submit the bid as it was, including the price
that was stipulated in it

 There was nothing on the face of the bid to

reveal that there was an error
(Owner’s cost estimate, prepared by
engineering firm, was slightly lower than Ron
Engineering’s bid containing the error)
Northern Construction
 City of Calgary vs Northern Construction Ltd.

 Northern Construction submitted a bid of

$9,342,000 to the City of Calgary for a
construction project and was the lowest of 9
lump sump bidders by $395,000

 Two hours after bid opening a clerical error of

over $181,000 was discovered

 Error had not been apparent “on the face of

the bid”
Northern Construction
 Northern requested that either:
• $181,274 be added to its contract
• Northern be allowed to withdraw its bid
and have its bond returned

 Northern noted that if amendment of its

bid were accepted that it would still be
lowest bidder

 Calgary refused the request and

accepted Northern’s bid
Northern Construction
 Northern declined, Calgary awarded contract
to next lowest bidder, and sued Northern for
damages
 Trial judge felt that the Ron Engineering
precedent was inapplicable – by accepting
the bid the case was moved from an A
Contract to a B Contract (a situation with
which the Ron Engineering case was not
concerned)
 Trial judge then applied traditional law of
mistake – Calgary being made aware of the
error could not legally accept the bid
Northern Construction
 Alberta Court of Appeal took a different
view of the case – Contract B had never
come into existence because it had not
been executed by both parties

 Northern took another approach –

mitigation of damages – Calgary should
have mitigated its damages by selecting
Northern’s amended bid (still the
lowest)
Northern Construction
 Rejected as it would turn bidding
system into an auction. Bidder refuses
contract then offers to do the work for
less than second lowest bidder

 The owner would have to accept in

order to mitigate its damages

 The Northern case affirmed Ron

Engineering reasoning
Two-contract System
 A contentious issue in the construction
industry – especially among contractors

 Essentially, contractor must take all

responsibility for mistakes in bid
Bidding Law and Bonds
 Bidding Law
– Traditional Law of Bidding
– Ron Engineering

 Bonds
– Construction surety bonds
– Types of bonds
• Bid Bond
• Performance Bond
• Other Bonds
Construction Surety Bonds
 HIRED GUARANTEE
 Why are they required?

 Guarantee of what?

 On whose behalf are the guarantees

made ?
 Who makes them and to whom ?

 What happens when demands are made

that the guarantees be made good ?

Surety Bonds
 Surety – one party guaranteeing the
acts of another

 History

 Essentially a guaranteed loan waiting

to happen
What is a Construction
Bond?
A construction surety bond is a three party
instrument under which the surety
joins with the contractor (principal) to
guarantee to the owner (obligee), that
the contractor will comply with the terms
and conditions of the contract.
3-Party Agreement
Construction Bond
 Similar to a co-signed note from a
financial institution, or a parent on a
rental agreement

 NOT an Insurance
Bonds vs. Insurance
Three-Party Agreement
 PRINCIPAL
• Contractor
• Entity that furnishes the bond
Three-Party Agreement
 OBLIGEE
• Owner
• The entity to whom the
guarantee of the bond is
promised
Three-Party Agreement
 SURETY
• Bonding company
• Typically a financial institution
• Possesses wealth and stability
• Furnishes the guarantee that
the bond promises
Surety Bond Terms
 Guarantee

• The performance of the principal

(contractor) that is underwritten by
the surety (depends on bond type)

 PenalSum
• The upper limit of the surety’s
potential financial liability to the
obligee
Surety Bond Terms
 Premium
• The fee that the principal pays to the
surety in exchange for providing the
guarantee to the obligee
Types of Bonds
 Bid Bond

 Performance Bond

 Labour & Material

Payment Bond

 Warranty/maintenance bond

 Supply bond
Bid Bond
 Guarantees to the owner that the
surety provides financial assurance
that the bid has been submitted in
good faith and that the bidder
intends to enter into the contract at
the price bid and provide the other
required bonds as stipulated in the
conditions of the contract.
Bid Bond
 Ensures integrity of the bidding process

 Ensures only qualified companies submit

bids

 In Canada:
-10% of the Bid Price
-Payable via cash, certified bank draft or bid
bond
-Includes “Consent of Surety”
Consent of Surety
A two-party agreement
– If the contractor enters the contract surety
mmuwill provide performance bond and
labour mmuand materials bond.
Performance Bond
 Protects the owner from financial loss
should the contractor fail to perform the
contract in accordance with the terms
and conditions of the contract
documents.

 In Canada
• 50% of the Contract Typically
• Retainage
Performance Bond Guarantee
 Surety’s promise to fulfill the
principal’s obligations to perform the
separate contract that the principal
has made with the obligee if the
principal is unwilling or unable to
perform (i.e. complete the
construction project)
Retainage
 Typically, the owner holds back a portion
of the monies due to the contractor as an
incentive for the contractor to properly
complete the project

 5-10% of the progress payments

 May be held back only for the first 50% of

the project (remaining 50% covered by
labour and materials bond).
Labour & Material
Payment Bond
 Protects the interest of the subcontractors,
suppliers and laborers if the construction
firm/general contractor fails to make
payments

 In Canada
• Usually 50% of the Contract Price
• A protection for the owner against lien
Labour & Material
Payment Bond
 Labour and Material Bond Guarantee:
• The guarantee of a labor and material bond is the
surety’s promise that it will pay claimants if the
principal is unable or refuses to pay them.

• Private owners want payment bonds to avoid

having their property sold to satisfy liens or legal
claims filed by subcontractor’s or suppliers, against
project property, in the case they are not paid by
the owners contractor for their services or furnished
materials
Warranty/maintenance Bond
 Guarantees that the contractor will fulfill
the obligation to the owner under the
warranty clause of the contract.

 Either 50% or 100% of the specific values

are bonded.
Supply Bond
 Similar to payment bonds.

 Issued to ensure that materials, supplies,

goods or machinery are supplied at a
specific time and place.

 Premium rate typically less than that of

payment bond.
Other Bonds
 Lien – jobs will be kept free of liens

 Retention – substitute for retainage.

 Sales and Use Tax – guarantees payment

of sales and use taxes

 Health and Welfare – union agreements

call for furnishing bonds guaranteeing the
payment of health and other benefits.
Liens
 Suppliers and subcontractors who have
provided materials, equipment or performed
work on the project for which payment has not
been made can file a lien against the property of
the owner even if owner has paid the general
contractor.

 Owner typically holds back retainage until

general contractor provides a lien release from
all subcontractors/suppliers or a release
holdback bond.
Bonding Capacity
 The maximum value of completed work the
surety will allow the contractor to have on
hand at any given time

 A function of his/her net worth and cash

liquidity.

 Parameters
– volume of work at hand
– accumulated retainage on present jobs
– type of work
– etc.
Bonding Capacity
 General rules of thumb for bonding capacity for
a contractor:
– up to 10 times their working capital (current assets
minus current liabilities)

– up to 4 times their net worth

– No more than half of their bonding capacity should

mmube used on any one project
Bond Premiums - Canada
EXAMPLE – Bid Bond
EXAMPLE – Bid Bond
 The bid bond guarantee for Bidder A is 10% of the
bid value.
– BB = 0.10 (Bid Value) = $18,000
 The penal sum for the bid bond is the difference to
the next highest bidder.
– PS = 200000 – 180000 = $20,000
 The surety pays the owner the lower of these two
values = $18,000.
 The monetary damage to the owner is the difference
between the penal sum and the amount paid.
– MD = 20000 – 18000 = $2,000
 The surety will seek to recover the $18,000 paid to
the owner from the principal through the indemnity
agreement.
EXAMPLE – Bid Bond
 Assume Bidder B’s bid was $190,000.
 The bid bond guarantee for Bidder A is 10% of the
bid value.
– BB = 0.10 (Bid Value) = $18,000
 The penal sum for the bid bond is the difference to
the next highest bidder.
– PS = 190000 – 180000 = $10,000
 The surety pays the owner the lower of these two
values = $10,000.
 The monetary damage to the owner is the difference
between the penal sum and the amount paid.
– MD = 10000 – 10000 = $0
 The surety will seek to recover the $10,000 paid to
the owner from the principal through the indemnity
agreement.
EXAMPLE – Performance Bond
 A contract is awarded to a Bidder for an amount of
$200,000. The bidder accepts the contract and
provides a 50% performance bond to the owner.
When the contract is approximately ¾ complete, the
contractor becomes bankrupt and unable to complete
the project.

 The performance bond is 50% of the total contract

– PB = 0.50 (200,000) = $100,000

 The progress payment due to the contractor for

completing ¾ of the work is:
– PP = 0.75 (200,000) = $150,000
EXAMPLE – Performance Bond
 Retainage by owner is 10% on first 50% of
the project.
– R = 0.10 ( ½ ) (200,000) = $10,000

 The balance of the contract price is equal to

the total value of the contract minus what has
been paid out to the contractor.
– BoCP = 200,000 – (150,000 – 10,000) =
$60,000
EXAMPLE – Performance Bond
When the contractor becomes unable to complete the
work, the surety has three options regarding how to
proceed:
1. Assist the principal to remedy the default by advancing
funds to the principal but not taking control of the
project.
2. Take control of contract performance and complete the
work by engaging another contractor or by retaining the
principal and subsidizing project operations and actively
directing the work.
3. Allow the obligee to complete the project by engaging
another contractor and, when the work has been
completed, pay money to the obligee for any excess
costs incurred in completing the work.
EXAMPLE – Performance Bond
 Assume that the surety opts to allow the owner to
complete the project, and that the additional costs are
$90,000.
 The penal sum under the performance bond is equal
to the cost to the owner to complete the work minus
the balance of the contract price:
– PS = 90,000 – 60,000 = $30,000
 The surety pays the lesser of the penalty sum or the
performance bond ($100,000), in this case the
penalty sum of $30,000 is paid by the surety to the
owner.
 The surety will seek to recover this amount from the
principal under the indemnity agreement
EXAMPLE – Performance Bond
 Assume that the surety opts to allow the owner to
complete the project, and that the additional costs are
$190,000.
 The penal sum under the performance bond is equal
to the cost to the owner to complete the work minus
the balance of the contract price:
– PS = 190,000 – 60,000 = $130,000
 The surety pays the lesser of the penalty sum or the
performance bond, in this case the performance bond
of $100,000 is paid by the surety to the owner.
 The surety will seek to recover this amount from the
principal under the indemnity agreement.
 The difference between the performance bond and
the penalty sum is a monetary damage to the owner.
EXAMPLE – Performance Bond
 Assume that the surety opts to complete the project
themselves, they essentially become the contractor
 The surety is responsible for the total cost, less the
balance of the contract price, even if this amount
exceeds the face amount of the bond
 The decision as to how to proceed is at the surety’s
discretion and will depend on their experience and
resources, as well as the reason for the contractor’s
default
 Most frequently, the surety will advance money or
bonds to assist the defaulting contractor through a
period of financial or legal difficulty