Knowledge Resources

Project stakeholders should consider the advantages and disadvantages of requiring performance bonds and other risk mitigation requirements such as bid bonds (1) because they may not be appropriate for all types of procurements. Agencies include performance bond requirements in an attempt to mitigate risk when procuring equipment, technology, or services. Performance bonds are a three-party agreement between a surety company, a contractor, and the project owner. The bond provides a guarantee that the contractor will comply with the terms and conditions of the contract. If the contractor is unable to successfully perform the contract, the surety assumes the contractor's responsibilities and ensures that the project is completed (2). Although performance bonds may be beneficial for risky projects such as those that may require extensive software customization and/or system integration, they can limit competition by excluding smaller firms. Smaller firms often have to pay substantially more to get a surety company to underwrite the bond.

RTA and SunLine chose to include performance bonds in their contractual requirements along with requirements for bid bonds (3) and liquidated damages. Early on, this caused significant deployment delays for the two agencies as the first vendor they selected was unable to supply the requisite performance bonds and the agencies were forced to begin the procurement process again. Some stakeholders felt that it was necessary to require performance bonds as a risk mitigation strategy, while others felt that it was unnecessary in this particular case and that it significantly increased costs and limited competition (i.e., some smaller vendors who specialized in CAD/AVL were unable to participate in the bid process as they did not have the required bonding capacity).

As evidenced by the Riverside example, it is important to consider the following:

• Make performance bond requirements clear to vendors at the out-set of the bid process. Failure to do so resulted in significant deployment delays for RTA and SunLine as the first vendor they selected was unable to supply the requisite performance bonds and the agencies were forced to begin the procurement process again. A discussion of risk mitigation should be an element in any pre-bid meeting with industry.
• Carefully consider the procurement situation to determine if surety bonds are appropriate. Performance bonds and other risk mitigation strategies (e.g., bid bonds, liquidated damages) may be unnecessary when procuring low-risk items such as commercial off-the-shelf software.
• Be aware that requiring performance bonds can increase project costs. It is expensive for firms to maintain bonding capacity. In order for a company to obtain a performance or bid bond, the company must enter into an agreement with a surety company and pay premiums to obtain the bond. The additional cost is often passed along to the procuring agency in the form of higher project costs.
• Be aware that requiring performance bonds may exclude smaller firms from bidding. Many smaller firms, particularly disadvantaged business enterprises (DBEs), may not be able to supply a performance bond. Some stakeholders involved in the Riverside County project felt that including the requirement for performance bonds significantly limited competition (i.e., some smaller vendors who specialized in CAD/AVL for paratransit were unable to participate in the bid process as they did not have the required bonding capacity).

These findings from the Riverside experiences are in line with the Federal Transit Adminstration's (FTA) recommendations. The FTA,

This lesson recommends that the extent of risk mitigation necessary for any procurement should be tailored to the situation. Procuring agencies should carefully consider the pros and cons of requiring performance bonds and other risk mitigation instruments such as bid bonds because they may not be appropriate for all types of procurements. If the project is not risky, requiring a bond can lead to unnecessary implementation delays, increased project costs, and limited competition.

(1) A performance bond guarantees that the contractor will perform the contract in accordance with its terms. United States Small Business Administration (November 2005). http://www.sba.gov/financing/bonds/osgprogram.html
(2) United States Small Business Administration (November 2005). http://www.sba.gov/financing/bonds/osgprogram.html
(3) A bid bond guarantees that the bidder on a contract will enter into the contract and furnish the required payment and/or performance bonds.
(4) Federal Transit Administration Best Practices Procurement Manual (November 2005). http://www.fta.dot.gov/library/admin/BPPM/toc.html