When a South Dakota county or town buys heavy equipment using 'total cost' bidding (purchase price plus guaranteed maximum repairs minus guaranteed buyback), can it just add and subtract the face value of those dollars? Or does it have to discount the future numbers to present value? And does the contract need a real performance bond, or is a corporate guarantee enough?
Plain-English summary
By the mid-1980s, equipment vendors selling to South Dakota counties had figured out a clever bidding wrinkle. Instead of just quoting an initial price, they would offer a "total cost" package: purchase price, plus a guaranteed maximum repair cost over a fixed term, minus a guaranteed buyback at the end of that term. Counties were taking the lowest face-value total. Auditor General Maurice Christiansen wrote AG Mark Meierhenry asking whether this practice complied with the competitive bidding requirements of SDCL chapters 5-18 and 5-21.
The AG's answer was a qualified yes. Total cost bidding as a concept was lawful. A 1965-66 AG opinion under the older term "guaranteed bidding" had reached the same conclusion. But the way local entities were currently doing it violated competitive bidding principles, because it ignored the time value of money.
The opinion's worked example made the problem concrete. Three flatbed truck bids:
- Supplier A: $20,000 + $9,000 max repairs $10,000 buyback = $19,000 net
- Supplier B: $25,000 + $4,000 max repairs $18,000 buyback = $11,000 net
- Supplier C: $35,000 + $2,500 max repairs $30,000 buyback = $7,500 net
At face value, Supplier C won. But if a county could invest its money at 8% (the prevailing CD rate in 1986), the future repair guarantees and the future buyback had to be discounted to present value. With discounting:
- Supplier A net present cost: $20,377
- Supplier B net present cost: $15,936
- Supplier C net present cost: $16,567
Supplier B was actually the best value. The face-value method had picked C even though C was the second-most expensive option in real terms. So the AG concluded that South Dakota local entities using total cost bidding had to publish, in the bid specifications themselves, the discount rate they would use to evaluate bids. Otherwise vendors and the entity could not arrive at a common standard for "lowest responsible bid," which Gridley v. Engelhart (S.D. 1982) had required.
On performance bonds: the AG advised that local entities should require a SDCL chapter 5-21 performance bond for total cost contracts, because the vendor's obligations (maximum repairs and guaranteed repurchase) stretched years into the future. Some entities were accepting "corporate guarantees" in lieu of bonds. The AG was blunt: a corporate guarantee added no security beyond the corporation's existing duty to perform. Only an actual performance bond or pledged collateral provided protection against a vendor who later became insolvent.
Currency note
This opinion was issued in 1986. Subsequent statutory amendments, court decisions, or later AG opinions may have changed the analysis. Treat this page as historical context, not current legal advice. Verify current law before relying on any specific rule, deadline, or remedy mentioned here. The competitive bidding statutes in SDCL chapters 5-18 and 5-21 have been amended in the decades since 1986. The 8% discount rate referenced in the opinion's example reflects 1986 interest rate conditions and is not a current benchmark.
What the opinion meant at the time
For county auditors and purchasing officers, the opinion was a procedural blueprint. Going forward, total cost bid specifications had to include the discount rate. A purchasing officer who skipped that step would have been buying litigation risk along with the equipment: any losing bidder could later argue that the bid award violated SDCL chapter 5-18 because the specs lacked an essential element under Gridley.
For equipment vendors, the opinion changed the calculus on how to structure a winning bid. A vendor that loaded up the back end of the deal (low purchase price, high guaranteed buyback) might have looked best at face value but worst at present value. Vendors had to think about the financing structure of their offer, not just the headline number.
For the Auditor General's office, the opinion gave a basis to push back on local entities that had implemented total cost bidding without present-value discounting. The Auditor could cite this AG opinion in correspondence with county and city governments to flag noncompliance.
For local entities, the bigger practical recommendation was about performance bonds. Many had been accepting corporate guarantees to avoid the bond cost. The AG's "no security beyond the corporation's existing duty" point was a useful frame: if the vendor went under, the guarantee was worth what the bankrupt entity was worth. Insisting on a proper bond protected the entity against exactly that scenario.
Common questions
Q: What was the time value of money in plain terms?
A: A dollar received next year is worth less than a dollar received today, because the dollar today can be invested and earn interest. By 1986 standards, an 8% CD rate meant a dollar today was worth about $1.08 a year from now. Equivalently, $1.08 promised for next year was worth only $1.00 today. Comparing a $1.00 cost now against a $1.08 cost next year as if they were equal was wrong because the future cost was actually a smaller real cost.
Q: Was 8% the required discount rate?
A: No. The opinion used 8% because that was what counties could earn on CDs in 1986. The required rate was "the current investment rate which the local government entity could invest funds." That rate would change over time. Each bid solicitation needed to use the prevailing rate.
Q: Did the AG say total cost bidding was preferable to traditional initial-price bidding?
A: No. The AG was neutral on which approach a local entity should choose. The point was that if you chose total cost bidding, you had to do the math correctly.
Q: What did Gridley v. Engelhart actually hold?
A: Gridley held that bid specifications had to be "sufficiently definite and precise so as to afford a basis for bids" and "free of restrictions the effect of which would stifle competition." Bid specs had to be detailed on all essential elements to support full and fair competition on a common standard. The AG used Gridley as the legal basis to require present-value disclosure: without it, there was no common standard.
Q: Why did a corporate guarantee not work?
A: A corporate guarantee from the bidding entity itself was a tautology: the corporation was already obligated to perform under the contract. Adding the corporation's promise to keep its promise added nothing. A real performance bond brought in a third party (the surety) who would pay if the principal failed. That's the security a local entity actually needed.
Q: Did smaller bid amounts trigger the same requirement?
A: The opinion focused on heavy equipment with multi-year repair and buyback structures, where the time value question is most pronounced. For small or short-term purchases with no future obligations, the present-value question is functionally moot.
Background and statutory framework
South Dakota's competitive bidding requirements in SDCL chapter 5-18 reflected the standard public-purchasing goal: get the lowest responsible bid, treating all qualified vendors on equal terms. The chapter set out thresholds for bidding, procedures for awarding contracts, and rules against anti-competitive specifications.
Total cost bidding was an innovation that emerged in the 1970s and 1980s, particularly for capital equipment with predictable maintenance profiles and resale markets. The idea was sound: comparing offers based on the full cost of ownership, not just the upfront price, gave a better picture of true value. The 1965-66 AG opinion under "guaranteed bidding" had blessed the concept.
The wrinkle, which the AG identified in 1986, was that face-value addition of future cash flows distorted the comparison. Present-value discounting was standard practice in private-sector capital budgeting by the 1980s, and the AG essentially imported the standard into public procurement law as a requirement under SDCL chapter 5-18's competitive bidding mandate.
The performance bond point under SDCL chapter 5-21 was a parallel concern. South Dakota's public works statutes had long required performance bonds for construction and supply contracts above a certain threshold. The "corporate guarantee in lieu of bond" workaround was a vendor-friendly accommodation that the AG flagged as fundamentally insecure.
Citations and references
Statutes:
- SDCL ch. 5-18 (competitive bidding)
- SDCL ch. 5-21 (performance bonds)
Cases:
- Gridley v. Engelhart, 322 N.W.2d 3 (S.D. 1982)
Earlier AG opinions referenced:
- 1965-66 AGR 211 (guaranteed bidding)
Source
Original opinion text
Total Cost Bidding
Dear Mr. Christiansen:
You have requested an official opinion from this office in regard to the following factual situation:
FACTS:
The Auditor General's Office has encountered numerous situations during the past year where local governmental entities have been implementing a 'total cost' bidding procedure for the purchase of heavy equipment. Using this total cost bidding procedure, the local government entity is requesting bids which are evaluated by netting at face value: (1) the initial purchase price of the equipment, plus; (2) the guaranteed maximum repair cost for a period specified by the government entity, less; (3) a guaranteed minimum repurchase price at the end of the specified time period.
With the above factual statement, the Auditor General's office has also enclosed several recent sets of bid specifications used by local government entities attempting to implement a total cost bidding procedure. Some of the specifications submitted did not require a performance bond or allowed a 'corporate guarantee' in lieu of the performance bond, and establishes a procedure where only the face value of the bid items addressed above were to be considered.
Based upon the above facts, you have asked the following question:
QUESTION:
Does the total cost bidding procedure as currently being used by local governmental entities violate the competitive bidding provisions of SDCL Ch. 5-18 or SDCL Ch. 5-21?
Total cost bidding describes a bidding procedure whereby a public entity seeks bids from a potential seller, based upon the total costs of ownership, in addition to the initial purchase price. This is the sole cost basis for governmental purchases under traditional bidding procedures. One of my predecessors in AGR 1965-1966, page 211, using the term 'guaranteed bidding,' determined that the concept of total cost bidding did not violate the competitive bidding provisions of SDCL Ch. 5-18. I concur with my predecessor's determination that total cost bidding, if properly implemented by the public entity, does not violate the competitive provisions of SDCL Ch. 5-18 or Ch. 5-21. It is my opinion, however, upon review of 'total cost bidding procedures' currently used by the local government entities, that the principles of competitive bidding are being violated.
The South Dakota Supreme Court in Gridley v. Engelhart, 322 N.W.2d 3, 7 (S.D. 1982), stated:
Bid specifications as they pertain to public contracts must be sufficiently definite and precise so as to afford a basis for bids and they must be free of restrictions the effect of which would stifle competition. Such specifications must be sufficiently detailed upon all essential elements so as to afford a basis for full and fair competitive bidding upon a common standard.
The flaw in the local government entities current total cost specifications is that these specifications totally ignore the time value of money which, in my opinion, is an essential element in total cost bidding. It does not take an expert financial analyst to determine that a dollar today is not the same as a dollar three or seven years in the future. The reason for this is that a dollar today can be invested so that it is worth more at a future date. A total cost bidding procedure that takes present dollars and future dollars and nets them at face value to determine the low bid compares dollars of different present value. This netting of face values has the effect of mixing apples and oranges which, in my opinion, makes it impossible for a local government entity as well as potential bidders, to determine what is the 'lowest responsible bid.'
This netting of dollars at face value also could result in potential abuses where the actual value of the equipment at the date of purchase is no longer relevant.
For purposes of illustration, I present the following example: A local government entity is seeking the purchase of a flatbed truck. The local government entity uses a total cost bidding procedure and wants guaranteed repairs for five years with a guaranteed repurchase price. Suppliers 'A,' 'B' and 'C' have products that meet the county's general specifications for the flatbed truck and all are responsible bidders. Bids are received and opened with the following results:
Dollars Bid
| A | B | C | |
|---|---|---|---|
| Initial price | $20,000 | $25,000 | $35,000 |
| Plus maximum repairs | 9,000 | 4,000 | 2,500 |
| Subtotal | $29,000 | $29,000 | $37,500 |
| Less repurchase guarantee | 10,000 | 18,000 | 30,000 |
| Total Cost | $19,000 | $11,000 | $ 7,500 |
The local government entity could currently invest money in C.D.'s at an investment rate of 8%. If the value of money was included in the specifications and the bids were reviewed in present value terms the bid results would be as follows:
| A | B | C | |
|---|---|---|---|
| Initial price | $20,000 | $25,000 | $35,000 |
| Plus maximum repairs [1] | 7,187.4 | 3,194.4 | 1,996.5 |
| Subtotal | $27,187.4 | $28,194.4 | $36,996.5 |
| Less repurchase guarantee [2] | 6,810 | 12,258 | 20,430 |
| Total Cost | $20,377.4 | $15,936.4 | $16,566.5 |
Under a traditional bidding procedure where only the initial price is considered, the truck from Supplier 'A' would have been purchased by the local government entity. Under a 'total cost' bidding procedure using dollars at face value as currently used by the local governments, Supplier 'C' would be awarded the bid although Supplier 'C's' initial purchase price was the greatest, the total cost at face value was less than either Supplier 'A' or 'B.' But, once the value of the dollar is added, Supplier 'B' would now become the lowest responsible bidder. When one looks at all costs of the local government entity, Supplier 'B' provides the best total value if the entity wishes to use the total cost approach.
It is, therefore, my opinion, that if a local government entity decides to use a total cost bidding procedure to comply with the competitive bidding provisions of SDCL Ch. 5-18, the local government entity must include in the bid specifications the current investment rate which the local government entity could invest funds. This ensures that the potential bidders and the local government entity have a uniform basis to compare the bid proposals submitted by the various potential suppliers.
In addition, though it is not a violation of SDCL Ch. 5-18, it is my opinion that a prudent local government entity, in order to guarantee future performance of the total cost contract, should require a potential bidder to submit a performance bond in accordance with SDCL Ch. 5-21. When a supplier enters into a contract based upon a total cost bid, that supplier has a contingent liability to the local government entity for the costs of repairs for the term of the contract and the guaranteed repurchase price. Without a performance bond, the local government entity has no guarantee that the terms of the contract will be fully performed. Currently, some government entities are requiring a performance bond with their total cost bid while other local government entities are not requiring a performance bond or allowing that a 'corporate guarantee' be submitted in lieu of performance bond. A corporate guarantee adds no additional security to future performance of the contract. Any corporation that enters into a contract with a local government entity for future services or products is getting that corporation's guarantee. Only a performance bond or submission of actual collateral or security to the local government entity will provide additional security in case the bidder is awarded a contract and is financially incapable of performing all of its terms.
Total cost bidding, if used properly, can reduce the amount of monies a local governmental entity needs to expend for the purchase and use of equipment. Unless properly implemented, however, the total cost bid procedures may result in the county needlessly expending additional funds for goods and services without added benefits.
Respectfully submitted,
Mark V. Meierhenry
Attorney General
[1] 3.993 — Present value of an annuity of $1.00 per year for 5 years discounted at 8% and assumes repairs of equal amounts each year.
[2] .681 — Present value of $1.00 due at the end of 5 years discounted at 8%.