What are Advance Payment Bonds?
An advance payment bond is a contract in which the issuer agrees to be liable for the fulfillment of a contractual obligation owed to another party if the first party fails to do so. In other words, it is given as a guarantee that the procuring agency will make an upfront payment to the contractor to promote contract mobilization activities. The issuer's duty may be primary (as in an on-demand obligation or indemnity) or secondary (as in a revolving credit facility) (as in a guarantee). A commercial contract's performance is usually underpinned or guaranteed by an advance payment guarantee or bond, such as a contract for the selling of products (where the buyer is the beneficiary) or a building contract (where the employer is the beneficiary).
A buyer or employer, for example, can make down or advance payments to a seller or contractor in order to provide funds for the seller or contractor to purchase required materials or machinery or otherwise plan for the contract's performance. As a result, the seller or contractor may be required to offer an advance payment guarantee or bond for these payments by the buyer or employer. The promise or bond will state that if the seller or contractor fails to fulfill their contractual obligations, the issuer will refund the buyer's or employer's advance payments.
Relevance of Advance Payments Bonds
- The Advance Payments Bonds helps clients compensate contractors in advance of work being completed through facilitating and supporting payments.
- For the contractor, there are always significant costs involved, and the advance payment may be critical to their cash flow and willingness to complete the project.
- An Advance Payments Bonds covers the customer in the event that the contractor fails to meet its contractual commitments, such as if the contractor goes bankrupt.
Advance Payments Bond’s General Uses
Advance Payment Bonds are commonly used in a variety of industries, including construction. In the case of a construction project, the contractor (in this case, the Principal) will request an advance payment prior to the start of the project in order to purchase high-value plant or materials that are unique to the project. The client may make an advance payment on the condition that the contractor provide an Advance Payment Bond to protect the client in the event that the contractor fails to meet its contractual obligations, such as if the contractor goes bankrupt. In certain cases, the bond's value is equal to the amount borrowed.
Things To Consider While Making Advance Payments Bond
An Advance Payment Bond is usually an On-Demand Bond, which means that if the bond is demanded in writing, it will be paid out in full without any preconditions. A Conditional Bond (or Default Bond) is one that allows the client (the Obligee) to satisfy certain conditions before the bond is paid out. This usually entails the client demonstrating that the contractor (the Principal) failed to meet their obligations and fulfill the contract, causing them to incur losses. This usually entails the client demonstrating that the contractor (the Principal) failed to meet their obligations and fulfil the contract, causing them to incur losses. Advance Payment Bonds must be carefully drafted to specify payment conditions and to make it clear that they are On-Demand Bonds. They are better issued by a surety rather than a bank since they can usually be supplied unsecured and does not affect working capital.