The principal is the party seeking an advance for costs that will be used for a contract. This could include materials, labor, equipment and other costs used for the contract. The contract holder, called the obligee, agrees to provide upfront payment to the principal for the contract. The obligee wants to make sure that the principal will use the money on their contract or repay the money and requires an advance payment bond. The principal obtains a financial guarantee from a third-party surety bond company ensuring repayment. 

The principal must use the advance funds for the specified contract purposes. If not, the obligee can make a claim on the bond. The surety company will investigate the claim and pay the obligee if necessary. In this way, the obligee can be assured that it will be repaid for any funds advanced. These advance payment bonds provide the obligee with valuable protection. It should be easier to collect from the bond company than the principal, if necessary.

If the surety does pay a claim on an advance payment bond, they can then seek reimbursement from the principal under the indemnity agreement.

Advanced payment bonds can be used for almost any contract. However, they are common in both construction contracts and international contracts. 

In construction contracts, material and equipment must often be purchased long before a customer can collect for it. For example, specialized equipment for a project may need to be ordered as much as a year or more in advance. Generally, the manufacturer will require full or partial payment for such specialized equipment. Waiting a year or more to get reimbursed for such costs could be very costly for a contractor or subcontractor. The owner or general contractor could advance the funds needed to secure the equipment. In exchange, they could require an advance payment bond from the contractor requesting the advance. Once the equipment is received and installed, the guarantee of the bond is absolved and no longer needed. 

Advance payment bonds are also used regularly in international projects. In fact, they are required by some countries. Unlike typically U.S. based construction contracts, where work is performed and then billed, many countries require an advance payment to subcontractors. Therefore, Advance payment bonds have become the norm in these countries. 

In some foreign countries, advanced payment bonds must be written as forfeiture bonds. That means if a claim is made, the surety is required to forfeit the entire bond amount (bond penalty). Some countries do not even allow the surety to investigate. It’s important to know the country’s laws, rules and bond forms.

Obtaining advanced payment bonds requires the principal to qualify financially with the surety. The surety bond company will want to make sure the principal has the resources to cover the advanced monies. Smaller bonds may only require a simple credit check. However, larger obligations will require the principal to submit financial statements on the company. The bond company will also want a copy of the contract and terms that are being guaranteed.

Advanced Payment Bonds can benefit owners and contractors by allowing project money to move freely, while protecting from default. They are also a valuable tool for any company operating internationally. Contact the surety bond experts at Axcess Surety to learn more about these bonds and other solutions that can protect a contract.