An advanced payment bond is a type of surety bond that is typically used in construction contracts to provide financial protection to the project owner. The bond guarantees that if the contractor fails to fulfill their obligations under the contract, such as not completing the project or not using the advanced payment funds for their intended purpose, the surety company will reimburse the project owner for any losses incurred.
An advanced payment bond is usually required when a project owner pays a contractor in advance of the completion of the project. The bond serves as a safeguard against the risk of the contractor failing to deliver on their contractual obligations. The bond amount is typically a percentage of the total project cost and is issued by a surety company.
In the event of a claim, the project owner must first attempt to recover any losses directly from the contractor. If the contractor is unable or unwilling to provide reimbursement, the project owner can then file a claim against the bond. If the claim is found to be valid, the surety company will pay out the amount of the bond to the project owner.
An advance payment bond, which can also be
referred to as a cash guarantee, is a common occurrence in commercial
contracts. The point of an advance payment bond is to ensure that when the
company doing the work receives payment, they complete the job as promised.
This type of bond also guarantees that the recipient of the payment will return
it if they fail to deliver the promised goods or services.
Keep reading to learn more about what advance
payment bonds are and how they work.
Advance payment bonds can apply to many
different industries, such as the construction industry. The goal of an advance
payment bond is to ensure the payer receives the work product they received
payment for. It’s understandable that a business or contractor would want to
receive payment upfront for a long term project, but it’s also understandable
that a client may feel nervous about making a large payment before they receive
the work product they’re paying for. An advance payment bond can protect the
payer allowing the payee to receive payment before finishing their work, which
can help them better manage their cash flow.
Some examples of companies that often need to
take out an advance payment bond include:
● Travel agencies
● Auto dealership bonds
● Construction companies
● Collection agencies
● Health clubs
● Public notaries
● Durable medical equipment providers
This is where an advance payment bond can
really come in handy. When the business receiving payment has an advance
payment bond, the payer can rest easy knowing that if they don’t receive the
work product they paid for that they can file a claim against the bond.
There are three parties involved in an advance
payment bond, the surety, principal, and obligee. The surety is the company
that issues and backs the bond—this is also the party who pays out claims to
the victim. The principal is the party who buys the advance payment bond. The
obligee is the party who requires the principal to hold the bond (this is often
a state government or licensing board).
The way that an advance payment bond works is
that if the payee fails to deliver the promised work product, then the payer
can file a claim against the advance payment bond and the surety company that
issued the bond will cover the loss if the claim is valid. The bonded company
will have to pay the surety back for this amount.
Depending on the industry you work in and the
state you run your business in, having an advance payment bond may be required in
order to become licensed. This is a common requirement for contractors.
It’s easy to confuse an advance payment bond
with a performance payment bond. A performance payment bond is a written
statement given by the contractor that he will repay or settle the advanced
cash paid by the owner related to the contract. An advance payment bond on the
other hand ensures that the principal will perform his obligation as mentioned
in the contract. If the contractor fails to complete the project as promised,
the client can then file a claim against the advance payment bond.
How much advance payment bonds cost depends on
quite a few factors including the required bonding capacity (the highest amount
a claim can be filed against the bond) and the state of your business and
In particular, your personal credit score
plays a large role in how much you will spend to secure an advance payment
bond. This is because your credit score is impacted by how often you make your
debt payments on time. If you have a strong history of on-time payments and a
good overall credit score, the surety can feel confident you’re likely to pay
them back if a claim does end up being filed against your advance payment bond.
Because of this, they’re likely to charge you less for your bond.
How advance payment bond pricing works is you pay a small percentage of the bonding capacity. The strength of your personal and business finances affects the rate you’re given. The stronger your financial history and business finances are, the lower the rate you’ll be offered. This is where your personal credit score (your business credit score can also be taken into account too) plays a major role. The higher your credit score is, the lower a percentage you’ll have to pay and the lower your bond premium (aka how much you’ll spend each bond term to secure the bond) will cost you. If you can, spend some time working on improving your credit score before you apply for a new advance payment bond or before you renew an existing bond so you can work towards a lower rate.