Any contractor relying on an advance payment when starting on a new construction project should anticipate being required to first provide an advance payment bond to the project owner. The required bond amount, also known as the bond’s “penal sum,” is established by the project owner based on the size of the advance.
Advance Payment Bonds for Projects
Contractors receiving funds before work begins need an advance payment bond to protect the project owner’s upfront payment. Surety Bonds Agent provides nationwide quote support with clear coordination. Request an advance payment bond quote now.
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What Are Advanced Payment Bonds?
It’s fairly common in the construction industry, especially on larger jobs and international contracts, for project owners to advance a certain amount of money to a contractor to purchase materials and/or equipment to get their project off the ground. Advance payments are an important source of working capital, but as with any loan, they must be repaid.
Typically, a project owner will deduct a certain percentage of an advance payment from each successive progress payment made to the contractor— until the balance owed has been repaid. But there is always the risk that the contractor will become insolvent or default on the contract for some other reason, leaving the project owner with no way to recover the advance payment. Hence, advanced payment bonds.
A project owner who is wise enough to consider the possibility of default won’t advance any funds to the contractor until the contractor purchases a surety bond guaranteeing repayment.
Who Needs Them?
How Do They Work?
There are three parties to an advance payment surety bond agreement, which is a legally binding contract. In the language of surety bonds, these are known as the bond’s “obligee,” “principal,” and “surety.”
- The obligee is the project owner requiring the advance payment bond,
- The principal is the contractor, and
- The surety is the bond’s guarantor.
If the principal defaults on the contract without reimbursing the obligee for the entire advance payment, the obligee will have a valid on-demand claim against the advance payment bond. This is simply a written demand for repayment of the amount owed by the principal.
What Happens if a Claim is Filed?
As the bond’s guarantor, the surety will pay that claim initially, but it’s the principal who is legally obligated to pay it. Essentially, in paying the claim, the surety is extending credit to the principal, thus creating a debt that principal must repay or face legal action by the surety to recover the claim amount plus any court costs or attorney’s fees.
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What Do They Cost?
The premium for an advance payment bond is determined by multiplying the required bond amount established by the project owner by the premium rate set by the surety. The surety’s underwriters will give careful consideration to the risk the surety will be assuming. The main concerns are the likelihood of default and the risk of the surety not being reimbursed for an on-demand claim paid on the principal’s behalf.
A principal in good financial standing with a high credit score is deemed a good credit risk and typically will pay a premium rate in the 1% to 3% range. A less creditworthy principal represents a greater risk and will be assigned a higher premium rate, perhaps as high as 10% to 15%.
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