Advance Payment Bonds Explained in 5 minutes
The current situation.
Contracts will often require for the supplier, sub-contractor or contractor to pay for finished goods, materials or ingredients well in advance of receiving their first valuation under the contract.
A steel frame contractor will purchase steel, cut and drill it specifically for a particular contract thus rendering it useless elsewhere. They might not get paid for the cost of this steel for over a month after the steel is installed on site.
Manufacturers of complex products will often not receive payment for bespoke products until they deliver the product to the customer. Not only is there a period of deficit cash flow when considering the cost of design, raw materials and manufacture but there is then a large credit risk to think about. What if the customer doesn't pay? What if the customer can't pay? If 2008 and 2020 taught us anything, it is that circumstances can change very quickly.
The above contractual examples are very common problems and the majority of manufacturing contractors will often require payment in advance of commencing work on a particular contract. This solves the contractor's problems that we have already discussed but now the customer is in vulnerable situation. How can the customer be sure that their advance payment has been applied to their contract? How can the customer hold the contractor to account if the product is late or fails to meet expectations or specifications? How does the customer know that the contractor will not go bust before delivering the contract?
If a customer doesn't pay in advance then the contractor enters a vulnerable position. If a customer pays in advance then suddenly they inherit the majority of the risk under the contract. This is a difficult situation and one that prevents contracts from being agreed on a regular basis.
How does an advanced payment bond improve the situation?
With an advanced payment bond in place the situation can be improved for all parties. The bond is put in place at the start of the contract, the customer pays in advance and as the contract is delivered, the customer deducts their advanced payment from any invoices received until the full balance has been attributed to the contract. Should anything go wrong then the customer can claim their advanced payment back from the Surety bond provider less any deductions for products or services that have been delivered and deducted from the advance payment sum.
The contractor is able to use the advance payment to undertake their project in a cash flow positive state and reduces any possible strain on the business by agreeing to take on the contract. An advance payment might also enable the contractor to take on projects which are larger than previously completed projects thus growing turnover and profitability.
Why would an employer accept an advanced payment bond?
Whilst paying in advance does change the cash flow profile of the contract for the customer, the advanced payment is now secure under the bond document and guaranteed by a highly rated insurance entity.
If the contractor is able to secure a bond from a Surety then not only does this guarantee that the contractor will use the funds appropriately but it can also be seen as an excellent credit reference. The Surety will undertake a detailed assessment of the contractor's financials before issuing an advanced payment bond, not only is the advanced payment insured but the customer can gain additional comfort that the contractor meets the underwriting criteria of the Surety.
What does an advanced payment bond look like?
The PS Surety standard advanced payment bond is universally accepted in the construction industry and can be found on our blog or we will happily email you a copy on request if you want to get in touch. Having a standard industry wording can be very advantageous, as it can save the contractor and the customer legal fees relating to the drafting and approval of an acceptable bond wording.
How much does an advanced payment bond cost?
Charges for advanced payment bonds vary from between 0.4% of the bond value to 10% of the bond value and some Surety providers will ask for additional security from the contractor if they deem that the risk demands it. The pricing is based on the contractor's strength and the Surety's assessment of how likely they feel they are to receive a claim under the bond following an insolvency or contract default. If a contractor already has a Surety bond facility then they can expect to be charged the same rate for advanced payment bonds as they currently currently pay for performance bonds. Some Surety providers charge a 50% uplift on facility terms for advanced payment bonds so it could be worth speaking with a specialist broker.
Who pays for an advanced payment bond?
Contractors tend to pay for advanced payment bonds but if it can be argued that the advanced payment is necessary for the contract to commence, given that the security benefit goes to the customer they should maybe contribute to the bond premium. The advanced payment bond premium is usually cheap compared to the cost of capital elsewhere however and these are bonds are very good value compared to the opportunity cost of not having cash in the bank.
Can PS Surety help?
PS Surety is a dedicated surety bond brokerage and we would be delighted to assist any contractor with placing advanced payment bonds. We are fully regulated by the FCA and we guarantee that we provide our clients with:
The best possible terms available in the market
An honest, open and joint approach to our client's Surety needs
Detailed client dashboard providing information on every bond ever placed by the client with PSS
Communication when bonds become overdue in order to help our clients to avoid or reduce additional premium charges
A single touch point within our organisation for wording reviews, quotes and queries
That sounds expensive.
Our service is completely free to contractors. We are paid a commission by the surety providers on each bond that we place with them on a contractors behalf, the details of which are fully disclosed in our client dashboard. The surety providers are happy to pay our commission because we specialise in bringing them business which fits their ever changing underwriting criteria. We also deal with frequent queries, wording issues, bond drafting and general administration. The price that you pay PS Surety for a bond is the same price that you would pay any Surety if going direct. We save you the hassle of going direct whilst providing expert, specialist knowledge.