Edited by Massimo Ferracci

Advance payment bond/Down payment guarantee

Advance payment bond or Refund Guarantee or, finally, Refund Guarantee is the obligation assumed by the bank, at the request of a supplier of goods or services (Payer), to make a payment to the beneficiary, within the limits of a declared sum of money, in the event of failure by the payer to reimburse, according to the terms and conditions established by the contract, any sum or sums paid in advance by the beneficiary to the payer and not otherwise reimbursed.

The function of the Advance Payment Bond is to guarantee, in the event of default by the contractor, the repayment to the client of the sums advanced by the latter.

In many contracts, in fact, to allow for greater self-financing, it is agreed that the client will pay advances upon signing the contract in exchange for the release of an adequate guarantee, represented precisely by the Advance Payment Bond.

Advance payments are related to the construction site setup costs, the purchase of machinery, and other organizational expenses.

Such advance payments provide the exporter with some liquidity to finance production costs and, to a certain extent, provide evidence of the buyer's serious intentions and financial readiness.

In most cases, the exporter must therefore provide a bank guarantee, through which the buyer can demand reimbursement of the deposits in the event that the seller defaults.

The advance amount is then gradually recovered by deduction from the sums paid by the contractor in relation to the progress of the work or the completion of shipments, with a consequent reduction in the initial amount of the guarantee.

Advance payments are based on a percentage of the contract price or a predetermined sum. However, their amount reflects the bargaining power of the parties, as they are similar to interest-free financing, which the client naturally tends to minimize while the contractor maximizes.

In relation to the expiry and enforcement of the guarantee, international rules specify that if the guarantee does not specify a final date by which the request for enforcement must not be received by the guarantor, such final date (the expiry date) is deemed to be set at six months from the date indicated in the contract for delivery or completion or that of any related extension.

If no claim is received by the guarantor by the due date or if a claim made under the guarantee has been granted in full satisfaction of all the beneficiary's rights, then the guarantee ceases to be valid.

If the guarantee does not specify the documentation to be submitted in support of a request for enforcement or merely requires a declaration of enforcement by the beneficiary, the beneficiary must submit a judicial ruling or arbitration award justifying the request, or the written agreement of the originator relating to the request and the amount to be paid.

As with the Performance Bond, the Advance Payment Bond also involves risks for both the principal and the customer. Therefore, for prudential reasons, the customer must be in possession of the guarantee before making the agreed advance payment. Alternatively, the customer could make the provision of the amount to the customer conditional upon its collection or release, on the customer's behalf, by the bank responsible for the guarantee in question in the composition with creditors.

The customer, on the other hand, also for prudential reasons, will want to avoid fraudulent use of the Advance Payment Bond.

Therefore, the bond is issued after receiving the agreed-upon advance payment, or it is issued immediately, but its effectiveness is conditional upon receipt of the advance payment. Contextuality, therefore, serves to avoid cases that have unfortunately already occurred in the past. However, once the security aspect of the bond is overcome, the risk of arbitrary enforcement of the guarantee remains. The arbitrariness of the enforcement, even if sometimes made in good faith by the client, remains a subjective factor that is difficult to categorize.

Finally, it must be taken into account that if a contract provides for the guarantee to be maintained for the deductible amount, there is a risk that the guarantee amount will not be reduced proportionally due to negligence or ill will on the part of the client. This is especially true because, although the contract provides for a reduction in the guarantee amount proportional to the payments made, the guarantee texts very rarely contain such a clause.

Furthermore, for the guarantor bank, as a party external to the contract, there is often the objective impossibility of linking the payments with the reduction of the commitment undertaken.

Maintenance or warranty bond 

In the period following the completion of the work, liability for any defects and for system maintenance is still covered by the aforementioned retention money. For the same reason, the construction company will only be able to obtain the full contractual price by providing the client with guarantees that ensure compliance with the maintenance obligations agreed to in the contract.

The reference period, although it varies from contract to contract, corresponds to the period necessary for complete fulfillment of the maintenance obligations.

The amount generally corresponds to 10% of the contractual price of the work carried out.

Payment clause “on first demand”

Bearing in mind the limitations of this type of analysis, let's now examine more closely the set of conditions and terms contained in the entire text of the guarantee (and not just a few isolated sentences) that qualify a bond as unconditional. Indeed, the primary interpretative resource for determining the parties' intention remains the text of the guarantee itself, as it represents their definitive agreement. Statutory rules of national legal systems, customs and practices of transnational commerce, uniform rules, the lex mercatoria, etc., while influential, constitute secondary sources.

A first indicator necessary to qualify the autonomy of the bond is undoubtedly represented by the "payment on first demand" clause.

If the "on first demand" clause is included in the bond, the beneficiary is entitled to payment without having to comply with any conditions other than the simple request for payment. The bond entitles the beneficiary to enforce the entire amount of the guarantee, requiring only compliance with the payment conditions specified in the bond text, which, in the case of a "first demand" bond, are represented by the simple request.

In particular, the “first demand bond” (or simply bond) is generally known in two variants:

(a) the first category includes bonds for the enforcement of which nothing more than a simple request, even if not written, is required.

(b) the second category includes those bonds for which a "statement of default" is required, i.e. a unilateral declaration by the beneficiary, not necessarily accompanied by further information, in which he must affirm that the risk deducted as a guarantee has occurred (without having to prove anything), for example the declaration that the successful tenderer has refused to sign the contract (in the case of a Tender bond) or that the builder has not completed the project as agreed (in the case of a Performance bond).

However, it should be noted that the term "first demand bond" refers to a legal concept. In this sense, a bond, to be considered a first demand bond, does not necessarily have to explicitly state that any payment to the beneficiary will be made on first demand. In fact, there are many other phrases that convey the same concept, so ultimately, careful attention must be paid to the entire text to determine whether the guarantee is a "first demand bond."

However, we can observe how, in guarantees issued by banks, the following expressions generally indicate that the payment must be made by the bank "on demand" in the sense described above: "payment will be made without any objection"; “regardless of any objection”; “despite any objection by…(principal debtor)”; “at simple request”; “on demand and without notice or any condition or restriction”; “payment without proof or justification / or no opposition, objection or recourse to arbitration or to the courts… shall be taken into consideration”; “payment will be made upon the contractor's default as determined by you in your absolute discretion”; “we guarantee payment on your request whether or not any amount is due on the… contract”; “your demand (or statement) shall be accepted as conclusive evidence of liability”.

“No exceptions” payment clause

According to prevailing Italian doctrine, the inclusion of a "first demand" clause is not sufficient to qualify a guarantee as autonomous, since "the existence of this contract can be deduced from the presence, in its text, of a series of clauses that are incompatible with the accessory nature of surety-type guarantees and that make it independent from the basic contract."