Advance Payments and Bonds: What the Security Package Costs

Every bond, guarantee and retention in a construction contract has a price, and most of it is paid twice. A breakdown of what the security package costs and what it buys.

A security package is a purchase of protection, and it is funded by whoever has to post it. Bonds carry bank charges and consume a contractor facility; retention withholds cash it has already spent; advance payments ease mobilisation and must be secured. Knowing what each instrument costs is how you assemble a package that protects you without paying for protection twice.

What this number does and does not include

This covers the cost of the instruments themselves and the knock on effect on the price, not the cost of the event each instrument protects against. It assumes a contract between commercial parties with a bank issuing the instruments. Charges, facility terms and the availability of particular instruments depend on the bank, the contractor standing and the project, and arrangements of this kind change over time, so every figure in a real package must be confirmed with the issuing bank at the time. Products are offered by banks and finance companies supervised by the relevant authority, and the terms come from them rather than from a general rule.

Bid or tender security

A bid security protects you against a bidder withdrawing or refusing to execute the contract after award. It is usually a modest percentage of the tender sum and sits in place only until award or expiry. Its real cost is selective: the charge is small, but requiring it narrows the field, because a smaller contractor may not have facility headroom to post securities on several tenders at once.

• Pushes it up: A long tender validity period, a high percentage, and a requirement for an unconditional instrument from a bank acceptable to you.
• Brings it down: A short validity, a modest percentage, and acceptance of a tender declaration from prequalified bidders where the risk is low.
• How to control it: Set the validity to the realistic award period, and release securities promptly for unsuccessful bidders rather than letting them run to expiry.

Advance payment and its guarantee

An advance payment funds mobilisation and early procurement, which materially improves contractor cash flow and often reduces the price. It is normally secured by a guarantee for the full amount, reducing as the advance is recovered from valuations. The cost to you is the loss of use of the money for part of the contract, and the cost to the contractor is the guarantee charge, which it includes in its price.

• Pushes it up: A large percentage, a long recovery period, and a guarantee that does not reduce as the advance is repaid.
• Brings it down: A recovery schedule tied to valuations, a reducing guarantee, and payment of the advance against evidence of actual mobilisation spend.
• How to control it: Set the recovery so that the advance is fully repaid before the final stages, and insist the guarantee reduces in step so the contractor is not paying for cover on money it has already returned.

Performance security

The performance bond or guarantee responds if the contractor fails to perform. Its purpose is to fund the additional cost of completing the works with somebody else, so the right size is an estimate of that cost rather than a conventional percentage. The contractor pays a charge and the instrument consumes its banking facility, which limits what else it can take on. Both effects reach you, one through the price and one through capacity.

• Pushes it up: A high percentage, an unconditional on demand form, a long validity extending through the defects period, and a requirement for a first class bank.
• Brings it down: A percentage sized to the realistic cost of completion, release at practical completion with a separate smaller instrument for the defects period, and acceptance of a reputable local bank.
• How to control it: Calculate the likely additional cost of completion for your project and size the bond to it, then state clearly when it is released.

Cash retention

Retention withholds a percentage of each payment as security for completion and defects. It is the cheapest security for you because it costs nothing to establish, and the most expensive for the contractor because it withholds money already spent on labour and materials. That cost returns in the price, and on a long contract the amount held can exceed what the defects risk justifies.

• Pushes it up: A high percentage, no limit on the total held, and release delayed well beyond the end of the defects period.
• Brings it down: A percentage with a stated cap, a step down at practical completion, and prompt release on issue of the final certificate.
• How to control it: Cap the total retention and release half at practical completion, so that the sum held matches the risk that actually remains.

Retention bond as an alternative

A retention bond replaces cash retention with a bank instrument: you hold a security of equivalent value and the contractor keeps its cash. The contractor pays a bank charge, which is usually far less than the cost of funding withheld cash, so the price effect can be favourable. The trade off is that calling a bond is a process, whereas cash in your hand needs no process at all.

• Pushes it up: A conditional form requiring proof of default, a short validity, or a bond issued by a bank you would struggle to pursue.
• Brings it down: An agreed standard form, a validity that covers the whole defects period, and an issuer on an agreed list.
• How to control it: Offer the option at tender and compare the price effect, but settle the form of bond and the issuing bank criteria before accepting it.

Insurance within the security package

Contractor all risks and third party cover protect against physical loss and liability rather than against non performance, and they sit alongside the bonds rather than overlapping them. Premiums depend on the value, the location, the perils and the excesses, and the allocation in the contract decides who buys what. Gaps between the contract allocation and the policy wording are common and expensive.

• Pushes it up: High excesses borne by you, a long programme, significant existing structures, and cover arranged after the risk allocation was drafted.
• Brings it down: A single project policy covering all parties, excesses aligned with the contract, and the broker reviewing the draft contract before it is signed.
• How to control it: Give the draft contract to your broker and ask for written confirmation that the insurance matches the allocation, including the defects and testing periods.

Parent company or third party guarantees

Where the contracting entity is small or newly formed, a guarantee from a parent or an affiliate gives you recourse to a stronger balance sheet. The direct cost is usually low, but the negotiation can be slow and the value depends entirely on the guarantor substance and on whether the guarantee is enforceable against it in practice.

• Pushes it up: A guarantor in another jurisdiction, a guarantee limited in amount or time, and conditions that must be satisfied before it can be called.
• Brings it down: A guarantor with assets in the same jurisdiction, an unlimited guarantee of the contract obligations, and a simple demand mechanism.
• How to control it: Assess the guarantor accounts as carefully as the contractor own, and have a licensed legal adviser confirm the guarantee is enforceable as drafted.

Costs that never appear on the first page

• The price uplift a contractor applies when the whole security package consumes a large part of its banking facility.
• Extension charges when bonds have to be renewed because completion is later than planned.
• Management time spent chasing expiring instruments, which on a long contract is a recurring administrative load.
• The cost of a narrower bidder field, since a heavy package excludes capable smaller contractors.
• Interest or financing cost the contractor incurs funding retention, recovered inside its rates rather than shown as a line.
• Legal cost of agreeing non standard bond wording, which can take weeks on each instrument.

Keeping the budget honest

Size each instrument to the loss it is there to cover, not to a percentage inherited from a previous contract. Write down what each one protects against, what it would need to pay out and when it is released, then total the package and ask whether a contractor would price it as proportionate. A package that looks excessive gets priced as excessive, and you pay for the perception as well as the protection.

• At tender, where the required instruments are stated and bidders price them.
• At execution, where the forms, issuers and validity dates are agreed and the instruments are delivered.
• At each valuation, where advance payment recovery and retention accumulation are applied.
• At practical completion, where the step down in retention and the release of the performance security fall due.
• At the final certificate, where every remaining instrument should be returned and cancelled.

Domira builds and supervises projects across Saudi Arabia, and the commercial discipline above is how its projects stay inside their budget and their programme. Send the drawings, the contract or the site and Domira will tell you where the risk actually sits.