Hello, this is Attorney Baek Gi-hyung from Cheongchul Law Firm.
In construction projects, various guarantees such as bid bonds, contract bonds, performance bonds, advance payment bonds, subcontract payment guarantees, and defect repair bonds are utilized at each stage of implementation.
Among these, Advance Payment Bond (Ap-Bond) and Performance Bond (P-Bond) often overlap in the aspect of 'returning the advance payment', which can easily lead to confusion.
What exactly are the advance payment bond and performance bond, and what are the specific differences between them?
[Question]
What is an Advance Payment Bond (Ap-Bond)?
[Answer]
In the event of a contractor's failure to perform their obligations under the basic contract, the client may claim the return of the advance payment made. The Advance Payment Bond (Ap-Bond) serves to guarantee this return of the advance payment. Accordingly, if the contractor fails to perform their obligations under the basic contract, the client will retrieve their advance payment through a claim under the bond.
The advance payment bond is often issued together with a performance bond, and in such cases, both exist concurrently. At this point, as the grounds for claiming are the same for both, claims for payment will also occur together.
The amount guaranteed is the total amount of the advance payment, usually around 3-5% of the contract amount. However, advance payment bonds typically include a clause for reducing the guaranteed amount, allowing the maximum guaranteed amount to be gradually decreased according to the progress of the construction contract execution, so that when the construction progresses to the extent equivalent to the amount of the advance payment, the maximum guaranteed amount is exhausted. Once the remaining maximum guaranteed amount is exhausted, the advance payment bond terminates, leaving only the performance bond.
On the other hand, if the advance payment bond is provided before the advance payment is made, a clause is typically included that makes the payment of the advance payment a condition for its effectiveness. In cases where the advance payment bond is not provided first, it is common for the payment of the advance payment to require the submission of the guarantee.
[Question]
What is a Performance Bond (P-Bond)?
[Answer]
A Performance Bond (P-Bond) is a guarantee that allows the beneficiary to make a claim under the bond in case the contractor fails to fulfill the contract under the basic agreement, and is the most commonly used type of bond. In a narrow sense, a performance bond guarantees the fulfillment of obligations related to key stages from the start of the contract to its completion, while in a broader sense, it refers to a single guarantee that covers all stages of the contract.
However, depending on the institution providing the performance bond, the scope of coverage may differ according to each institution's terms, and as a result, the return of the advance payment may be excluded. Article 1, Section 2 of the newly established Contract Guarantee Terms of the Construction Guarantee Corporation from October 14, 2000, stipulates that advance payments are excluded from the object of contract guarantees, suggesting that the obligation to return advance payments is not included in the debts guaranteed by the corporation (as the return of advance payments is closer in nature to restorative return, it may not be appropriate to include it in the contract guarantee, which carries the nature of either pre-estimated damages or compensation limits). Conversely, since such provisions do not exist in Article 1 of the Seoul Guarantee Insurance’s guarantee insurance terms, it can be seen that advance payments are naturally included.
The amount guaranteed is usually around 10-15% of the contract value and is generally stated in the form of a maximum guarantee amount. However, in international construction contracts, there may be instances where the maximum guaranteed amount increases as the amount the contractor receives from the client (construction payment) increases according to the progress of the construction.
A concise table summarizing the differences between the Advance Payment Bond and the Performance Bond for better understanding is as follows:
Category | Advance Payment Bond | Performance Bond |
Meaning | A bond guaranteeing the return obligation when the contractor unreasonably retains the received advance payment (nature of unjust enrichment return) | A bond guaranteeing the payment of a predetermined amount if the contractor fails to fulfill contractual obligations (nature of damages) |
Payment Conditions | Failure to fulfill contractual obligations and failure to return unaccounted advance payments | Failure to fulfill contractual obligations due to the debtor's fault and occurrence of damages (however, if the case is seen as a pre-estimation of damages, proof of occurrence may not be required) |
Guarantee Timing | Submission of the bond upon receipt of the advance payment | Upon contract signing |
Guaranteed Amount | The total amount of the advance payment (generally around 3-5% of the contract amount) | Generally around 10-15% of the contract amount |
Scope of Effect | Until the return of the advance payment, if there are unpaid amounts related to the progress, the advance payment is prioritized for settlement against unpaid amounts, and the guarantee's effect exists for the remaining balance | (i) Damages due to project delays (ii) Obligation of restoration due to termination of the subcontract (iii) Obligation of the contractor to return the advance payment (may be excluded depending on the terms) (iv) Damages due to additional construction costs (increased construction costs incurred due to the contractor’s work suspension necessitating alternate means of completing unworked parts) |
However, depending on the terms, (i) Where there are provisions stating that the contract guarantee is naturally accrued: it is presumed as the pre-estimated damages or penalties, and proof of damage amount is not required. (ii) Where there are no provisions stating that the contract guarantee is naturally accrued: it is interpreted as a general damage security agreement, and actual damage amounts must be proven. |
Attorney Baek Gi-hyung works in the construction/real estate team of the Defense Acquisition Program Administration (DAPA) and a large law firm, providing legal advice throughout the process of large-scale construction projects including government procurement projects, national defense facility projects, and SOC construction projects, and boasts extensive experience and skills in resolving related litigation. Please feel free to contact us if you need assistance related to government procurement projects, private construction projects, public procurement contracts, state-owned properties, local properties, or public assets.
Cheongchul Law Firm is composed solely of attorneys from major law firms like Kim & Chang, Kingdom, Pacific, Sejong, and Yulchon and attorneys from in-house legal teams of large corporations, who form teams of specialized attorneys relevant to each case rather than a single attorney. Cheongchul provides comprehensive solutions beyond solving specific issues, focusing on delivering legal consulting that ultimately achieves what clients desire. If you need help achieving your goals, do not hesitate to contact Cheongchul.
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