The Dilemma of Pre-payment. At the heart of many business transactions is a simple question: should a buyer pre-pay for goods or services? The obvious risk for buyers is that, after paying, the supplier may default on delivery or not meet the agreed-upon standards. This is where the Advance Payment Guarantee (APG) comes into play.

The Role of an Advance Payment Guarantee (APG)

An APG is a financial instrument, typically provided by a bank or financial institution on behalf of a supplier, which guarantees that any advance payments made by the buyer will be returned if the supplier fails to fulfill contractual obligations.

Benefits of an APG for Buyers

• Security: Ensures that advance payments are safe and can be claimed back if the supplier defaults.
• Flexibility: Enables more flexible payment terms which can be beneficial for cash flow.
• Trust: Strengthens the business relationship by showing the supplier’s commitment.

The Cost to Suppliers

• While APGs can be beneficial for buyers, they come at a cost to suppliers:
• Bank Fees: Banks or financial institutions charge fees for providing these guarantees.
• Collateral: Depending on the supplier’s creditworthiness, the bank might require collateral.
• Opportunity Cost: The funds kept as collateral could have been used elsewhere in the business.

Alternatives to APG – Navigating Other Payment Terms

If both parties want to avoid APGs, there are several alternative payment terms that can be negotiated:

• Letter of Credit: This is a promise by a bank on behalf of the buyer to pay the seller upon receipt of certain documentation (like a bill of lading). It provides more security than an APG but can be costlier and complex.
• Escrow: A neutral third party holds the payment and only releases it to the supplier once the terms of the contract are met. This ensures both parties are protected.
• Open Account: This is favorable for the supplier, where goods are delivered, and payment is made later, based on agreed terms. It requires a high level of trust between both parties.
• Documentary Collections: Important transaction documents (like the bill of lading) are handled by banks, which ensures that the seller gets paid once the buyer receives the documents.

In Conclusion

While APGs offer a layer of protection for buyers making advance payments, they come at a cost to suppliers. Understanding the dynamics of different payment terms and choosing the right one for a specific transaction is key to a successful and trustful business relationship. Always assess the risks, costs, and benefits before diving into any agreement.

Learning tips

If you want to learn more about the Tactical buyer role and a standard sourcing process, we recommend “The Sourcing Engine“. The sourcing engine room is build on three courses presenting the basics of a modern sourcing process. Learn about the key activities when preparing, negotiating and implementing a new improved supply chain.

Payment terms and insolvency matters with Jon Kihlman introduce the principles related to payment terms and how to manage insolvency matters.

Knowing the importance of payment terms (PT), the value that can be created and implications on the cash flow are important. Learn how to calculate the cost of capital, benefits that can be created and supplier cost for financing the PT. Visit the Payment Terms course.

The ICC (International Chamber of Commerce) Publication No. 758 refers to the “Uniform Rules for Demand Guarantees” (URDG). The URDG establishes a framework for demand guarantees and counter-guarantees, including those related to advance payment.

Advance Payment Guarantee for illustrative purposes

Here’s a basic example of an Advance Payment Guarantee for illustrative purposes based on the Uniform Rules for Demand Guarantees (URDG) ICC Publication No. 758:

ADVANCE PAYMENT GUARANTEE

Guarantee No: [Unique Guarantee Number]

Date: [Issue Date]

Issuing Bank: [Name of the Issuing Bank, Address, Country]

Applicant (Seller/Contractor): [Name, Address, and Contact Details]

Beneficiary (Buyer/Employer): [Name, Address, and Contact Details]

Guarantee Amount: [Currency and Amount]

Expiry Date: [Date]

Place of Presentation: [Location, typically the Issuing Bank’s address]

1. We, [Name of Issuing Bank], hereby unconditionally undertake to pay you, [Name of Beneficiary], on your first written demand, any sum or sums up to the aggregate amount of [Amount], without the need for you to prove or show grounds or reasons for your demand or the sum specified therein.

2. This guarantee is issued under the Uniform Rules for Demand Guarantees (URDG), ICC Publication No. 758.

3. Any demand under this guarantee should be accompanied by the following:

a. A written statement from the Beneficiary stating that the Seller/Contractor has failed to perform its obligations under the contract.

b. A copy of the underlying contract between the Applicant and Beneficiary.

4. This guarantee shall expire on [Expiry Date] at [Location of Expiry]. Unless a claim or demand is presented to us on or before the expiry date, your rights under this guarantee shall be forfeited, and we shall be relieved of all our obligations hereunder.

5. This guarantee is governed by and subject to the Uniform Rules for Demand Guarantees (URDG), ICC Publication No. 758.

6. This guarantee is indivisible, and any demand made hereunder must be for the full guarantee amount. The guarantee is not transferable or assignable.

7. Communications with respect to this guarantee should be made in writing and addressed to [Issuing Bank’s Address]. All charges related to this guarantee are to be borne by the Applicant.

Authorized Signature and Bank Seal

Please keep in mind this is a simplified illustrative example. Actual Advance Payment Guarantees may have additional clauses or details depending on the specific requirements of a transaction. Consulting with a legal or trade finance professional is essential when drafting or dealing with such guarantees.