Pay When Paid Provisions: Are you Actually Shifting the Risk
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Construction contracts contain many risk-shifting mechanisms. One such mechanism is the “pay when paid” provision that requires payment from one party before there is any requirement to pay another party. Typically, this contract provision is found in the contract between the general contractor and its subcontractors, as well as in the subcontractor’s contract with its subcontractors. If not properly worded, this risk shifting provision will not have its intended consequences.
I. Pay When Paid Provisions May Not Be What They Appear
As a starting point, the burden of drafting a clear and unambiguous pay when paid provision is on the general contractor. International Engineering Services, Inc. v. Scherer Construction & Engineering of Central Fla., LLC, 74 So.3d 531 (Fla. 5th DCA 2011); OBS Company, Inc. v. Pace Construction Corp., 558 So.2d 404 (Fla. 1990). If the pay when paid provision is ambiguous, it will not have the desired effect and will result in the general contractor being required to pay the subcontractor in a reasonable time. International Engineering Services, Inc. v. Scherer Construction & Engineering of Central Fla., LLC, 74 So.3d 531 (Fla. 5th DCA 2011); OBS Company, Inc. v. Pace Construction Corp., 558 So.2d 404 (Fla. 1990). Therefore, the contract between the general contractor and its subcontractor must be clear that payment to the sub is expressly conditioned on payment by the owner to the general contractor.
The next factor to consider on the enforceability of the pay when paid provision is whether the subcontract incorporates the terms of the prime contract (contract between owner and general contractor). If the prime contract is incorporated into the subcontract, then the terms of the prime contract will be made part of the subcontract, which can result in ambiguities. For instance, many prime contracts require that the general contractor provide an affidavit or certification that the general contractor has paid all of its subcontractors before the owner has made payments to the general. If the prime contract is incorporated into the subcontract, this provision creates an ambiguity with the pay when paid provision in the subcontract. International Engineering Services, Inc. v. Scherer Construction & Engineering of Central Fla., LLC, 74 So.3d 531 (Fla. 5th DCA 2011); OBS Company, Inc. v. Pace Construction Corp., 558 So.2d 404 (Fla. 1990).
In International Engineering, the subcontract contained a valid pay when paid provision, where the subcontractor would only be paid if the owner paid the general contractor. However, the subcontract incorporated the prime contract, which said the owner was not required to pay the general until the general had paid all of its subcontractors. The court found that incorporating the prime contract into the subcontract resulted in the pay when paid clause being ambiguous. As such, even though the owner had not paid the general, the general was still required to pay the subcontractor.
II. Ways to Avoid an Ambiguous Pay When Paid Provision
In light of the case law cited above, the general contractor must first understand the prerequisites of payment under its prime contract. Assuming the general contractor desires a pay when paid arrangement with its sub, the general contractor should negotiate the prime contract such that its payment terms will not conflict with that of its subcontract. One way of accomplishing this in the prime contract is to provide only affidavits/certifications for amounts paid (not to be paid). The general contractor can also agree to provide conditional lien waivers from its subs until payment is made by the owner, followed by unconditional lien waivers upon payment and clearing of funds.
The general contractor must also have a clear pay when paid provision in its subcontract. The provision must be a clear expression that payment from the owner to the general is an express condition precedent to the general’s obligation to pay its sub. This provision should apply to both progress and final payments.
The general contractor should also give careful consideration to incorporation of any of the terms of the prime contract into the subcontract. Like with the potential pay when paid ambiguities referenced above, the burden is on the general contractor to ensure that risk shifting provisions are clear and unequivocal. Assuming the prime contract does not require its incorporation into subcontracts, the general contractor should determine what, if any provisions, should be incorporated into the subcontract.
The process outlined above should help eliminate any ambiguity between the prime contract and subcontract and eliminate any unintended consequences.