Do Construction Contract Contingent Payment Clauses Mean What They Say? A guide for contractors and subcontractors.

Assume you are a subcontractor working on a project to build a large multi-family apartment complex.  You’ve timely and properly performed your work and have submitted monthly pay applications that have been accepted by the contractor and the owner.  However, the owner has recently encountered financial difficulties.  Because of this, the owner has not paid the contractor on its last two pay applications, which also include your last two pay applications seeking payment for several hundred thousand dollars of completed work.  You’ve demanded payment from the contractor, but the contractor has refused to pay you, stating that it has no obligation to pay you under the pay-if-paid contingent payment provision in your subcontract until the contractor is first paid by the owner.

Is the contractor correct, or does the contractor ultimately have to pay for the completed work under the subcontract regardless of any issue with payment from the owner?  Conversely, if you’re the contractor, do you have an obligation to pay the subcontractor even though you have not received payment from the owner?  In short, does the contingent payment clause really mean what it says?

The answer can vary greatly depending on the specific language of the subcontract and the state where the project is located.  This is because while many subcontracts contain some form of contingent payment clause, which is a contractual provision that states that the obligation to make payment is contingent on payment of the contractor by the owner, different states have different laws and requirements regarding the enforceability of contingent payment clauses.

I. Pay-When-Paid Versus Pay-If-Paid Provisions

There are two basic types of contingent payments clauses, pay-when-paid clauses and pay-if-paid clauses.  While sometimes these terms are used interchangeably, the two types of clauses have very different legal effects.  A Pay-when-paid clause links the timing of the contractor’s obligation to make payment to the subcontractor to the time when payment is made to the contractor by the owner.  However, a pay-when-paid clause does not relieve the contractor of the contractual obligation to ultimately pay the subcontractor.  Instead, under a pay-when-paid clause, the contractor is ultimately required to pay the subcontractor within a “reasonable time” of the subcontractor’s completion of its work, even if the contractor does not ever receive payment from the owner.  What constitutes such a “reasonable time” is not clear cut and can vary greatly depending on the specific factual circumstances of the project and the law of the jurisdiction where the project is located.

The second type of contingent payment clause is the pay-if-paid clause, which actually functions to make the contractor’s obligation to pay the subcontractor entirely dependent on the contractor first receiving payment from the owner.  In other words, pay-if-paid clauses actually shift the risk of the owner’s nonpayment from the contractor to the subcontractor, so that if the owner never pays the contractor, the contractor has no legal obligation to ever pay the subcontractor.

II. Enforceability of Contingent Payment Clauses

In large part because the contractor is the party with a direct contractual relationship with the owner, and is therefore generally seen as being in a better position than a subcontractor to assess the risk of nonpayment by the owner, many jurisdictions either significantly restrict the enforceability of pay-if-paid clauses, or make them unenforceable all together.

A. Some States Allow Enforcement in Only Limited Circumstances

In many of the states that allow pay-if-paid clauses to be enforced as written, the courts require that the pay-if-paid clause clearly and unambiguously state the intent to shift the risk of nonpayment by the owner to the subcontractor in order to be enforceable, with any ambiguity in the clause being construed against the contractor.  In Florida, for instance, the courts will generally only enforce a pay-if-paid clause as written if it uses words expressly making payment from the owner a “condition” or a “condition precedent” to the contractor’s obligation to pay the subcontractor, or if it expressly states the contractor’s payment obligation is “contingent” upon the contractor receiving payment from the owner.[1]  Without language clearly and unequivocally expressing the intent to shift the risk of owner nonpayment to the subcontractor, Florida courts will construe the clause as simply creating an obligation for the contractor to pay the subcontractor within a reasonable time of the subcontractor’s work, i.e. as a pay-when-paid clause.  For example, one Florida court ruled that a clause providing that payment would be made by the contractor “after receipt of payment by the owner” did not sufficiently make clear that the contractor’s payment obligation was contingent on payment from the owner.[2]  For that reason, the court construed the clause as only fixing a reasonable time for payment after the subcontractor’s performance, and not as relieving the contractor of the obligation to pay the subcontractor.

Other jurisdictions that allow pay-if-paid clauses to be enforced often have similar requirements for express and unequivocal language that must make clear that the parties intended to shift the risk of the owner’s nonpayment from the contractor to the subcontractor.  These include Georgia,[3] Louisiana,[4] and Michigan,[5] among others.  Without such clear and unambiguous contract language, the pay-if-paid clause will not be enforceable or will be construed as having the effect of a pay-when-paid clause under which the contractor still has the obligation to pay the subcontractor within a reasonable time notwithstanding the owner’s nonpayment.

B. Other States Make Contingent Payment Provisions Unenforceable Altogether

Some jurisdictions go even further, making pay-if-paid clauses unenforceable altogether.  For example, North Carolina has a statute that expressly provides that “Payment by the owner to a contractor is not a condition precedent to payment to a subcontractor … and an agreement to the contrary is unenforceable.”[6]   Other states, such as South Carolina[7] and Delaware[8] have similar express statutory prohibitions on pay-if-paid clauses.  In other states, such as California[9] and Nevada,[10] for example, the courts have construed statutes the bar the waiver of lien rights as also prohibiting the enforcement of pay-if-paid provisions due to the indirect impairment of a subcontractor’s lien rights caused by a pay-if-paid provision.

III. Conclusion

As can be seen, the answer to the question of whether a contingent payment clause means what it says is dependent on the specific language used in the subcontract and the law of the jurisdiction where the project is located.  Since enforceable pay-if-paid clauses shift the risk of owner nonpayment to the subcontractor, it is important for subcontractors to be aware of these types of provisions in subcontracts and understand the legal issues related to enforceability.  If an enforceable pay-if-paid clause cannot be avoided, subcontractors need to make sure that they take steps to ensure that an enforceable pay-if-paid provision is also flowed down to their contracts with their subcontractors and suppliers.  Similarly, contractors that intend on including an enforceable pay-if-paid provision in their subcontracts need to clearly understand whether pay-if-paid clauses are enforceable in the relevant jurisdiction of the project, and if so, the specific legal requirements that must be met to ensure the clause will actually be enforced as written by a court if necessary.

 

[1] See e.g., DEC Electric, Inc. v. Raphael Constr. Corp., 538 So. 2d 963, 964-65 (Fla. 4th DCA 1989) (aff’d by DEC Electric, Inc. v. Raphael Constr. Corp., 558 So. 2d 427 (Fla. 1990) (“In most cases which have found that the language of the payment provisions created condition precedents, the term ‘condition’ or ‘contingency’ was explicitly used.”)

[2] G.E.L. Recycling, Inc. v. Atlantic Environmental, Inc., 821 So. 2d 431, 432-33 (Fla. 5th DCA 2002).

[3] See St. Paul Fire & Marine Ins. Co. v. Ga. Interstate Elec. Co., 187 Ga. App. 579, 580 (Ga. Ct. App. 1988) (“A provision in a contract may make payment by the owner a condition precedent to a subcontractor’s right to payment if ‘the contract between the general contractor and the subcontractor should contain an express condition clearly showing that to be the intention of the parties.”).

[4] See Imagine Constr. v. Centex Landis Constr. Co., 707 So. 2d 500 (La. App. 4 Cir. 1998) (holding that provision providing that “actual receipt of full payment from Owner shall be a condition precedent” to right of subcontractor to seek payment constituted enforceable pay-if-paid clause).

[5] See Christman Co. v. Anthony S. Brown Dev. Co., 210 Mich. App. 416, 419 (Mich. Ct. App. 1995) (holding that subcontract provision providing that receipt of payment by the owner was a “condition precedent to payments to the subcontractor” created an enforceable pay-if-paid clause).

[6] N.C. Gen. Stat. § 22C-2. 

[7] See S.C. Code Ann. § 29-6-230.

[8] See 6 Del. C. § 3507(e).

[9] Wm. R. Clarke Corp. v. Safeco Ins. Co., 15 Cal. 4th 882, 896-897 (Cal. 1997) (holding that general contractor’s liability to a subcontractor for work performed may not be made contingent on the owner’s payment to the general contractor because it would unlawfully inhibit subcontractor’s mechanic’s lien rights).

[10] Lehrer McGovern Bovis, Inc. v. Bullock Insulation, Inc., 124 Nev. 1102, 1117-1118 (Nev. 2008) (“Because a pay-if-paid provision limits a subcontractor’s ability to be paid for work already performed, such a provision impairs the subcontractor’s statutory right to place a mechanic’s lien on the construction project … Therefore, we conclude that pay-if-paid provisions are unenforceable because they violate public policy.”)

 

 

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