In previous blog articles we have explained the difference between “pay if paid” and “pay when paid” clauses (For more information regarding the “pay-if-paid” and “pay-when-paid” provisions, see our blogs dated. June 19, 2012, April 26, 2012, April 5, 2011 and March 17, 2008).
Generally, if the pay if paid clause is precisely drafted, courts will uphold the provision and shift the risk of non-payment to the subcontractor. The burden of drafting a clear and unambiguous clause falls on the general contractor. If the clauses are not clearly drafted, that is if they are ambiguous, courts may refuse to shift the risk of owner non-payment to the subcontractor. A recent Florida case illustrates such an example of how a broad incorporation by reference clause in a subcontract can negate an otherwise enforceable pay if paid provision.[1]
The subcontractor had performed all of its work under the subcontract, but did not receive payment in full from the contractor. The contractor’s defense was that the subcontract contained a pay if paid clause, which provided that payment by the owner was a condition precedent to the general contractor’s obligation to pay the subcontractor, and the owner had not paid the general contractor. The pay if paid provision in the subcontract read as follows:
“Subcontractor . . . agrees that Owner’s payment to Contractor of all progress payments and final payment for any work performed by Subcontractor, other subcontractors and Contractor, shall be an express condition precedent to any obligation of Contractor to make any progress payment, retainages or final payment to Subcontractor.”
After finding that this provision constituted a clearly expressed pay if paid clause, which would ordinarily be valid and enforceable, the court further analyzed the subcontract, which contained an incorporation by reference clause of the prime contract between the owner and the general contractor, and provided:
“Neither final payment nor any remaining retained percentage shall become due until Contractor submits to the Architect (1) Affidavit that payrolls, bills for materials and equipment, and other indebtedness connected with the work for which the Owner or the Owner’s property might be responsible or encumbered (less amounts withheld by Owner) have been paid or otherwise satisfied.”
The court reasoned that the prime contract provided that the owner was not obligated to pay the general contractor until the general contractor paid all of its subcontractors (“other indebtedness”), including the subcontractor at issue. Thus, the court reasoned that the general contractor was obliged to pay the subcontractor before any amounts became due from the owner, which clearly conflicted with the pay if paid clause in the subcontract.
The court went on to find that the conflict made the pay if paid provision ambiguous and thus unenforceable.
Comment: To avoid having the payment provision of the prime contract invalidate a pay if paid clause, many subcontracts include a phrase in the beginning of the clause along the following lines: “Notwithstanding anything to the contrary contained in the contract documents.” This qualifying language may serve to establish an order of precedence to address the inconsistency or ambiguity issue. In this case, the qualifying language was contained in the subcontract, yet the court nevertheless found the pay if paid clause unenforceable in light of the payment requirements of the prime contract. Therefore, the best way to avoid this issue would be to remove from the prime contract the requirement that subcontractors be paid before the owner’s obligation to pay the general contractor arises. When that is not possible, that is when negotiation of the prime contract terms are not available, such as in public contracts, it may be necessary to limit the way the prime contract is incorporated into the subcontract, which presents a difficult dilemma for the general contractor.
___________________________________________________________________________________________________
[1] International Engineering Services, Inc. v. Sherer Construction and Engineering of Central Florida, LLC, 74 So.3d 531 (2011).