Readers of our blog likely already know that a pay-if-paid clause provides that payment by the owner to the contractor is an express condition to any payment due subcontractors or suppliers. In contrast, a pay-when-paid clause typically provides that payment from the contractor to subcontractor or supplier must occur within a reasonable time after the contractor receives payment from the owner, regardless of whether the owner ever actually pays the contractor. Pay-if-paid clauses shift the risk of non-payment to the subcontractor, while pay-when-paid clauses place the risk of non-payment on the contractor.
While Washington courts have not yet dealt with the pay-if-paid versus pay-when-paid distinction, some other jurisdictions have legislatively or judicially declared that pay-if-paid clauses are unenforceable as a matter of public policy. These jurisdictions reason that a pay-if-paid clause is against public policy because, they believe, a contractor is in a better position to know the financial dealings and likelihood of payment from an owner, as compared to a subcontractor or supplier who does not deal directly with an owner.
Recent Ohio Court of Appeals’ Decision
The Ohio Court of Appeals recently interpreted whether a clause in a construction contract was a “pay-if-paid” or a “pay-when-paid” provision.[i] In that case, the parties entered into a subcontract for electrical work for a swimming pool in a hotel. After performing the job, the subcontractor sued the general contractor for $44,088.90 for work that it completed, but did not get paid (the subcontractor had received $142,620.10 in partial payment for its work). The general contractor filed a motion for summary judgment, asserting that the subcontract contained a “pay-if-paid” clause and, therefore, the general contractor did not have to pay because the owner had not paid the general contractor. The subcontractor filed a cross motion for summary judgment, asserting that the subcontract’s “pay-if-paid” clause was actually a “pay-when-paid” clause because the condition of payment from the owner to general contractor was not clear and explicit.
The provision of the subcontract reads as follows:
The Contractor shall pay to the Subcontractor the amount due [for work performed] only upon the satisfaction of all four of the following conditions: (i) the Subcontractor has completed all of the Work covered by the payment in a timely and workmanlike manner, (ii) the Owner has approved the Work, (iii) the Subcontractor proves to the Contractor’s sole satisfaction that the Project is free and clear from all liens, and (iv) the Contractor has received payment from the Owner for the Work performed by Subcontractor. Receipt of payment by Contractor from Owner for work performed by Subcontractor is a condition precedent to payment by Contractor to Subcontractor for that work.
(Emphasis added). The trial court agreed with the general contractor and held that the above clause was a valid pay-if-paid clause and ruled in the general contractor’s favor. The subcontractor, however, appealed the trial court’s ruling contending that the trial court incorrectly concluded that the provision was pay-if-paid because it was not clear that the subcontractor bore the risk of nonpayment. The Ohio Court of Appeals addressed the issue by first stating that the risk of insolvency of the owner is ordinarily borne by the general contractor, and that pay-if-paid provisions are generally disfavored.
In Ohio, to enforce a pay-if-paid clause it “must clearly and unambiguously condition payment to the subcontractor on receipt of payment from the owner.”[ii] In particular, a pay-if-paid clause must expressly state that: (1) payment to the contractor is a condition precedent to the subcontractor, (2) the subcontractor is to bear the risk of the owner’s nonpayment, or (3) the subcontractor is to be paid solely from the owner.[iii]
In this case, the court held that the “condition precedent” language in the clause was not plain and clear enough to sufficiently shift the risk of the owner’s nonpayment to the subcontractor. The court provided that a pay-if-paid clause requires a “clear, unambiguous statement that the subcontractor will not be paid if the owner does not pay” and that this clause was not sufficiently clear in this respect, despite the fact the provision contained the “condition precedent” language. The court found that “condition precedent” was not sufficiently defined to inform both parties that the subcontractor would bear the risk of nonpayment by the owner. Thus, the Court of Appeals reversed the trial court’s ruling, and ruled in the subcontractor’s favor that the clause was actually a pay-when-paid clause because it was not sufficiently clear to transfer the risk of nonpayment to the subcontractor.
AGC of Washington Subcontract Pay-if-Paid Provision
As mentioned above, Washington courts have not yet interpreted pay-if-paid vs. pay-when paid provisions. However, the recent case from Ohio may shed some light on what Washington courts may focus on, if presented the opportunity. The following pay-if-paid provision provided from the AGC of Washington Subcontract would likely be interpreted as a valid pay-if-paid provision based on the Ohio Court of Appeals opinion because it clearly and expressly states that payment to subcontractor is a condition precedent, and that the subcontractor bears the risk of the owner’s nonpayment:
Payment Contingent on Owner Payment. It is agreed that as a condition precedent to any payment by Contractor to Subcontractor hereunder the Contractor must first receive payment from the Owner for the Work of Subcontractor for which payment is sought. Subcontractor specifically agrees that it is relying upon the Owner’s credit (not the Contractor’s) for payment, and Subcontractor specifically accepts the risk of nonpayment by the Owner. At the reasonable request of Subcontractor, Contractor agrees to furnish such information as is reasonably available to Contractor from Owner regarding Owner’s financial ability to pay for performance under the Main Contract. The parties agree Contractor does not warrant the accuracy or completeness of information provided by Owner.
Comment: The result in Ohio represents a departure from most jurisdictions’ holdings that phrases such as “condition precedent,” “if and only if,” or “unless and until” constitute valid pay-if-paid provisions. Although Washington courts have not yet tackled this issue, they likely will someday soon and may look to other courts’ decisions for guidance. Contractors should examine their subcontracts to make sure the pay-if-paid clauses are sufficiently clear, explicit, and contain the “required” language that the Ohio Court of Appeals indicated in the event that a dispute arises regarding the pay-if-paid provision.
[ii] Id. (citing Kalkreuth Roofing & Sheet Metal, Inc. v. Bogner Constr. Co. (Aug. 27, 1998) 5th Dist. No. 97 CA 59, 1998 WL 666765.