- Posted by John P. Ahlers
- On March 17, 2008
A “Pay When Paid” clause provides that payment to the Subcontractor will be made within a certain period of time after the contractor has been paid by the owner, rather than within a period of time after the subcontractor has performed its work. Generally, “Pay When Paid” clauses are interpreted to merely postpone payment for a reasonable time. “Pay When Paid” clauses do not excuse an unpaid prime contractor from all obligations to pay the valid invoices of subcontractors and suppliers. An example of a “Pay When Paid” clause is:
Payment Not Contingent on Owner Payment. It is agreed that payment by Contractor to Subcontractor hereunder is not due until ten (10) days after payment has been received by Contractor from Owner, or until the passage of a reasonable time from when payment from Owner is due, whichever is sooner. “Reasonable time” as used herein shall not exceed ninety (90) days.
By contrast, a “Pay If Paid” clause establishes that payment by the Owner to the Contractor is a condition precedent to the Contractor’s duty to pay its Subcontractors and Suppliers. To be enforceable, the assignment of the risk of non-payment must be clear and unambiguous. Any doubt will be construed against the prime contractor.
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 on the Owner’s credit (not the Contractor’s) payment. Subcontractor specifically accepts the risk of non?payment by Owner.
- “Pay If Paid” Clauses Are Not Favored By Courts Or Legislators:
The New York Court of Appeals refused to enforce a “Pay If Paid” clause on public policy grounds. The court reached its result by noting first that the Subcontractor’s lien right depended upon its contract rights and then observed that a “Pay If Paid” clause could indefinitely suspend a Subcontractor’s contractual right to payment. It, therefore, concluded that a “Pay If Paid” clause amounted to a forfeiture of the Subcontractor’s lien right and will quote West Fair Electric Contractors v. Aetna Casualty & Surety Co., 666 NE 2d 967, 972 (N.Y. 1995). Courts in California and Florida have reached similar conclusions. Other states have addressed the conditional payment provisions by way of legislation. Payment by an Owner to a Contractor is not allowed to be a condition precedent for payment to a Subcontractor in the states of North Carolina, Wisconsin, Maryland, Illinois and Missouri.
- Bonding Companies May Not Be Able To Rely On The General Contractor’s Pay If Paid Clause:
Bonding companies cannot enforce a subcontract’s “Pay If Paid” clause and must compensate an unpaid Subcontractor when the General Contractor has not been paid by the Owner. See Moore Brothers Co. v. Brown & Root, Inc., 207 F.3d 717 (4th Cir. 2000) and U.S. Ex Rel. Walton Technology v. Weststar Engineering, Inc., 290 F.3d 1199 (9th Cir. 2002). Courts have hinted, however, that if the bonding companies insert the “Pay If Paid” language in the payment bond itself, the surety will be permitted to delay payment until the General Contractor has been paid by the Owner. Another way for General Contractors to protect their bonding companies is to specifically refer to the payment bond surety in “Pay If Paid” clause itself. Finally, General Contractors should include an express Miller Act or Little Miller Act (state bond claim act) waiver as part of the “Pay If Paid” provision. Miller Act waivers are generally not valid unless they mention the Miller Act by name.
- Prevention Doctrine
Finally, where the General Contractors’ own actions or in-actions contribute to the non?occurrence of a condition precedent, the condition precedent to pay out is deemed waived or excused – this is known as the “Prevention Doctrine.” Moore Brothers Co. v. Brown & Root, Inc., 207 F.3d 717 (2000). The Prevention Doctrine provides that the general contractor cannot cause the non-payment to occur and then rely on that same condition as a basis not to pay its Subcontractor. If the Owner fails to pay the general contractor because of the general contractor’s own fault, the general contractor will not be able to rely on the “Pay If Paid” clause to withhold payment to the subcontractor.