By Kelly Bundy and Liz Burneson
Many contractors employ pay-if-paid provisions in their subcontracts, which may present difficulties for subcontractors seeking to be paid in a timely fashion. A pay-if-paid provision generally provides that a contractor’s obligation to pay the subcontractor is contingent upon the contractor’s receipt of payment from the owner. Under a pay-if-paid provision, if the owner never pays the contractor, then the contractor has no obligation to pay the subcontractor.
These provisions can cause significant hardship and cash flow issues for subcontractors. This article discusses the enforceability of pay-if-paid provisions and alternatives to those provisions as well as tips for subcontractors performing work under a pay-if-paid provision.
Determine whether the pay-if-paid provision is enforceable under the applicable law of the contract
States treat and enforce pay-if-paid provisions differently, so subcontractors should pay attention to the governing law of each subcontract and understand how pay-if-paid provisions are treated under applicable law. A majority of states enforce pay-if-paid provisions in subcontracts. By way of example, Alabama, Arizona, Arkansas, Colorado, Florida, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maryland, Michigan, Minnesota, Mississippi, Missouri, New Jersey, Ohio, Oregon, Tennessee, Texas, Utah, Virginia, and West Virginia all generally enforce pay-if-paid provisions.
Some states only enforce pay-if-paid provisions if the language used in the subcontract is explicit and clear enough. For example, in Colorado, the contract must “unequivocally state” that the subcontractor will be paid only if the general contractor is first paid by the owner, and the provision must also state that the subcontractor bears the risk of the owner's nonpayment.
Some states impose other limitations on pay-if-paid provisions. In Massachusetts, for example, pay-if-paid clauses are unenforceable in all general and subcontracts for private projects worth over $3,000,000.00 unless the work is defective.
Several states—California, Delaware, New York, Nevada, North Carolina and South Carolina—have passed legislation stating that pay-if-paid provisions are always unenforceable. Accordingly, subcontractors should take the time to ensure they understand how applicable law treats pay-if-paid provisions when entering into subcontracts.
Analyze your negotiating position and propose an alternative provision if possible.
A subcontractor faced with a pay-if-paid provision should consider its negotiating position and whether it may be in a position to propose an alternative provision. When negotiating contracts, subcontractors should consider the contractor and owner, the scope of work, the size of the Project, the specialty nature of the subcontract work and whether there are many other contractors who can perform the same work. Subcontractors on public projects may have little to no room to negotiate an alternative provision as compared to a highly specialized subcontractor with few competitors on a private project. If possible, subcontractors should try to negotiate the pay-if-paid language out of the subcontract entirely or include an anti-pay-if-paid provision. Other alternatives include pay-when-paid provisions and limited pay-if-paid provisions.
A pay-when-paid provision may provide the contractor with more time to pay and set an outside date by which contractor must pay the subcontractor, even if it has not received payment from owner. Here is an example:
If Contractor does not receive payment from the Owner for Subcontractor’s Work for any cause that is not the fault of Subcontractor, Contractor shall pay Subcontractor within forty-five (45) days of when Contractor’s payment to Subcontractor would otherwise be due.
Another alternative might be to limit the pay-if-paid provision to instances where the subcontractor’s actions or inactions are the reason for the owner’s non-payment. Here is an example:
Receipt by Contractor of payment from the Owner for Subcontractor’s Work is a condition precedent to Contractor’s obligation to pay Subcontractor all progress, change order or final payments only if Subcontractor’s breach of this Agreement or deficient or delayed Work is the cause of Owner’s failure or refusal to pay Contractor for Subcontractor’s Work.
When negotiating alternatives it is important for subcontractors to pay attention to all of the places in the subcontract that contain pay-if-paid language. Such language might appear in provisions dealing with progress payments, final payment, changes, dispute resolution and elsewhere. Subcontractors should ensure they are negotiating alternatives for each such pay-if-paid provision or, at minimum, ensure they understand how each provision applies.
Pay attention to the other provisions of the subcontract and important provisions of the prime contract
In the event that a subcontractor is unable to negotiate an alternative, it is important to pay attention to other provisions of the subcontract that might impact a subcontractor’s ability to obtain payment. Subcontractors should pay attention to the notice and claims provisions in any subcontract so that, in the event a payment dispute or other claim does arise, the subcontractor can properly notify the contractor and preserve its claims. Similarly, subcontractors should be mindful of the provisions governing change orders. In any event where the subcontractor is faced with additional work, a delay or a request from the owner or contractor that it believes will involve an increase in the contract price, a subcontractor should ensure it properly provides notice of such a claim and endeavors to obtain written agreement from the contractor before beginning the work.
Many contracts also expressly reference and incorporate the contract entered into by the owner and contractor—most frequently called the prime contract. Provisions of the prime contract often flow down to subcontractors. Accordingly, a subcontractor should obtain a copy of the prime contract and become familiar with its provisions. This will help the subcontractor ensure that it complies with any and all requirements for receiving payments, properly preserves any claims for payment and provides timely notice of claims or issues to the contractor such that timely notice may be provided to the owner.
Know your defenses to the enforceability of pay-if-paid provisions
Lastly, a subcontractor should be aware of any defenses it might have to the pay-if-paid provision. For example, the prevention doctrine may bar the contractor from relying upon the pay-if-paid provision if the contractor’s breach of its agreement with the owner led to the owner withholding payment. Understanding what defenses a subcontractor may have at its disposal to potentially defeat a pay-if-paid provision can assist a subcontractor during the contract negotiation phase of a project, during the course of the work and during the assertion, negotiation or resolution of a claim.
Subcontractors who fail to pay attention to pay-if-paid provisions in their subcontracts may find themselves in an untenable position unable to obtain payment from the contractor. Diligence during the contract negotiation and execution stage is crucial as is diligence during the course of the project to ensure compliance with other important contract terms related to payment. Knowledgeable legal counsel can serve as a good resource to assist subcontractors at any stage of their project—whether it be understanding proposed contract terms, negotiating more favorable provisions or asserting and pursuing claims.
Kelly J. Bundy and Liz C. Burneson are attorneys at Hirschler Law in Richmond, Virginia. Kelly focuses her practice on construction law, commercial and product liability law, with an emphasis on dispute resolution. Liz represents businesses in dispute resolution related to construction claims, breach of contract, business torts and more. Kelly may be reached at [email protected], and Liz may be reached at [email protected].