Cashflow and prompt payments are vital in each construction business, yet virtually every subcontractor has experienced a payment delay or dispute while working under a general contractor. In many of these situations, the general contractor’s default results from the property owner’s failure to pay the general contractor. In other words, payment issues tend to ‘roll downhill.’
In such circumstances, the question becomes – is the general contractor still obligated to pay its subcontractor, or must the subcontractor take up the payment delay with the owner directly? Like most other legal questions, this is usually answered in the contract between the GC and subcontractor. Specifically, the subcontractor will need to check if the subcontract contains a “contingent payment clause,” such as a “pay if paid” clause or “pay when paid” clause.
Key difference between “Pay if Paid” and “Pay when Paid” clauses.
In simplest terms, a “pay if paid” clause states that a subcontractor will only be paid if the GC is paid by the property owner. Under this clause, there may be no limit on how long the GC can withhold payment so long as the owner remains in default. Thus, if the owner never pays, the subcontractor’s only recourse may be against the owner – not the GC. The risk of the owner’s default is effectively shifted from the GC to the subcontractor.
On the other hand, “pay when paid” clauses typically specify how quickly the subcontractor must be paid after the GC is paid; however, they usually do not condition the subcontractor’s payment upon the GC’s payment. For example, AIA’s form contract provides: “The Contractor shall pay the Subcontractor each progress payment no later than seven working days after the Contractor receives payment from the Owner.” In the absence of express, contingent language, most courts obligate the GC to pay subcontractors within a reasonable period of time, even when the owner’s payment never occurs.
Validity of contingent payment clauses in Washington.
Washington courts have not definitively addressed the enforceability of “pay if paid” clauses. Despite this ambiguity, subcontractors should account for the risk that “pay if paid” clauses may be enforced as valid, and thus, take necessary precautions to protect their interests. Otherwise, at least one Washington court has ruled that a “pay when paid” clause did not condition the GC’s payment upon the owner’s payment. Thus, the owner’s default did not absolve the GC of its obligation to pay subcontractors. In such circumstances, the GC bears the risk of the owner’s default or financial insolvency – not the subcontractor.
How subcontractors can address contingent payment clauses.
Like most terms, contingent payment clauses are subject to negotiation during contracting. Subcontractors should always review the contract documents to identify these key terms. After identifying any contingent payment clauses, subcontractors should attempt to strike or modify any clause which they deem unacceptable.
If a GC is unwilling to remove a contingent payment clause, the subcontractor should approach the project as though it is relying entirely on the property owner for payment. Thus, the subcontractor should perform independent due diligence. For example, ask: Is the property owner capable of paying for the project? Is the GC reputable and, thus, capable of completing the project without causing a payment dispute? Does the owner possess sufficient equity in the property to make a construction lien an effective remedy?
Practices such as these may serve to reduce the risk of non-payment. Therefore, subcontractors should be acutely aware of contingent payment clauses in their contracts and the methods they can use to guard against them.
Disclaimer: The information contained in this article is for general educational information only. This information does not constitute legal advice, is not intended to constitute legal advice, nor should it be relied upon as legal advice for your specific factual pattern or situation.
Cotney Construction Law is an advocate for the roofing industry and General Counsel of RCAW, WSRCA, and NRCA. For more information, contact the author at 866.303.5868 or go to www.cotneycl.com.