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The State of Contingent Payment Clauses in Indiana

Contingent payment clauses are provisions in contracts which state that the roofing contractor will only be paid once the general contractor is paid by the owner.  There are two types of contingent payment clauses in construction contracts: Pay-if-paid and pay-when-paid.  A “pay if paid” clause, in its simplest terms, means that a contractor will only get paid if the prime contractor is paid by the owner. Under this clause, there is no timetable on how long the prime contractor and/or other subcontractor can withhold payment, so long as the owner has not made any payment to the prime contractor. This can lead to long delays in getting paid if there is a dispute between the owner and the prime contractor or if there is an issue with the financial solvency of the owner.

Under a “pay when paid” clause, payment is made when the prime contractor is paid. In most states, payment is essentially guaranteed, and payment must be made within a reasonable amount of time. In these states, this payment is made regardless of whether the owner pays the prime contractor.

In Indiana, the State Legislature and the State courts have not directly taken up the issue of enforceability of contingent payment clauses in constructions contracts, except for a statute related to mechanics’ liens. When it comes to mechanics’ liens, Indiana has a statute that states the following (Ind. Code § 32-28-3-18(c)):

c) An obligor’s receipt of payment from a third person may not:

    • be a condition precedent to;
    • limit; or
    • be a defense to;

the provider’s right to record or foreclose a lien against the real estate that was improved by the provider’s labor, material or equipment.

Under this statute, a pay-if-paid clause cannot stop both the recording of a mechanics’ lien and the foreclosing of mechanics’ lien and is therefore unenforceable in mechanics’ liens cases. While pay-if-paid clauses are unenforceable with regards to mechanics’ liens, the enforceability of both pay-if-paid and pay-when-paid otherwise in Indiana courts have not been addressed by the state courts or the state legislature.

While Indiana courts have not directly addressed the issue of contingent payment clause, federal courts applying Indiana law have. The Seventh Circuit Court of Appeals established the precedent—which was based on reviewing the law in several other states—that under Indiana law, pay-if-paid clauses are recognized and enforceable, so long as the clause contained condition precedent language that was clear and unambiguous. Similarly, the United States District Court for the Northern District of Indiana ruled that pay-when-paid clauses are recognized and enforceable under Indiana law. While federal courts are required to apply the state court interpretations of Indiana law, since there currently are no interpretations regarding contingent payment clauses, lawsuits involving these clauses filed in federal court are bound by the federal courts’ interpretations.

Based on the existing statute and federal law, it is safe to presume that pay if paid clauses will be enforced if explicit.  However, recognize that there are always a variety of defenses to pay if paid clauses including failure to be written in an explicit manner (failing to include magic language like “condition precedent to payment”), the course of conduct between the parties and ambiguity created in the contract by incorporating the prime contract’s terms.

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.

Trent Cotney is an advocate for the roofing industry, General Counsel of Indiana Roofing Contractors Association (IRCA) and several other industry associations. For more information, contact the author at 866.303.5868 or go to www.cotneycl.com.