Canada: Pay When Paid Clauses: How Do They Hold Up?

Courts in Alberta and Ontario have recently released two notable decisions on "pay when paid" clauses: Sprague Rosser Contracting Co. Ltd. v. EOS Pipeline & Facilities Inc., (EOS Pipeline) and 6157734 Canada Inc. v. Bluelime Enterprises Inc. (Bluelime Enterprises). In EOS Pipeline, one of the only-reported Alberta decisions on pay when paid clauses, the Court of Queen's Bench of Alberta held that the clause in issue was not a condition precedent to payment of the subcontractor. In Bluelime Enterprises, the Ontario Superior Court of Justice found that a contractor's duty to use best efforts to recover payment on behalf of a subcontractor did not require the contractor in this case to take any formal steps to recover payment because the subcontractor had committed a clear breach of contract.

A "pay when paid" clause is a provision sometimes found in commercial contracts stating that party B will not pay party C until party A (who is not a party to the contract) pays party B. A common example is a clause in a construction contract between a contractor and a subcontractor stating that the contractor will not pay the subcontractor unless the owner pays the contractor.

EOS PIPELINE: TIMING VERSUS ENTITLEMENT

On April 26, 2016, Justice D.B. Nixon of the Court of Queen's Bench of Alberta granted summary judgment to a subcontractor, E.O.S. Pipeline & Facilities Inc. (EOS), despite an argument by the contractor, Sprague-Rosser Contracting Co. Ltd. (Sprague-Rosser), that the pay when paid clause in their subcontract relieved it of its obligation to pay EOS.

The contract between EOS and Sprague-Rosser contained a pay when paid clause, which reads: "The Subcontractor's entitlement to payment under this Subcontract is subject to the Contractor's receipt of payment for the corresponding Work from the Owner." Sprague-Rosser argued that it had not been paid by the owner, as the owner's payment was subject to trust conditions, and accordingly, that Sprague-Rosser was not required to pay EOS.

Justice Nixon was not satisfied on the evidence before him that the owner's payment was in fact subject to trust conditions, and could have granted summary judgment in favour of EOS solely on the basis that the owner had paid Sprague-Rosser. More notably, Justice Nixon also held that EOS would have been entitled to payment in any event since the owner had terminated the prime contract between itself and Sprague-Rosser. In addition to the pay when paid clause, the subcontract between EOS and Sprague-Rosser also contained a clause stating as follows:

Payment of the balance owing under this Subcontract shall be made in a reasonable period of time after total performance or termination of the Prime Contract, or stoppage of the Project, whichever is earlier.

Justice Nixon therefore held that the pay when paid clause in the subcontract between EOS and Sprague-Rosser spoke to timing of the payments to EOS, not EOS's entitlement to be paid. In other words, payment of Sprague-Rosser was not a condition precedent to payment of EOS; the pay when paid clause simply meant that payments to EOS would come due when the owner paid Sprague-Rosser for the corresponding work, but EOS would be entitled to be paid when the prime contract was terminated or the work stopped, regardless of whether the owner had paid Sprague-Rosser.

The timing versus entitlement debate that arose between EOS and Sprague-Rosser frequently arises when courts interpret pay when paid clauses. If a pay when paid clause clearly indicates that party B and party C agreed that the risk of party A not paying for the work should be transferred from party B to party C, courts will hold the parties to their bargain (see, for example, Timbro Developments Ltd. v. Grimsby Diesel Motors Inc., a 1988 decision of the Ontario Court of Appeal). If the clause is not sufficiently clear, or other terms of the contract suggest that it speaks to timing of payment rather than entitlement to payment, the court will find (as in EOS Pipeline) that party C is entitled to be paid for its work at the end of the project even if party A has not paid party B.

BLUELIME ENTERPRISES: PARTY B NOT REQUIRED TO SUE PARTY A FOR PAYMENT

When a pay when paid clause transfers the risk of non-payment from party B to party C, courts often imply an obligation on party B to use best efforts to collect payment from party A. Party B is not always required to sue party A for payment, as illustrated in Bluelime Enterprises.

In Bluelime Enterprises, the Ontario Superior Court of Justice held that the defendant, Bluelime Enterprises Inc. (Bluelime), was not required to sue party A (a consulting firm retained by Alberta Justice) because Bluelime was unlikely to recover the money even if it did sue party A.

Bluelime hired the plaintiff, 6157734 Canada Inc. (615), to provide information technology services to Alberta Justice through the consulting firm. The contract between Bluelime and 615 contained a pay when paid clause providing that if the consulting firm did not pay Bluelime, Bluelime would not pay 615. Several months after 615 started work, Alberta Justice discovered that 615 failed to disclose in its background check two insider trading convictions against its principal. Alberta Justice terminated 615's services, and the consulting firm refused to pay Bluelime on any of the invoices outstanding when 615 was terminated.

Bluelime made enquiries to determine why the consulting firm had refused to pay the invoices. The consulting firm told Bluelime that Alberta Justice had refused to pay the consulting firm because Alberta Justice had spent at least two to three times the amount owing on extra measures to ensure the security of its data after it terminated 615. Bluelime did not enquire further or sue for payment. Justice J.A. Thorburn found that it was appropriate for Bluelime to accept this response and not take any further steps to receive payment, as it was unlikely to be successful in recovering payment. Accordingly, Justice Thorburn dismissed 615's claim against Bluelime.

This decision highlights the fact-specific analysis courts engage in when determining whether party B should be relieved of its obligation to pay party C. Party B is not always required to take formal steps to recover payment from party A: if party B can show that it was unlikely to recover payment from party A, the court may allow party B to rely on a pay when paid clause even if party B did not take formal steps to recover payment from party A. Party B should proceed with caution, however: in Bluelime Enterprises, party C's own omission is the reason party A refused to make further payments. Courts may take a less lenient approach to party B's obligation to use best efforts to recover from party A when that is not the case.

The author wishes to acknowledge the assistance of Stephen Vincelli (Summer Law Student) in researching and writing this bulletin.

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