If you are in the construction industry, you will have heard of the "pay-when-paid" clause and its evil twin, the "pay if paid" clause. Though widely used, these clauses remain controversial and are often confused.
While both of these terms attempt to affect a general contractor's obligations to subcontractors when the owner does not pay that general contractor, they differ in important ways.
A "pay-when-paid" clause (i.e., that the general contractor will pay the subcontractor within "X" days of receiving payment from the owner) really only addresses the timing of payments; it does not affect the underlying obligation to pay for work performed.
On the other hand, a "pay-if-paid" clause (i.e. that the general contractor only incurs an obligation to pay the subcontractor if, and only if, it is first paid by the owner) may constitute a condition precedent that excuses the general contractor from having to pay the subcontractor if the owner does not pay the general contractor.
The issue with a true pay-if-paid clause is that it attempts to create a condition precedent, that is, a clause upon which the entire trade contract depends. But, unlike other conditions precedent that generally depend on the conduct of the subcontractor, pay-if-paid clauses are activated by a non-paying owner, a situation subcontractors have no control over. For this reason, courts have been hesitant to penalize subcontractors by enforcing this type of clause.
Take the Nova Scotia Court of Appeal case, Arnoldin Construction& Forms Ltd. v. Alta Surety Co.(1995), where the owner failed to pay the general contractor. The surety inturn refused to pay the subcontractorunder the labour and materials paymentbond. Surprisingly enough, thesubcontractor was dissatisfied andsued.
At issue was a clause in the tradecontract that stated the final paymentto the subcontractor would be madewithin 30 days of the general contractor being paid. The surety claimed the clause was a condition precedent, pay-if-paid clause.
The subcontractor argued the clause was not a condition precedent but a pay-when-paid clause that only affected when payment was to be made, not whether payment would be made. The subcontractor lost at trial and appealed.
The Nova Scotia Court of Appeal agreed with the subcontractor, stating the clause "did not negate the [prime] contractor's obligation to pay for the work." The court looked at the clause in the context of the whole contract and the obligations it imposed on the general contractor. In this light, the clause only outlined when payment was to be made, and did not constitute a condition precedent. The Court of Appeal reversed the trial decision and awarded the subcontractor the balance owing on the completed contract, $547,857.27.
The Court of Appeal also noted that pay-if-paid clauses require much clearer language than that used in this clause, stating that "an intention so important cannot be buried in obscure language that would not alert the subcontractor that payment for the subcontract work was conditional on the owner paying the [prime] contractor."
Another example of the court's disdain for these clauses is a recent decision out of Ontario where a pay-when-paid clause was examined in the context of Ontario's lien legislation.
In Bradhill Masonry Inc. v. Simcoe County District School Board, it was argued that the pay-when-paid clause eliminated the subcontractor's entitlement to a builder's lien.
The owner argued that since the subcontract provided that the subcontractor would only be paid once the general contractor had been paid and since the general contractor had not been paid at the time the lien was filed, the subcontractor had no right to lien.
The court had little time for this argument and found that the owner's argument amounted to little more than a shell game that was contrary to the purposes of the Lien Act.
It based its decision on two grounds. First, the court found that the contract, like all building contracts, was subject to the Ontario Lien Act, not the reverse. Accordingly, this contractual payment provision could not affect the rights of the subcontractor under the Lien Act.
Second, the court found that the fundamental nature of the lien right, based as it is on the price of the material or services and the supply of those materials and services to the improvement, could not be affected by the status of the accounts as between the general contractor and the subcontractor.
Despite impediments to the enforcement of these clauses in the courts, it is unlikely that pay-when-paid or pay-if-paid clauses will disappear from construction contract vocabulary anytime soon.
Subcontractors can, however, take some comfort in the fact that an unpaid subcontractor's rights to lien a project for its unpaid accounts are not likely to be significantly impaired by such clauses.
This article by Chris Hirst and Norm Streu first appeared in the 'Construction in Vancouver' supplement of the 8th – 14th October 2013 issue of 'Business in Vancouver'.
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