A popular question among some construction law clients is whether the so-called pay-when-paid clause is enforceable. As with many construction law issues, the real answer is, "It depends".
What is a Pay-When-Paid Clause?
Construction industry participants will be familiar with the basic concept behind these provisions, which are sometimes also referred to as provisional payment clauses. Typically found in subcontracts, pay-when-paid clauses generally seek to link a general contractor's obligation to pay its subcontractor to the general contractor's receipt of payment from the project owner. A significant issue that arises in this context is whether the subcontractor has altogether waived its right to be paid in the event that the general contractor is never paid by the owner.
A Recent Example – A&B v. Canotech
This question was recently considered by the Manitoba Court of Queen's Bench in A&B Mechanical Ltd. v. Canotech Consultants Ltd. (2013 MBQB 287). Canotech was the general contractor retained for the construction of a water park near Headingley, Manitoba and retained A&B as one of its subcontractors. When Canotech withheld payment to A&B for work performed, A&B sued to recover the amount owing to it and initiated a summary motion to bring its claim to a quick conclusion. Having not received payment from the project owner for the work at issue, Canotech defended A&B's claim on the basis of the following subcontract provision:
Payments will be made monthly on progress estimates as approved by the Architect and/or Engineer and the Contractor's Superintendent covering 92.5% of the value of the work completed by the Sub-Contractor to the end of the previous month, such payments to be made five days after the Contractor receives payment for such work form the Owner.
Payment of the balance of 7.5% owing under the Sub-Contract will be made wtihin five days after final payment has been received by the Contractor. [emphasis added]
However, the prime contract between Canotech and the project owner, which was incorporated by reference into the subcontract, provided that Canotech would be paid by the owner "no later than fifteen days following the receipt of an application for payment".
Canotech's evidence was that it had every intention to pay A&B, but not until five days after Canotech received payment from the owner. A&B had fulfilled the other conditions for payment (i.e. the performance of its work and the delivery of the required statutory declaration for each payment application submitted).
It should also be noted that the amount owing by the owner to Canotech was the subject of a separate court action that did not involve A&B. Essentially, argued Canotech, A&B would have to wait for the outcome of that action in order to be paid.
Court's Ruling – A&B Did Not Waive its Right to Be Paid
Citing the Nova Scotia Court of Appeal's decision in Arnoldin Construction v. Alta Surety Co. (which had in turn cited a well-known American line of cases) and two Ontario decisions (Tam-Kal Ltd. v. Stock Mechanical and Builders' Supplies v. 1489683 Ontario Ltd.), the Honourable Chief Justice Joyal ruled in favour of A&B and granted summary judgment for payment of the amount owing.
In so doing, his findings included the following:
1. The clause in question was not sufficiently clear to make it a true pay-when-paid clause and therefore constitute a waiver of A&B's right to be paid;
2. The interpretation favoured by Canotech would have been inconsistent with the fifteen day payment requirement contained in the prime contract between Canotech and the owner;
3. Canotech's interpretation would have also been inconsistent "...with what most smaller subcontractors would logically and reasonably expect (absent much clearer and alerting language)..." (para. 32);
4. Canotech's obligation to make payments to A&B for work performed on the basis of approved monthly progress estimates and the submission of the requisite statutory declarations was clear;
5. Rather than indicating a condition precedent to payment, the reference to Canotech paying A&B five days after receiving a corresponding payment from the owner should instead be interpreted as "a timing provision to ensure prompt payment upon Canotech's receipt of payment" (para. 39);
6. A&B had never represented to Canotech that if Canotech did not get paid, it would not have to pay A&B; and
7. As was the case in the Ontario Builders' Supplies decision, nothing in the prime contract or subcontract documents indicated that A&B and Canotech had a "co-adventurer" or partner relationship for the project that would suggest a pay-when-paid arrangement.
What Does the Canotech Decision Mean for Pay-When-Paid Clauses?
While the Canotech decision does not contain new law, it does serve as a recent and useful reminder to those who are seeking to rely upon pay-when-paid provisions and those who are seeking to overcome them.
The key message is that a court asked to uphold such a provision will look for clear, unambiguous language alerting the subcontractor to the fact that it may be waiving its right to be paid. Absent such wording, the parties may find themselves arguing over evidence relating to their intentions at the time they entered into the contract and their understanding of its provisions.
Canotech also offers another useful reminder. By clarifying their objectives at the outset of a project when contracts are being negotiated, parties will reduce the possibility that they will instead have to explain them in a courtroom, after the project has been completed.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.