United States: High Court Enforces "Pay-If-Pay" Clause Protecting CM; But Allows Fabricator And Erector To Recover Extras Directly From Owner

On Thursday, December 14, 2017, the Supreme Court of Kentucky reversed an intermediate appellate court decision and reinstated a jury verdict of slightly more than $600,000 awarded to a structural steel fabricator and erector. The award compensated the fabricator and erector for unpaid retainage and extras on a high rise project.

This decision is significant because, in the process, the high court also upheld a "pay-if-paid" clause in the subcontract between the fabricator and the project construction manager. The pay-if-pay clause shielded the CM from liability to the fabricator/erector team because the CM had not been paid for the extras in question by the project owner.

However, the high court applied the "equitable" doctrine of "unjust enrichment" (rarely used in construction contract disputes) to hold the project owner directly liable to the fabricator/erector team for the benefit the owner received from their work. The court indicated that it would not have applied the doctrine of unjust enrichment against the owner but for the enforceability of the pay-if-pay provisions in the fabricator's subcontract, the fact that the jury found that the fabricator/erector team to be entitled to payment for the work, and the fact that the CM had not been paid by the owner.

Yet to be determined are the interest due to the fabricator and erector on their judgment, and the manner in which that judgment could be allocated in a future trial between the CM and the owner.

The most significant take away from this decision for structural steel fabricators, erectors, and other subcontractors is the Kentucky Supreme Court's enforcement of the subcontract's pay-if-pay provision. Pay-if-pay provisions are sometimes distinguished from so-called "pay-when-paid" provisions – the latter (pay-when-paid) have been held by some courts to control only the timing of payment, not the duty of a CM or GC to ultimately pay a subcontractor. The former (pay-if-paid) was found by the Kentucky Supreme Court (and has been found by courts in other states) to constitute a so-called "condition precedent" to payment – the duty to pay the subcontractor does not arise until the GC/CM has actually been paid by the owner.

The Kentucky court found that because the CM had not been paid by the owner, the fabricator/erector team had no contract remedy against the CM for payment. Absent a contract remedy, the court could apply the equitable remedy of unjust enrichment directly against the owner under the circumstances of this case.

Application of the pay-if-pay provisions had one other, negative, impact on the fabricator. The subcontract contained a provision awarding attorney fees to the successful party to the contract in any litigation arising under the terms of the contract.

Initially the trial court had awarded the fabricator attorney fees in excess of $300,000 as the successful party in the litigation against the CM. The intermediate Kentucky appellate court and the Kentucky Supreme Court rescinded that award, however, when they held that, because of application of the pay-if-pay provisions, the fabricator was not entitled to a judgment against the CM after all.

Under this very unique decision liability ran to the fabricator/erector directly from the owner (with which the fabricator did not have a contract), not from or through the CM (with which the fabricator did have a contract). Therefore, absent a specific contract provision binding the owner to pay attorney fees, both the intermediate appellate court and the high court found that the fabricator was not entitled to recovery of its attorney fees from either party.

The Kentucky Supreme Court's discussion of pay-if-paid clauses is especially relevant to structural steel fabricators and other subcontractors who provide work on projects in any number of separate states. The court notes that while the high courts of at least two jurisdictions have held pay-if-pay clauses to be void as against public policy and have refused to enforce them, the high courts of many other states have found no such safe harbor for subcontractors and have enforced the clauses as written. The court notes that at least for the state of Kentucky (and likely for other states as well) an act of the state legislature will be needed to establish that pay-if-paid clauses violate the state's public policy and are thereby unenforceable.

Accordingly, minimally, fabricators and other subcontractors should be aware of the status of the state law governing a project prior to entering into a subcontract containing a pay-if-pay provision. Even better, where possible fabricators and other subcontractors should avoid signing contracts containing these provisions altogether.

As a secondary matter, it also appears that, at least in Kentucky and perhaps in other jurisdictions, in instances where subcontract balances or subcontract extras have not been paid by the project owner to the project CM/GC, the unpaid subcontractor may be able to maintain a legal action for payment simultaneously against both the CM/GC and the project owner.

Finally, a word about judicial efficiency may be in order. This case was tried before a jury. The trial lasted for 15 days. A good bit of that trial time and a good bit of space in the 49 page decision of the Kentucky Supreme Court and the earlier decision of the intermediate appellate court was taken up dealing with legal procedural issues that apply only to jury trials. This additional time and space would not have been necessary in a bench trial (where a judge, sitting without a jury, decides both the law and facts at issue) or a construction arbitration (where a single arbitrator or three arbitrator panel decides both the law and facts). Circumstances often dictate whether there is a choice of forum for resolution of disputes, or which forum is better suited to efficiently resolve the dispute. Where there is a choice, the selection of the dispute resolution forum should be the subject of a discussion with counsel prior to entering into the fray.

A verbatim copy of the decision can be found here: Superior Steel, Inc., and Ben Hur Construction Company, Inc. v. The Ascent at Roebling's Bridge, LLC, et al., 2015-SC-000204-DG and 2015-SC-000636-DG (December 14, 2017).

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.

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Joseph L. Hardesty
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