United States: Construction Contract Clauses: An Intro To Pay-If-Paid vs. Pay-When-Paid

If you are a contractor, subcontractor, or supplier in the construction industry, you've likely heard the terms "pay-if-paid" and "pay-when-paid."  Payment provisions are some of the most controversial and heavily negotiated provisions in construction contracts.  This article defines the pay-if-paid and pay-when-paid provisions, explains their differences, and provides guidance on how to recognize them in practice.

Pay-if-paid and pay-when-paid clauses can alter the normal (i.e., common law) payment obligations running from the contractor to its subcontractor (or subcontractor to its supplier).  Without a contract clause or state statutei addressing payment obligations, payment for construction work is due on substantial completion of the work.

A "pay-if-paid" clause alters the common law payment obligation by requiring payment from the owner as a condition precedent to the contractor's duty to pay a subcontractor or supplier.ii  A condition precedent is "an act or event, other than a lapse of time, that must exist or occur before a duty to perform something promised arises."iii  In other words, a pay-if-paid clause means the contractor is only obligated to pay the subcontractor if it receives payment for the subcontractor's work from the owner.  An example of a pay-if-paid clause is as follows:

Contractor's receipt of payment from the owner is a condition precedent to contractor's obligation to make payment to the subcontractor; the subcontractor expressly assumes the risk of the owner's nonpayment and the subcontract price includes the risk.iv

A "pay-when-paid" clause, on the other hand, is a payment condition that establishes a reasonable time for the contractor to comply with its duty to make payment to a subcontractor or supplier upon the contractor's receipt of payment from the owner.v "A pay-when-paid clause governs the timing of a contractor's payment obligation to the subcontractor, usually by indicating that the subcontractor will be paid within some fixed time period after the contractor itself is paid by the property owner."vi  An example of a pay-when-paid is as follows:

Contractor shall pay subcontractor within seven days of contractor's receipt of payment from the owner.vii

Under the majority viewviii, a pay-if-paid clause is a condition precedent to payment and a pay-when-paid clause is merely a timing provision.  Recognition of the difference between these two types of payment clauses is, therefore, vitally important because they can govern whether there is a duty for the contractor to make payment to a subcontractor if payment is never received from the owner.

In Peacock Construction Co. v. Modern Air Conditioningix, the Supreme Court of Florida interpreted a subcontract provisions stating

Final payment shall be made within 30 days after the completion of the work included in this subcontract . . . and full payment therefor by the Owner . . .

as a pay-when-paid provision that did not create a condition precedent to payment "but rather constitutes [an] absolute promise to pay, fixing payment by the owner as a reasonable time for when payment to the subcontractor is to be made."x

Under the majority view, a payment provision will only be found to be a pay-if-paid clause when it is written in a clear and unambiguous manner, which removes any doubt about the purpose of the clause.  Pay-if-paid clauses are valid "where the language of the contract in question is clear on its face."xi

The rational for the majority view, as stated by the Supreme Court of Florida, is as follows:

[The] intent in most cases is that payment by the owner to the general contractor is not a condition precedent to the general contractor's duty to pay the subcontractors. This is because small subcontractors, who must have payment for their work in order to remain in business, will not ordinarily assume the risk of the owner's failure to pay the general contractor.

...

Our decision to require judicial interpretation of ambiguous provisions for final payment in subcontracts in favor of subcontractors should not be regarded as anti-general contractor. It is simply a recognition that this is the fairest way to deal with the problem. There is nothing in this opinion, however, to prevent parties to these contracts from shifting the risk of payment failure by the owner to the subcontractor. But in order to make such a shift the contract must unambiguously express that intention. And the burden of clear expression is on the general contractor.xii

As stated by another court, "[a] clause which provides that the contractor shall pay a subcontractor within a stated number of days after the contractor has received payment from the owner merely fixes the time when the payment is due and does not establish a condition precedent to payment."xiii

To accomplish the goal of a clear and unambiguous pay-if-paid provision, a pay-if-paid will normally (1) expressly state that payment by the owner is a condition precedent to contractor's duty to pay subcontractor; (2) include other conditions precedent, such as owner and architect's acceptance of subcontractors work; and (3) expressly state that the subcontractor assumes the risk of the owner's nonpayment.  Without this wording, parties can find themselves arguing about their intentions at the time they went to contract and run the substantial risk that a court will find the provision to be a pay-when-paid provision regardless of the parties intentions.

In instances where the parties intend to create a pay-when-paid obligation, the pay-when-paid provision should (1) define what constitutes a reasonable period of time for when there is payment by the owner and when there is not payment by the owner; and (2) expressly state that payment by the owner is not a condition precedent to contractor's duty to pay subcontractor.

When reviewing contracts containing pay-if-paid and pay-when-paid provisions it is important to verify the enforceability of such provisions under the applicable state's laws.  Not surprisingly, these provisions are the topic of legislation throughout the United States with some states going so far as to ban their use.  Pertinent state laws and other defenses relating to the enforceability of these provisions will be the topic of a future article.

Footnotes

i Many states have enacted Prompt Payment Acts to ensure timely payment.  See, e.g., O.C.G.A. § 13-11-1, et seq.

ii Subcontractors may also use pay-if-paid clauses to condition their obligation to pay lower-tier subcontractors and suppliers.

iii BMD Contractors v. Fidelity and Deposit Co. of Md., 679 F.3d 643 (7th Cir. 2012) (quoting Black's Law Dictionary 334 (9th ed. 2009)).

iv Id. at 648-49.

v Subcontractors may also use pay-when-paid clauses to condition their obligation to pay lower-tier subcontractors and suppliers.

vi Id. at 648-49.

vii Id.

viii Despite widespread recognition of the distinction between the terms pay-if-paid and pay-when-paid, the terms are not always applied consistently.  In fact, there are some states where they are used interchangeably.

ix 353 So. 2d 840, 842-43 (Fla. 1977).

x Id.; but see Peacock Construction Co. v. A.M. West, 111 Ga. App. 604, 142 S.E.2d 332 (1964) where the Georgia Court of Appeals interpreted the exact same provision as a ". . . clearly expressed condition precedent to defendants' liability for final payment of the contract price."

xi Galloway Corp. v. S.B. Ballard Constr. Co., 250 Va. 493, 464 S.E.2d 349, 354 (1995).

xii Peacock Construction Co. v. Modern Air Conditioning, 353 So. 2d 840, 842-43 (Fla. 1977).

xiii American Drilling v. City of Springfield, 614 S.W.2d 266, 273 (Mo. App. 1981); Meco Systems v. Dancing Bear Ent., 42 S.W.3d 794, 806 (Mo. Ct. App. 2001) ("As written, American Drilling is authority for the proposition that if a "pay if paid" provision is clear and unambiguous, it will be interpreted as setting a condition precedent to the general contractor's obligation to pay.  Conversely, if such a provision is ambiguous, it will be interpreted as fixing a reasonable time for the general contractor to pay.")

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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