Canada: Payment On Payment Clauses: Do You Know Your Rights?

Payment on payment clauses are standard practice in construction contracts. They are often found in subcontracts and consist of conditioning payment for the subcontractor's services on payment by a third party for services rendered by the general contractor, usually the owner or the client.

All construction contractors should pay close attention to the extent of their rights and obligations under such clauses. Whether it is a term or conditional obligation, this clause will not grant the same rights to the general contractor who benefits from it. The general contractor will also have to behave in good faith, otherwise the application of the payment on payment clauses may be completely negated.

Term Obligation: Delay Payment as per the Contract

The clause giving rise to a term obligation consists of delaying payment for the subcontractor's services until a future and definite event provided for in the contract occurs, namely, the third party's payment to the general contractor. This means that when a payment on payment clause is included in a contract, the payment of the subcontractors does not depend on any actual payment received by the general contractor, but on the payment agreed upon by the parties under the terms of their contract.

As an example, the following wording is often used:

• the general contractor shall pay the subcontractor within 10 days, on the next day following receipt of progress payment from the owner [...];
• 10 days after payment [...];
• payment shall be made 10 days after the [Client]'s payment.

Under such a clause, if the specific event of third-party payment to the general contractor does not occur, section 1510 of the Civil Code of Québec ("C.C.Q.") would require the general contractor to pay the subcontractor for his services. The general contractor will be required to pay within the period provided for in the payment on payment clause as of the date on which payment should have been made by the third party or as of the date on which it becomes clear that the third party will not pay its contractor, such as when the client becomes bankrupt.

Conditional Obligation: Payment Dependent on Contractor's Payment

The payment on payment clause giving rise to a conditional obligation can best be defined as making payment for the subcontractor's services conditional upon payment by the third party to the general contractor. Such a clause will include wording such as "if" and "provided that."

In these cases, sections 1497 C.C.Q. and following will apply and will allow the general contractor to delay payment due to the subcontractor until the condition has been met, in other words, until he has been paid for his own services.

Beware of the Duty to Act in Good Faith

The payment on payment clause, whether term or conditional, is always subject to a duty for the general contractor to act in good faith during the life of the contract. This includes, but is not limited to:

• taking the proper actions to collect payment from the third party so that the subcontractor's work is paid for;
• claiming the debt owed to him by the third party;
• initiate any necessary proceedings to recover the amounts.

In Signalisation SMG Inc. v. Construction Garnier Ltée, the Superior Court of Québec confirms that a general contractor refusing or neglecting to take all necessary actions to ensure payment of the sums owed by the owner implicitly waives his entitlement to the benefit of the payment on payment clause.

Likewise, in his book La clause de paiement sur paiement: son utilisation et ses limites, author Raymond A. Daoust, explains that the payment on payment clause applies, in theory, to all parties to the construction contract. However, in exceptional circumstances, such a clause may become unenforceable against one or the other of the contracting parties if the clause is ambiguous or if the general contractor is negligent and/or acts in bad faith. If, for example, a contractor abuses his right to withhold amounts due to subcontractors, the payment on payment clause could be challenged.

Four Key Points to Keep in Mind

In a nutshell, these are the key points to keep in mind regarding the extent of the rights and obligations arising from payment on payment clauses:

• Term obligations only delay payment to the subcontractor until the general contractor is to be paid under the terms of his contract with the client;
• Conditional obligations make the subcontractor's payment fully contingent upon the general contractor's payment, so that the subcontractor's payment may be delayed indefinitely if the general contractor is not paid;
• There is an ongoing duty of good faith between the parties. Failure of the general contractor to take the necessary actions to be paid may result in the general contractor not being able to benefit from its payment on payment clause and therefore being bound to pay the subcontractor without further notice or delay, whether or not he himself has been paid, and regardless of the nature of his payment on payment clause;
• The contract entered into between the client and the general contractor may include provisions requiring the general contractor to pay his subcontractors and provide the related releases, whether or not there is a dispute between them and regardless of the payment on payment clauses. The general contractor must therefore pay close attention to clauses that may require payment to the subcontractor out of any progress payments received. Depending on the nature of the clauses found in his contract with the client, the general contractor might be limited in the way he disposes of the progress and final payments that he receives from the client.

The payment on payment clause therefore does not apply automatically, its interpretation being highly factual. When entering into a contract, a general contractor should ascertain that there are no clauses in its contract with the client that might limit the application of the payment-on-payment clause.

For more than 25 years, BCF has developed and refined its expertise in construction law and the professionals within our firm have been assisting contractors in all types of litigation so as to minimize the financial impact that these problematic situations may generate.

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.