ConstructionPro Week, Volume: 2 - Issue: 33 - 08/16/2013

Could ‘Pay-if-Paid’ Clauses Be Any Clearer?

By Bruce Jervis

It is well established that if a contractor wants to enforce a “pay-if-paid” clause in a subcontract, the clause must state that payment by the project owner for the subcontractor’s work is a condition precedent to the contractor’s obligation to pay the sub for that work.

In recent years, an additional element has evolved from the case law. Contractors are advised to include language where the subcontractor acknowledges it is relying solely on the creditworthiness of the project owner and assumes the risk of owner nonpayment.

Now, a contractor has further refined the language. The pay-if-paid clause said that upon written request from the subcontractor, the contractor would provide the sub with all information in the contractor’s possession regarding the project owner and its ability to pay for the work.

This language proved very helpful to the contractor when the project owner filed for bankruptcy. An unpaid subcontractor argued the contractor had misrepresented the identity of the project owner. The sub thought the owner was a large multinational corporation when it was actually a smaller affiliated company. A Michigan court ruled, however, that the subcontractor had independent means of determining the project owner’s status, so there could be no reasonable reliance on any contractor representations.

Pay-if-paid clauses are controversial. Trade contractors quite understandably consider them unfair and inconsistent with the customary chain of payment in the industry. But if a clause is written in such a clear, ironclad manner and a subcontractor elects to sign that subcontract, can the sub reasonably complain of the consequences? Or, do general contractors utilize their financial leverage to coerce subs into accepting these terms even with the knowledge the contractor has passed a portion of its business risk through to the subcontractor? I welcome your comments.

COMMENTS

Aren't these illegal in some states?
Posted by: Barbara R - Friday, August 16, 2013 11:24 AM

If we are partners and share in the misfortunes why not share the profits but we know thats not happening. I think this stinks if I'm going to take a hit financailly I would like to be involved in the negotiations and where is the contractors incentive to protect his "team". This is not good!
Posted by: Carl De Nunzio - Friday, August 16, 2013 11:43 AM

As a materials vendor/supplier we see this language in contracts and agreements all the time, especially when a contractor attempts to disguise a subcontractor agreement as a supplier/vendor agreement.

On the other hand, it is incombant on any supplier/vendor to perform its due diligence and actually read what is presented before signing off on it. I have challenged these clauses and adverse terms and conditions many times and have had them stricken or completely removed from the agreement.

No one is forcing a vendor/suppplier to accept an order that is not in the best interests of the supplier. If the risk is too high, politley walk away.
Posted by: Jon Mitovich - Friday, August 16, 2013 11:53 AM

The obvious solution for a sub is not to sign the contract. I would imagine the General Contractors will have very little information "in their possession" regarding the owner's credit and/or ability to pay. The GC should have all the liability since they control the project and are the only one negotiating any payments or lack there of.
Posted by: Don Godi - Friday, August 16, 2013 12:03 PM

As a former Mechanical Contractor working Baja Norte for several years, Mexico has a simple solution. When Owner/GC sign a contract with a Subcontractor the Owner/GC must provide "Consideration" equal to 50% of contract amount in order to make the contract complete. This process usually ferret's out a finacially weak Owner/GC.
Posted by: Ray Miller - Friday, August 16, 2013 12:53 PM

Deep down, I feel that an effective pay-if-paid clause is hostile to contractual privity. A really tight one creates a beast indistinguishable from a 3-party agreement, where prime has all the duties to subctr OTHER than payment, and owner has the payment duty. Being a contractor, rather like being an adult, means you are responsible for your undertakings. If you cant' handle that, don't try to pass yourself off as prime contractor. I can't swing the mortgage if my boss doesn't pay me but my lender shouldn't need to care because I'm competent to contract.
Posted by: David Bennett - Friday, August 16, 2013 1:47 PM

Yes, in many states precedent payment clauses are not enforceable.
Posted by: Brian F. - Friday, August 16, 2013 1:54 PM

Pay if Paid clauses are illegal in New Jersey even if a Sub signs the clause it is meaningless because the clause itself is not legal. Interestingly enough that has not stopped General Contractors from inserting it into sub contracts.
Posted by: JHovJr - Friday, August 16, 2013 3:16 PM

We've had success in stricking these clauses from the contract. Especially if the owner does not have a lender or if the owner is listed as an LLC. I understand the Prime not wanting to take the financial obligation of the owner onto their shoulders, but there is a chain of command and they need to accept they are the first in line with the owner and the only one able to negotiate with the owner during the project. Contracts make it clear the Prime needs to approve all work, therefore the Prime should be responsible for payment of said work. Again, we've had success, but we've also walked away when needed.
Posted by: Michelle Boom - Friday, August 16, 2013 4:30 PM

I didn't know about Jersey. I researched it in '08 after Texas Legis put restrictions on it. At that time, they'd been voided by legislatures in Delaware, North Carolina, and Wisconsin; Voided by the courts in CA & NY; and restricted by legislature in GA, Illinois, Maryland, Missouri, New Mexico, Texas & Utah. But some of those only said you couldn't use them to prevent lien rights.
Posted by: M.G. McGee - Friday, August 16, 2013 5:22 PM

Almost all us subcontractors (aka bank for the GC)know what we have strike out and in plug into a general contractor's ridiculous contract yet we still sign them because of two reasons. Some other sap will sign it and the GC knows this. They also know how valuable a negotiating tool that fact is. 2nd, the owner and GC are, in the beginning of a construction contract, a-hole buddies. They both know that their relationship is a charade that is orchestrated by an unrealistic schedule. The pressure of that schedule rolls directly down to us subcontractors because we actually have to perform the work while the GC gets paid a percentage to shuffle paper and mitigate risk down to us. Nothing is their fault. And even if it is, the sub must indemnify them per the signed contract. The unedited, fully executed GC contract in of itself, a game of Russian roulette for the sub.

If the building business is to get better, localities should not permit the project to start, including demolition if applicable, until ALL subcontracts are signed and in place. This will take the pressure off of us and put squarely onto the GC where it belongs.
Posted by: James DiMezza - Friday, August 16, 2013 8:28 PM

I was driven out of the Test Adjust and Balance business and into poverty because I could not maneuver the risks of being a third tier subcontractor. Too often my client who insisted on flow-down conditions did not know of the ability of the GC to pay him, even if the owner had paid the GC. When I get paid you get paid, is not just and should be illegal because it shifts the risk from the prime contractor who should be in the know to the subcontractor and sub-sub contractors who are in the dark.
Posted by: Philip J. Bisesi, PE - Friday, August 16, 2013 8:50 PM

Pay if paid clauses are not illegal in NJ. They are illiegal in NY, but not NJ. In NJ, they are disfavored, and courts will try to construe them as pay when paid clauses whenever possible. However, a clear well drafted pay if paid clause will be enforced in NJ.
Posted by: Michael Zicherman - Monday, August 19, 2013 11:05 PM

The day of the handshake, trusting contract is pretty much over. If you find a contractor who is honorable and honest, grab him and don't let go. We must protect ourselves - who else will?

Subcontractors and vendors who don't read the contract and ask for proof of funding in place are truly putting themselves, their employees, their vendors and clients at risk.

The associations (ASA, AWCI, etc.) do their best to educate us and help us to negotiate the warren of contracting.

Remember when there used to be general contractors? Companies who actually participated in the work? Now, we primarily have construction managers who pimp the subs and vendors on behalf of the owners and their own bank accounts and have no scruples.

For instance, "Subcontractor will perform all work associated with this scope, whether or not written into the specs and drawings, but in accord with the designer's intentions".

Having a degree in English and psychology helps, but doesn't protect us from unscrupulous contractors and owners.
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