ConstructionPro Week, Volume: 3 - Issue: 9 - 02/28/2014

Are ‘Pay-if-Paid’ Clauses Dead?

By Bruce Jervis

 

Some commentators have questioned the continuing viability of “pay-if-paid” and “pay-when-paid” clauses. These subcontract provisions make the prime contractor’s obligation to pay, or at least the timing of the payment, contingent upon the contractor’s receipt of payment for the sub’s work from the project owner. The enforceability of these clauses has been under relentless assault by both statute and judicial decision. A recent federal case provides another example.

 

An unpaid subcontractor on a federal project sued to recover against the Miller Act payment bond. The surety responded that it had no obligation to pay because its contractor had not yet been paid by the government and the subcontract contained a pay-when-paid clause. The court rejected this argument.

 

Citing decisions from the Fifth and Ninth Circuits, the court ruled that these clauses cannot be used as a defense to a Miller Act bond claim. Enforcement of the clause would constitute an implicit, prospective waiver of the subcontractor’s payment bond rights, something that is prohibited by the act itself.

 

What is your opinion regarding the continuing viability of pay-if-paid and pay-when-paid clauses? Are they still enforceable in the areas where you work? Do you still use or see this language in subcontract agreements? I welcome your comments.

 

COMMENTS

Being from California we lost the battle many years ago. It would be interesting if some of the work around's that we as GC's use have been tested in court cases.
Posted by: John - Friday, February 28, 2014 10:35 AM


The clause is present in every contract we sign and for the majority [> 50%] it works well. Owners are the culprit in most cases because of their built in procedures delay payments to the GC or CM. This delay is generally 45 - 60 days and the owners are unconcerned. Sometimes they are even arrogant about it. It is mostly public or hospital work that is culpable. Private owners are much friendlier when it comes to paying on time.

You have to have some form of payment rules in the contract. I have always said the owner should put in escrow at least 10% of the general contract for use by the GC to pay subs. It would be replenished immediately upon receipt of the pay app for the month ending. When the application has been approved then the GC is informed and he can pay subs. We have seen a form of this in action on one major project.

The other issue is deposits and payments to vendors prior to the material arriving on site. This can turn a sub - contractor into a lending institution to service the owner and his contractor. The time frame here can be months before the sub gets paid for money he has advanced the vendor. The amounts involved can easily reach the high 5 and low to mid 6 figures. The subs line of credit really takes a hit for this. Owners, public and private must be made to pay this cost up front.
Posted by: Bill Enderle - Friday, February 28, 2014 11:21 AM


The entire payment system for subcontracting work is fraud. The end user of the services should be made to deposit 100% of money in an escrow account (or at least 2 months worth) upon signing the contract. Payments should be mandated to be made upon delivery (either material or service or both) to the sub-contractor/vendor.
Posted by: Ravi Manabala - Friday, February 28, 2014 11:39 AM


I have the Answer when its comes to "Materials"

and direct cost and billing simply, have the

Supplier do a Third Party Check form, A this releases you from direct form of payment and lien procedure errors, plus + it confirms that the G/C & OWNER are held accountable for payment in full on your contract end. Then simply get paid back from your major supplier as a overbill. And by the way any custom order material cannot be canceled or changed, since most major supplier of each trade and scope of work has that obligation to you the Trade Subcontractor. Labor you may have wait the delays and punch outs from G/C, P/M, Owners,Architects . Hope this help someone
Posted by: Kenneth e Jones / Jones/Jones Dev and Flooring Contractor - Friday, February 28, 2014 1:45 PM


Having worked both sides, that is both as a General Contractor (GC) and Subcontractor (SC), and thereby having an understanding of both perspectives, I can say that this subject has always been a contentious issue. In the old days, many GC’s self-performed much of their’ own work, and this was not so much a problem. But today's GC fundamentally wants to work from the position of a broker, subletting out the vast majority of their work to individual trade SC in order to limit their liability. And as an extension of this liability reduction, the ‘paid-if-paid’ clause was and is now become an institutionalized contract practice to shift even the financial obligation of the GC off onto the Owner. In essence, taking the ‘Rockefeller’ approach of controlling everything and owning (responsible for) nothing, and forcing their SC’s to bear the burden of compelling the Owner—whom they have relatively little access to, and are often precluded from direct access to contractually—into paying the GC (via the threat of liens).

Fortunately, where some States (like North Carolina) have recognized this as an unfair burden on the SC, they have written statutes declaring the practice unenforceable contractually. But just having a statute on the books is meaningless, where the State rarely if ever enforces it. Many GC’s still put the ‘paid-if-paid clause into their contracts despite the law, and even where a contract does not have the clause, they often actually pay as if it does. Particularly throughout and following the ‘Great Recession’, where it has become almost the ‘new normal’ to stretch sub-pays out 60 and 90 days, and where retention can be left unpaid for 6 to 9 months. In effect, the GC’s are making it a routine practice to operate off of the SC’s money and credit as a substitute to using a bank. And ‘paid-if-paid’ clauses only serve to aid and abet such practice.

Added to this is the murky area regarding retention. Again, many GC’s are stretching the pay-out of retention to their SCs in order to be able to use it for operating capital. As retention monies should be held in escrow, much like a lawyer holds a retainer (that is to say that it is the SC’s money being held by the GC in trust), where this is occurring, it is effectively misappropriation of funds. And again, this is where the ‘paid-if-paid’ practice serves to aid and abet the practice.

Anything can be written into a contract, regardless of what some State statute says. And unless there is some legal action brought to render clauses like ‘paid-if-paid’ mute, or unless States begin to actively enforce their own laws, then they will continue to be exercised without some sort of industry wide effort to correct the practice. Unfortunately, the long term affects of such policies and practices affects everybody; it affects—long term—even those who are currently enjoying the fruits of the practice. Over time, reputation precedes you, and the quality and continuity of the SCs such GCs use erodes and degrades, particularly as the economy strengthens and there is more work and better paying GCs for them to choose from to work for. Thus the pendulum, will swing back.


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