ConstructionPro Week, Volume: 2 - Issue: 15 - 04/12/2013

Are Subcontract Payment Procedures Waiving the Pay-if-Paid Clause?

By Bruce Jervis

Two recent cases involving the waiver of subcontract “pay-if-paid” clauses illustrate the uncertainty of enforcing these provisions. In one case, the prime contractor waived the right to enforce the clause against the subcontractor. In the other case, the contractor narrowly averted a waiver.

Pay-if-paid clauses shift the risk of project owner nonpayment from the prime contractor to the subcontractor. The contractor’s obligation to pay the subcontractor is contingent upon the contractor’s receipt of payment from the owner for the sub’s work. A number of jurisdictions have rendered pay-if-paid clauses unenforceable by statute or court ruling. In the majority of jurisdictions, however, these clauses -- if properly drafted -- are enforceable … unless they are waived.

A case reported in Construction Claims Advisor (CCA) several weeks ago involved an enforceable pay-if-paid clause (CCA, March 22, 2013, “Contractor Waived Pay-if-Paid Clause by Making Progress Payments”). The contractor had no obligation to pay the subcontractor unless the contractor had been paid by the project owner for the sub’s work. Nonetheless, the contractor made progress payments to the sub despite lack of payment from the owner. The contractor waived the right to enforce the clause.

A case reported this week also involved an artfully drafted, enforceable pay-if-paid clause. The subcontractor became concerned about the project owner’s solvency. The contractor’s project manager assured the sub, contrary to the terms of the subcontract, the contractor would pay the sub out of its “own pocket” if necessary. The contractor did not waive the clause, however, because the contractor then declined to pay seven progress payment applications on the grounds the contractor had not been paid by the owner for the subcontractor’s work.

Are you aware of situations where subcontract payments have been inconsistent with the terms of the subcontract? Can you suggest procedures or “best practices” which would maintain consistency and avoid the waiver of provisions such as pay-if-paid clauses? I welcome your comments.

COMMENTS

The majority of our work is Gov. Everyone of our contracts are "paid when paid". However, we have some GC's that seem to have a hard time getting paid by the Gov. We know that most of the time, there are other reasons for them not getting paid in a timely manor. We started requesting all pay applications, updated schedules and all correspondence between the GC and owner. There should not be anything hidden. The bottom line, this is a joint venture whether we want to look at it that way or not. The subs carry a note for their share of the contract yet getting paid is contingent upon the whole project. Subs need to be more proactive in the complete project in order to minimize their risk.
Posted by: Clifton Dodge - Friday, April 12, 2013 11:33 AM

I am a consulting engineer and have a number of subs working for me. Administratively, not in writing, I tell them they will be paid when I am paid, as soon as I am paid. For some, because their cash flow is affected, or as a matter of just being reasonable – I pay them 50% of their invoice when I receive the invoice and they get the other 50% when I get paid. As I like to say, that makes us both uncomfortable and even better, equally uncomfortable, until we get paid and are able to pay them. It works very nicely.
Posted by: John swallow - Friday, April 12, 2013 12:38 PM

all subcontracts in Mauritius prepared by the main contractor's quantity surveyors weigh in m.contractor' favor by using the back to back payment clause.

subcontractors are denied sight of correspondences between owner and m.contractor and kept in the dark on the real reasons for non payment;This leads to abuse by main contractors to use any sort of excuse to deny payment to subcontractor due non payment by owner and for reasons that has nothing to do with that particular subcontractor's performance.

Posted by: joe chan - Friday, April 12, 2013 12:40 PM

There "Paid IF Paid" and "Pay WHEN Paid" clauses in contracts. It seems this discussion may be confusing the two clauses.
Posted by: anonymous - Friday, April 12, 2013 12:58 PM

from a sub's position, Paid If Paid or Paid when Paid makes no difference.these clauses are abused by some main contractors in mauritius.
Posted by: jc - Friday, April 12, 2013 1:08 PM

J.C.,

I'm sorry but I beleive there is a huge legal distinction, and corresponding ability of subs to recover, between paid if paid and paid when paid clauses.
Posted by: anonymous - Friday, April 12, 2013 2:57 PM

Two issues come immediately to mind. 1) How to know when the prime has been paid and 2)Does a voluntary and honorable payment by a prime to take care of valuable, appreciated subs in tough cash flow positions negate the clause? In both cases, working with trusted associates seems to be the key to success......call it the good ole boy system if you want, but it why tested and proven relationships are still a key selection factor and are ones least likely to result in court cases.

Posted by: Marshall Wilson - Friday, April 12, 2013 3:07 PM

The paid if paid clause creates an unmitigated risk for the sub when time lines are abused both by the owner and prime. Who absolves the sub contractor on issues of contract risk management both for suppliers and creditors since at most times it creates a huge credit damage to the subs portfolio in their ability to secure additional credit.
Posted by: EUGENE BEN - Friday, April 12, 2013 3:49 PM

Operating in North Carolina, where the state has seen fit to anact a statute (22C) which declairs all 'paid-if-paid' contractual language unenforceble, it is still routine for prime contractors to embed such clauses in their contracts, even those that reside withing the State. And in fact, most practice a paid-if-paid policy regardless of the statute; and therefore, just having an exclusionary statue does not necessarily equate--other than through arduous and expensive litigatory resolution--any sort of practical protection for the subcontractor; particularly where the practice has become routine and commonplace. Many times this results in the subcontractor--told that the owner hasen't paid--receiving delayed payments, so that the prime contractor can use the subcontractor funds to finance their own costs through a project.
Posted by: Rich Honeywell - Friday, April 12, 2013 4:57 PM

From a practical point of view, best for a sub to avoid this clause., whether if paid or when paid.

Is it legal in UK?
Posted by: Jc - Friday, April 12, 2013 11:26 PM

This is a test. Please disregard.
Posted by: Amir Khosrodad - Monday, April 15, 2013 12:09 PM

"Pay if paid" and 'pay when paid' both clauses represent the same interpretation. This clauses would have been a very good clause for the Prime contractor to mitigate her risk on the contract but often times this principle get abused by the main contractor for the following reasons:

1. Most prime contractor in Nigeria and most other places get to abuse the clause by not paying the sub as at when due oven when they paid by the employer. They keep on withholding the the sub's due on the excuse that they have not been paid by the employer

2. This clause might be unfair to the sub as in most cases the sub is not aware in full the kind of agreement that exist between the prime contractor and the employer and as such they sub is not supposed to suffer for what he knows notting about.

3. The prime contractor should be in good position to bear his own risk and not attempt to transfer it to the sub who might not possess a very strong financial backup.

Posted by: Ayorinde Olasehinde - Friday, April 26, 2013 12:16 AM

3. The prime contractor should be in good position to bear his own risk and not attempt to transfer it to the sub who might not possess a very strong financial backup.

Posted by: Ayorinde Olasehinde - Friday, April 26, 2013 12:19 AM