“Pay-if-paid” clauses in subcontracts purport to shift the risk of project owner nonpayment from the prime contractor to the subcontractor. If drafted carefully, with express “condition precedent” language, they are enforceable in most (but not all) jurisdictions. The clauses, however, are understandably resented by trade contractors. The prime or general contractor elected to do business with the project owner and had the opportunity to ascertain the financial capability of that owner? Why should a subcontractor, which contracted only with the prime, be asked to assume the risk of owner insolvency?
In a recent federal appeals court decision, an enforceable pay-if-paid clause in a subcontract had been modified. If the prime contractor did not receive final payment from the owner within six months of the date due, the prime would pursue payment remedies against the owner and make a pro rata distribution of any recovery to the unpaid subcontractors. The subcontractor in question still received only a fraction of the subcontract balance. But the risk of owner insolvency was at least shared by the prime, which disbursed the full settlement amount to its subs.
How do you feel about pay-if-paid clauses? Should a prime contractor assume all the risk of project owner insolvency? Or is it fair to pass that risk through to the subcontractors as a cost of doing business? A risk sharing arrangement, such as the one described above, may be a reasonable compromise. I welcome your comments.
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What case was that?
Posted by: stephen scharr | 08/25/2011 at 10:24 AM
Many states have taken steps to essentially outlaw Pay-If-Paid clauses. In Kansas, a Pay-If-Paid clause is not available as a defense to a payment bond surety.
Posted by: KCconstrlawyer | 08/25/2011 at 10:26 AM
The reason for this clause is not just a question of owner solvency, but attitude as well. I have worked many projects where the owner had the money, but chose to withhold payment for various reasons.
If the GC were required to still pay every sub and vendor, they would in effect be financing the entire project causing the GC to over extend. This could cause the GC to become insolvent jeopardizing every subcontract.
While not ideal, it is better for many smaller subs to carry some cost so that one GC does not have to carry the whole burden.
Posted by: Heath S. | 08/25/2011 at 10:35 AM
This is a common condition for consultants working for architects. The difficulty is the consultant rarely sees the prime contract to know what risk is actually being assumed. And the consultant must rely on the Architect to make a good faith effort to collect payments, yet this requirement is rarely accepted by the architect as a condition of the consultant agreement.
Posted by: David Stutzman | 08/25/2011 at 10:41 AM
Subcontractors shouldn't agree to such a clause unless it pertains specifically to their product or services. Why would you allow yourself to be penalized for disputes between the contractor and the owner, or another subcontractor and the owner?
Posted by: william pangelinan, jr. AIA | 08/25/2011 at 10:48 AM
yes, each sub should price and plan his portion of the work with the understanding that risk equals reward. there are many reasons why the subs "profit" from the risk and this is one. public contracts are usually bound into the specifications for the sub to review before he submits his bid to the GC.
Posted by: Scott Addison | 08/25/2011 at 10:49 AM
I recently had a contractor send me payment agreement not specific to any job, but all jobs that we do together. It specifically stated he will not pay us until he has been paid by his customer.
I did sign the agreement, with the following change to his terms : Deposit on all jobs before we will process the job as an actual order.
Posted by: Heather | 08/25/2011 at 10:50 AM
I think the "pay-if-paid" language is fair. Just like the contractor had a choice to do business with the Owner, the subcontractor also has a choice. Nobody is forcing them into a subcontract. I also know many subcontractors that now ask for evidence of funding from the Owner or bank. Shame on them if they don't do their own due diligence. Why is it that the contractor is always in the middle and has to deal with everyone else's problems.
Posted by: Dr. J | 08/25/2011 at 11:00 AM
In your predicate, why do you assume the 'reason' for non-payment relates to insolvency? ...or as one poster suggests, an Owner 'attitude' problem?
More often than not the reasons for non-payment relate to work not performed properly, or not timely, or both. The problem is that if funds are withheld from a GC, and fault for the improper work has not yet, or cannot be easily allocated, all the subs suffer.
This is only one of the reasons laws (state by state) are gravitating away from pay if paid clauses.
Posted by: howard i. littman, aia | 08/25/2011 at 11:03 AM
Does that mean subcontractors can pay if paid their employees? If the subs don't get paid how do small business owners pay their employees? Contractors usually have payroll too, but they generally get a large draw to even start the project whereas subs are more services rendered. We bill every two weeks and pull off a job if we don't get paid and work on another project if possible. We return to the project when the check comes in. If they want the work done, they have to pay. We've have had times we've waited up to 3 months for payment. Small subs can't make payroll in those situations.
Posted by: Melissa | 08/25/2011 at 11:04 AM
Both California and New York have ruled that such clauses are unenforceable and violate the subcontractors rights.
Posted by: Jerry | 08/25/2011 at 11:08 AM
I do a lot of engineering for contractors and architects. All my customers pay on delivery except for one. His refusal to pay in a timely fashion are not about cash flow. I feel it is an excuse to prioritize his own expensive antiques collecting habit. He buys old safes, bells, phones, John Deere tractor toys, and many other lines of valuable collectibles. But, he will carry a two thousand dollar balance for months. "We haven't been paid yet for that job. In this industry, no one pays until they have been paid."
I agree with the above post that this is really an attitude, at least when small sums are involved.
Posted by: Robert | 08/25/2011 at 11:09 AM
Very obvious who on here is on the GC side and who is on the Sub side... Most PM's and employees of larger GC's dont understand what it is like to make payroll and finance projects for slow payers. Fortunately most of the GC's we work for are larger and its not a matter of pay if paid but pay when paid which is sometimes is ridiculously slow...
Posted by: Mike P | 08/25/2011 at 11:10 AM
"Pay WHEN paid" is a reasonable contract term because it recognizes that the general contractor may have legitimate collection issues but it does not preclude eventual payment. "Pay IF paid" is fundamentally unfair. The subcontractor, supplier, consultant or any other third party usually has no means to control the prime contract or the relationship between GC and owner. They usually have limited to no ability to gauge the owner's solvency or integrity. My GC friends admit that they are primarily in the risk management business. To the extent that's true then it makes sense to shift payment risk to subs, but that doesn't make it right. Risk of non-payment by the Owner is properly the province of the GC and they should not ever allow their exposure to exceed their ability to settle claims resulting from failure of payment. That said, a risk-sharing provision that assures proportional distribution of recovered funds is something that would enhance our confidence in a GC.
Posted by: William McCord, AIA | 08/25/2011 at 11:12 AM
Architecture firms such as ours ALWAYS make a "good-faith" effort to collect from property owners, yet in the end have very little recourse other than a costly lawsuit to recover payments. In every state in the union General Contractors have legal rights to "lien" a project, which usually forces the owner to pay unless they are insolvent. Architects have no such rights - and if we cannot guarantee that we will be paid for our work, our subs don't get paid, either. That's the unfortunate reality - I think what is going on here is the undue influence most construction companies have on those who write and enforce these "laws". GCs already have more than enough protection under state and federal laws; they should assume the burden in all cases. Architects may be primes, but they should not be confused with General Contractors, ever.
Posted by: Frank Boyle | 08/25/2011 at 11:15 AM
Unless frozen collections are a direct result of a Sub Contractor, then the GC should pay all Subs except the Sub directly responsible for the holding of payments and pay all Subs if the problem is a GC related problem. The GC/owner contract is not normally privy to the Subs as to input or collections and not made directly to a Sub. Subs contracts are generally to a GC and that is the legallity of the contract for collection purposes. They would not sue the owner 1st they would sue the GC for collection.
Posted by: Bill Norton | 08/25/2011 at 11:20 AM
Pay-if-Paid frequently allows the contractor to hide behind the provision, when in fact it or another one of its subs was the cause of the Owner's non payment. I have seen numerous circumstances, created by retainage differentials, where it would cost the G.C. money they already had in hand to solve a problem get paid and then pay the subs.
Posted by: Mark Decker | 08/25/2011 at 11:20 AM
Why should the subcontractor be expected to share in the General Contractor business decisions unless; he then to is compensated for that risk sharing and receives part of the profit the General makes as well. I have never had a General Contractor offer to share profits. But have damn sure had them be the first to ding me if the owner doesn't agree work completed. They are also the first to keep full retention even after theirs is reduced. They also the first to shop to raise their profit margin, and the last to commit to any sub until they have made the best deal for themselves,and not necessarily for the sub. They commit to schedules and then hammer the sub's to meet them. The pay as paid clause did not come about because it benefited the sub nor was it created by a subcontractor for his benefit. The exact opposite it true.
Posted by: JeremyWiley | 08/25/2011 at 11:24 AM
Paid when paid clauses are nothing more than a mechanism to spread the financial risk of non-payment by or insolvency of the project Owner which is essentially fair amongst the construction team members especially when you consider the reverse problem,i.e. the general contractor having to cover the cost of non-performance by any or all of the construction team members.
Posted by: Joe Valrose | 08/25/2011 at 11:33 AM
Why is the General Contractor allowed to bid work that he is incapable of financing. If he can not pay subs and vendor he shouldn't be doing business as a General. That was one of the first rule of contacting in the past. Now we have want to be Generals whom are not capable and they expect someone to take the risk for their incompetence, Just like our government. Contracting has changed I agree, but not for the better in the financial end. IF YOU CAN'T GET PAID OR PAY THEN DON'T DO THE WORK. When owner find out they either pay or no one works for them we will all be better off. It starts with a owner whom expects a profit, then to a General Contractor, Then to the Subcontractors whom does the work, but least able to defend himself. Each tier has less and less remedies available to them so you have the trickle down effect leaving last man in the chain to bear the burden
Posted by: JeremyWiley | 08/25/2011 at 11:44 AM
We work in the public realm, doing city halls, justice centers, and the like. The wheels of bureaucracy grind slowly. A County project manager confided to me that every invoice in his department has to be signed 17 times, sometimes by the same person more than once. That means payment is often received over 90 days from billing. As a small firm, we've relied on our sub-consultants to be patient. They know it comes with the territory.
When working with non-profits, it really gets interesting! Quite often they will pay the interest from late payments, but they are at the whim of the government and private agencies that support them. Their cash flow is always irregular. But we've had a great track record with non-profits paying their bills, with gratitude to boot.
Except for once: A former boss had to sue the Sisters of Charity for stiffing him on a bill. They signed the contract for services and they darned well better pay. And they did - after being forced by a judge. (So there!)
Posted by: Ruth Vallejos | 08/25/2011 at 11:52 AM
What is that express "condition precedent" language (actual or example)?
Posted by: John S | 08/25/2011 at 11:55 AM
Short and simple. When a subcontract is submitted to our contracts department and review finds "paid-if-paid" language in the document, we simply will not accept it, and if the GC is not willing to negotiate a compromise to the language, then that GC can look elsewhere.
Our company prides itself on performing on-time, on-budget, and to specification. Our dedication to quality and focus on performance minimizes the GC's risk and we believe that we are entitled to be paid for that level of exactitude and reliability.
A GC who uses and relies upon paid-if-paid language as a risk mitigation tool ought to think twice. After all, you get what you pay for.
Posted by: K. B. Coxe | 08/25/2011 at 12:00 PM
Wouldn't "pay when paid" turn into "pay if paid" for a vanishing final payment?
Posted by: Bill Charleton | 08/25/2011 at 12:14 PM
As a material supplier, the companies that we buy from expect uis to pay within terms. I am selling my products to the GC and I look to the GC for payment, my contract is not with the owner. Why should I finance his project? The GC should be obligated to determine the owners ability to pay before entering into a Contract with the owner. I can appreciate his problems,but that is his obligation.
Posted by: Bob Boswell | 08/25/2011 at 12:20 PM
In short, no matter how any GC wants to spin it- it is just another example of the them using the Sub to loan them money. Use the little guys to finance the big guy(s). The have non incentive to collect for the sub and can hide behind the clause as an excuse for not paying. It, also, reduces their incentive to make the Owner behave better and pay more timely. We, also, refuse to do business with any GC who uses this contract language. Let them deal with the subs who have nowhere else to go. And Lastly, look at what allowing this stuff leads to. Governments and Owner's who don't pay their bills, but get completed projects and everyone down the line is stiffed. City of Chicago is 18 months in contractor payments. If work had stopped no one would have been out more than a month of work and the City could not have over contracted or extended.
Posted by: DLF | 08/25/2011 at 12:25 PM
Pay-if-paid clauses are simply and unequivocaly wrong! The Subcontractor contracts with the General Contractor, not the owner. If a Subcontractor performs his work properly, the G/C should be obligated to pay him period. There is no gray area, there is no "shared responsibility", it is the resopnsibility of the General Contractor to pay the Sub contractor.
Posted by: Keith Colvin | 08/25/2011 at 12:35 PM
The prevailing principle should be that the entity best able to manage a risk, exercise control over the contributing factors and/or get rewarded for taking and managing the risk should be bearing that risk. Paid if or when paid clauses transfer risks to entities that have neither control or rewards associated with the risk and since that means to transfer risk stops somewhere downstream, whoever is last in the chain gets the hit with no possibility to mitigate. As long as its not OK for me to tell the power company and my landlord that I will pay my bills if and when my client pays me, the whole procedure is intrinsically unfair and as such, fundamentally dishonest and dishonorable.
Architects and engineers often have clauses like that in contracts with design-builders who enter into a dispute with project sponsors. Of course, whatever claims come from professionals are the first thing that the design-builder is willing to take off the table in negotiating a settlement of the dispute with no recourse from the source claimant.
Paid if paid clauses automatically put the prime contractor in a situation of conflict of interest that always get resolved at the subs' expense. It creates business relationships where suppliers are asked to give up control over their destiny. I understand how expedient and convenient it can be for prime contractors to have such a clause, but that certainly is no justification for it. The practice is simply a shameful form of avoidance of responsibility.
Posted by: François Hogue | 08/25/2011 at 12:52 PM
I have been in business as electrical subcontractor for more than 25 years, never have a problem with Owners.
Owners want the job finished on time and well done but I have seen many fights between Owner and GC.
Why Subcontractors have to be penalized for those problems.
Posted by: Tau Electric Inc | 08/25/2011 at 01:01 PM
The way we are handling this now is that we are tired of chasing the money that is owed to us and others, especially when the GC or owner insists on a 10% retainage until you have satisfied their conditions of the contract, ask for riems of paperwork showing we have paid people, and them holds our check for some obviously phony reason so he can get a few weeks interest in his account and pay his employees.
What we are doing is going into a two party check system. That way we just sign checks over to the suppliers when they are issued by the GC and after our detailed billing has been submitted. We can't pay the supplier and our subs, if we dont get the check form the GC. We make sure we have billed enough in every cycle to pay our suppliers from the previous month, submit it along with the suppliers bills and let the GC cut the checks and we countersign them.
We find that is a lot less paperwork for us, the suppliers get paid faster, the GC's are insured that our suppliers are paid, and everyone seems happy.
If we have a GC who is not paying a two party check to any supplier when due, then the argument goes between the supplier and the GC and we are more than happy to sit in between them, listen to the GC complain about not being able to pay the supplier and listen to the supplier threaten not to deliver any more material or provide the necessary releases of lien that the GC needs to
get paid the next month.
Fecal matter always flows downhill. But in business unless the supplier is satisfied and paid, it begins to go back uphill, to the sub, then to the GC then to the owner. The quicker the better for everyone.
Posted by: J. Sheedy | 08/25/2011 at 01:34 PM
I build 3 to 5 mil private homes. I have been burned to the tune of 500K. Owner paid out of pocket, got mad at architects and held us all out to dry. 2 years and 80k in legal fees later we settled for about 25%. Sometimes the owners pay out of their pockets. NEVER NEVER do this. Escrow account and a bank to make progress payments will solve this issue. Also AIA contract documents can help if constructed correctly.
Posted by: Mike Holmes | 08/25/2011 at 01:37 PM
I never accept pay-if-paid language. For starters, you're relinquished your lien rights if you do!
Posted by: John | 08/25/2011 at 01:45 PM
Pay if paid is not legal. It does not hold up in court. Unfortunately, the subcontractor, has to sue the GC. However, to avoid such a problem it does require the subcontractor to do some do diligence about how the GC is going to get paid, and the financial strength of the owner. Most time with a little checking one can avoid the problem. That being said, it pays to know a good lawyer.
Posted by: Tom Sofos | 08/25/2011 at 01:53 PM
I suppose it depends on which side of the fence you are on, we are both a prime and sometimes a sub, so i understand both sides of the argument. The problem is contractors as a whole have allowed owners whether they be public or private develop practices and contract language that would not be acceptable in any other industry.
Posted by: W.P. Hunter | 08/25/2011 at 02:03 PM
In Arizona a lot of subcontractors have been hurt by the paid when paid clause. The GC is only out $20,000 or so and a lot of the subcontractors are out $200,000.00 or more for labor and materials. Here after the funding was approved by the bank half way through the project the bank pulled the funding from the owners. Now every body is out a lot of money except the bank. they repo the proptery have a project 60% complete and the land and sell it for a profit. If we turned the tables and in order to get a permit to build the Owner/bank put up a payment bond.
Atleast this way the money is there to go after. We have been chasing several hundred thousand dollars for a couple of years now. Every time I make progress that bank is sold to another bank. Now we start the same BS all over.
Also the judges in the court have absoutly no construction law experenice and do not know what they are looking at
Posted by: drf | 08/25/2011 at 03:43 PM
I've enjoyed reading this thread. I own my own MEP engineering firm and most of our contracts is with architects on a 'pay when paid' basis. We've been lucky and have only been burned once. We're trying to get away from this practice as our AR is often more than 120 days out which puts a pinch on our cash flow.
I'm wondering, does a subcontractor have any recourse against the owner or since their contract is only with the GC, can they only go after the GC for payment?
Also, I think contractors can put liens on the owner's property for non-payment, can architects and engineers do this too?
Posted by: M. Gardner | 08/25/2011 at 06:48 PM
As a small GC, it was a matter of pride to ensure that my subs and suppliers were paid. Since most of my clients were honest people, it took more than seven years to find the one who put me out of business. My subs were paid, my conscience is clean, but my family suffered. If you don't like the terms of the contract, negotiate or walk away. I have also been a subcontractor and suffered as a result of slow or no pay. First rule of contracting is not to have a single client who can put you under.
Posted by: Glenn Smith | 08/26/2011 at 02:46 AM
We simply don't do any contract under "Pay-if-Paid" because the language isn't fair for subs. Especially if you are a sub of a sub and sub and especially if your prime contractor adds 20-150% on top of your services. In a Pay-if-Paid" case you carrying the risks of two, three or more potentially insolvency parties. If you convert this risk in a $-value you are getting so expensive that you don#t get the contract anyway. So why bothering from the beginning with - in my opinion- criminal practices?
Posted by: Jörg Breuning | 08/26/2011 at 04:36 AM
Don't perform any work or services under "Pay-if-Paid". If a GU wants to see that go to their client and let them know that this -almost criminal- practices might jeopardize or delays his project.
GCs are getting paid for these risks when doing a contract with their clients. Distributing these risk to the subs is like double dipping.
I recommend starting a black list with all double dipping "Pay-if-Paid" GCs if we want a profitable and efficient industry.
Posted by: Jörg Breuning | 08/26/2011 at 04:48 AM
On a typical AIA Draw Schedule,the amounts of the monthly draws are determmined by the schedule of values (percentage of work performed by each trade)and General Conditions. Why should the GC assume all the risk when generally the subcontractors run off a higher percentage of profit? Reports show by a wide margin that most issues releated to non-payment from the Owner is created by lack of performance and inferior work from subcontractors, followed by the Owners intent to simply defer payment without probable justification. Only in 3% of the cases studied were the GC's in error. You have risk in every business and "Subcontracting" certainly has no exceptions.
Timing would indicate that the GC already has a contract, and the Subcontractor is free to decline the work offer. In these times the option of the GC would be "Next".
Posted by: Alan in Orlando | 08/26/2011 at 01:52 PM
Several responses to posted comments:
The subcontract in question said final payment by the project owner to the prime contractor "shall be a condition precedent" to the contractor's obligation to make final payment to the subcontractor. The U.S. Court of Appeals, applying Pennsylvania law which governed the subcontract, said this was enforceable. But the clause was modified by other language in the subcontract.
The citation to the case: Sloan & Company v. Liberty Mutual Insurance Co., U.S. Court of Appeals, 3rd Cir., No. 10-1725 (August 1, 2011); 2011 U.S. App. LEXIS 15798.
As noted in the initial commentary and by several commenters, these clauses are not enforceable in every jurisdiction. Familiarity with applicable state law is important. Beware of statements that these clauses are or are not enforceable in a particular jurisdiction. Sometimes it is more subtle than that.
Posted by: Bruce Jervis, Editor, Construction Claims Advisor | 08/27/2011 at 11:46 AM
Lets say Im a subordinate and my boss asks me to go down to the local pizzaria and order a large pie with the works for him to take home to his wife and kids. The boss tells the subordinate that he will be down in a few moments with the cash for the pie.The subordinate does just that, the pie is made, the pie is excellent, the pizzaria gives the pie to the subordinate and says" thatll be $12.50..the subordinate says to the pizzaria Ill pay you when My boss gets here, to pay me...just then the boss shows up and says nevermind my wife made dinner and walks away....so should the pizzaria be stuck with cost of the unpaidfor pie? I DONT THINK SO. Pay when paid clauses should be federally banned in contracts in all 50 states, they are criminal clauses that hurt subs.
Posted by: Joe GMA inc. | 08/28/2011 at 03:39 PM
I believe that paid when paid or paid if paid closes are completely unfair to subcontractors. First of all, most general contractors often prequalify the subs submitting bids. However, subs never have the ability to do the same with GCs. Additionally, GCs must have the ability to fund the entire project either by project loans or with their own working capital. GCs always use subs to fund the projects @ zero % financing, and they distribute the risk down to subtiers. However, courts have upheld that non-payment of owner does not constitute a release of the liability GCs have with subtiers. If and when this happens the costs of taking a GC to court can sink any sub, because the legal process is long and not cash flow friendly.
Posted by: Carlos Cabrera | 08/29/2011 at 08:49 AM
Owners hould be required to hold the so-called retention in an escrow account.
General contractors shoul have the balls to stop work if they are not paid.
Subs should not agree to pay if paid contracts, because not only do owners have attitudes, but GCs and their lawyers have attitudes.
YOu do the work, you get paid. What the hell is wrong with that?
Posted by: Barbara R. | 09/02/2011 at 01:13 PM
Pay if Pay or Pay when paid?....Prompt Pay Act states you have 7 days to pay your subs...Bond & Lien claim can also assist in collecting money. I call around Mechanical Contractors all the time right up to the owner if I need to...joint checks help too. NO GC wants anyone to go after their Bond and risk their "good" rating. They will help in getting subs paid vs a claim against their Payment Bond.
Posted by: Bill Collector | 09/06/2011 at 12:29 PM
The issue is not just a question of owner solvency, but behaviors as well. I have worked many projects where the owner had the money, but withhold the payment for various reasons.
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