In California, It’s Time to Revisit Your "Pay-When-Paid" Contract Clause

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Snell & WilmerIn California, the "pay-when-paid" contract language typically found in general contractor’s subcontractor agreement may no longer be enforceable. A contract provision requiring a subcontractor to wait until the general contractor concluded its litigation with the owner before it could seek payment on a payment bond was held unenforceable as against public policy in a recent appellate court decision, Crosno Construction, Inc. v. Travelers Casualty and Surety Company of America (2018) WL 4183622 (Cal.App. 4 Dist.). California law distinguishes between pay-when-paid clauses and "pay-if-paid" clauses. Pay-if-paid clauses have been unenforceable for some time in California. However, if a clause is a pay-when-paid clause, it is enforceable, but only for reasonable time. Crosno has now called into question just what is a reasonable time. It is likely much shorter after Crosno.

The Crosno case arose out of a water system improvement project owned by a public owner. Crosno was a subcontractor to the general contractor on the project and Crosno was the principal on a project payment bond. The subcontract between Crosno and the general contractor (The AGC Short Form Subcontract) contained a pay-when-paid clause that provided that if the owner delays in paying the general contractor then the general contractor and its surety:

Shall have a reasonable time to make payment to Subcontractor. Reasonable time shall be determined according to the relevant circumstances, but no event shall pass less than the time Contractor and Subcontractor require to pursue to conclusion their legal remedies against Owner or other responsible party to obtain payment, including but not limited to mechanics’ lien remedies.

The general contractor was terminated from the project and as result was not able to pay Crosno in full. The general contractor did bring an action against the owner, but before the general contractor's action against the owner had concluded, Crosno moved for summary judgment against the surety on the payment bond. In its motion Crosno argued that the pay-when-paid clause in the subcontract agreement violated California Civil Code 8122 which precluded advance waivers and releases of lien claims, which rendered the time the parties agreed upon for payment in the subcontract unenforceable. The trial court granted the motion and the appellate court affirmed the trial court's decision. In affirming the judgment of the trial court in favor of Crosno, the appellate court stated:

After carefully considering the parties' arguments, we agree with the trial court's sound analysis. Enforcing the pay-when-paid provision found in Crosno’s subcontract would postpone Crosno’s right to recover under the payment bond for an indefinite time period until Clark’s [general contractor's] litigation against the District [Owner] concludes. Such a result would unreasonably affect or impair Crosno’s statutory payment bond remedies ([Civil Code] 8122) and is unenforceable for the same reasons expressed in Wm. R. Clarke [William R. Clarke Corp. v. Safeco Ins. Co. of America (1997) 15 Cal. 4th 882 (holding pay-if-paid clauses unenforceable in California)].

Although the Crosno case concerns pay-when-paid language as it relates to a claim against the surety on a payment bond, one now has to anticipate it will be argued that any language used in an agreement that "affects or impairs" a claimant's mechanics' lien statutory scheme rights is analogous to "affecting or impairing" the payment bond rights like Crosno; and, therefore the pay-when-paid language would be unenforceable, if it unreasonably delayed the time for payment.

What is the take away here on the unenforceability of pay-when-paid clauses? It is likely that a pay-when-paid clause will be unenforceable when it impermissibly affects or impairs rights because the duration for payment extends to long, such as the time beyond which a mechanics’ lien rights can be enforced. The reality is that a reasonable time must be something short of "the time Contractor and Subcontractor required to pursue to conclusion their legal remedies against the Owner…" to avoid unenforceability of the pay-when-paid clause.

General contractors may want to promptly review and revise their pay-when-paid clauses in their subcontracts or master contracts to accommodate the holding in Crosno. General contractors and Subcontractors may want to review your pay-when-paid contract clauses for enforceability; and, going forward, negotiate a "reasonable" duration for pay-when-paid clauses on all future contracts.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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