Pay-if-paid clauses provide that a general contractor is not required to pay subcontractors unless and until it receives payment from the owner. The ConsensusDocs Standard Agreement 655 provides the following example:
Receipt of payment by the Contractor from the Owner for the Subcontract Work is a condition precedent to payment by the Contractor to the Subcontractor. The Subcontractor hereby acknowledges that it relies on the credit of the Owner, not the Contractor, for payment of Subcontract Work.
By contrast, pay-when-paid clauses provide that a general contractor will pay the subcontractor within a certain period of time after receiving payment from the owner but do not shift the entire risk of non-payment. The ConsensusDocs Standard Agreement 750 provides the following example:
Progress payments to the Subcontractor for satisfactory performance of the Subcontract Work shall be made no later than seven (7) Days after receipt by the Contractor of payment from the Owner for the Subcontract Work. If payment from the Owner for such Subcontract Work is not received by the Contractor, through no fault of the Subcontractor, the Contractor will make payment to the Subcontractor within a reasonable time for the Subcontract Work satisfactorily performed.
Confusion over which clause is actually intended in contract documents has led to considerable litigation when subcontractors are not paid. Differences in interpretation and enforcement of these clauses can mean the difference between the obligation to pay subcontractors within a reasonable time after receipt of the invoice or withholding payment until disputes with the owner are resolved.
Jurisdictions addressing these distinctions tend to interpret uncertainties as creating a pay-when-paid clause. See, e.g., Sloan & Co. v. Liberty Mut. Ins. Co., 653 F.3d 175, 180 (3d Cir. 2011). However, if the clause provides language such as “condition precedent,” “unless and until,” or “if and only if,” courts interpret the clause as pay-if-paid provisions. In BMD Contractors, Inc. v. Fidelity & Deposit Co. of Maryland, 679 F.3d 643, 648 (7th Cir. 2012) as amended (July 13, 2012), a sub-subcontractor sued the subcontractor’s surety for payment upon the owner’s default. The sub-subcontract provided that “Owner’s acceptance of Subcontractor’s work and payment to the Contractor for the Subcontractor’s work are conditions precedent to the Subcontractor’s right to payments by the Contractor.” The Court considered this a pay-if-paid and found no liability on the surety’s part absent payment by the owner.
In other instances, a contractor and subcontractor may create a pay-if-paid clause that is modified by a pay-when-paid clause. In Sloan, the contract stated that payment by the owner was a “condition precedent” of payment to the subcontractor. However, the contract then provided that “if within six months of the date that final payment is due to Contractor by Owner, Subcontractor has not received final payment for its Work, Subcontractor may pursue its claim against Contractor and its Surety for final payment….” The modified pay-if-paid condition “yields after six months of [owner] non-payment and is replaced with a timing mechanism that specifies when… [the subcontractor] may sue [the contractor].”
Minimizing litigation risks
As a general contractor, opt for abundantly clear pay-if-paid clauses including language making payment from an owner a condition precedent to payment to down-stream subcontractors.
As a subcontractor, avoid pay-when-paid and pay-if-paid clauses in your contracts. If they cannot be avoided, opt for payment within a reasonable period of time even if the owner does not pay due to disputes beyond your control.
As an owner, you can prohibit such clauses in your general/prime contracts, combined with flow-down provisions, and you should include lien waivers wherever possible to protect against mechanic’s liens in the event of non-payment.