To Pay or Not To Pay

By Timothy R. Hughes

Whether you are the one signing the checks or the one colleting them, it pays to understand the terms in subcontracts.

Determining precisely when subcontractors will be paid and under what terms they will be paid is a point of emphasis in many subcontracts. Such terms are sometimes called "pay-when-paid" and "pay-if-paid" clauses. Whether you are a general or a subcontractor, you need to be familiar with the law applicable to such clauses.

Pay-when-paid vs. Pay-if-paid

Generally stated, a pay-when-paid clause provides for the timing of a payment from a general contractor to a subcontractor. Such clauses often include language which suggests that a general contractor will pay the subcontractor only when the general contractor has received payment for the work in question.

In contrast, a pay-if-paid clause provides that the subcontractor shall be paid only if the general contractor receives payment. By its nature, the pay-if-paid clause is a far harsher. A pay-if-paid clause shifts the risk of non-payment and insolvency by the owner completely to the subcontractor.

The court's positions

Many courts struggle with the harsh result of enforcement of pay-if-paid clauses. Most courts state that pay-if-paid clauses are theoretically enforceable, but are disfavored. An ambiguity may be read into the clause. A clear clause passing along risk of non-payment to the subcontractor is likely enforceable in most states.

Virginia courts provide that a clause which states the subcontractor will be paid five days after the general is paid constitutes a pay-when-paid clause. Such a clause does not shift risk of the owner's non-payment downstream to the subcontractor [Galloway Corp. v. S.B. Ballard Construction. Co. (1995)]. Virginia holds further that a clause stating the owner's payment is a condition precedent to the subcontractor payment is a pay-if-paid clause that is enforceable.

Maryland courts have followed a similar chain of analysis and reached the same result [Gilbane Building Co. v. Brisk Waterproofing Co., Inc. (1991)]. By implication it appears Delaware applies the same rule [Worthy Brothers Pipeline Corp. v. Acierno (Del. Super. 1996)].

Some states have refused to permit the enforcement of such clauses as being against public policy. North Carolina provides by statute that a general cannot make the owner's payment a condition precedent to the subcontractor's payment. [N. C. Gen. Stat. § 22C-2].

Practical advice

Whether you are a general or a subcontractor, you should know your risks and rights before you sign your contracts. You should know exactly what language is required to meet the standard for pay-if-paid clauses and whether they are enforceable in your specific state.

If you are the subcontractor, the availability of bonding and mechanic's lien remedies may offer addition protections to alleviate your risk under these clauses. You may need to be more aggressive about asserting such rights if you face a pay-if-paid clause. Generals insisting on such clauses may face increased aggressive tactics from subcontractors filing lien and bond claims on their jobs. As such, these clauses may eventually have unintended consequences.

Regardless of the position you occupy, these types of contractual provisions offer the dramatic potential for shift of risk of non-payment. In this particular arena, you need to know and understand the applicable law and its implications before you sign the deal rather than after you have a problem on the project.

Timothy R. Hughes, Esq., is the principal of the Northern Virginia law firm of Hughes & Associates, P.L.L.C. He specializes in construction litigation, corporate and business related representation, and complex civil litigation. He may be reached at tim@hughesnassociates.com, or by phone at (703) 671-8200.