Construction Contract provisions — “Pay-if-paid” clauses v. “Pay-when-paid” clauses

For those of you construction professionals that insist and take pride in taking an “all-inclusive” interest in your company; I applaud you. You should take pride in what you do, your work, your clients and developing those relationships. It is, after all, your business. It is, after all, how you pay your bills and provide for your family. Pretty important, huh. I’m not trying to minimize this, rather, I’m trying to emphasize how important your business is to you, your family, your employees and their families.

Being that as it is, why would you ever negotiate, enter into and sign a construction contact without knowing what you have obligated you and your company to? Would you ever agree to buy a house without knowing whether the foundation in sound? Would you ever buy a car without knowing how many miles it has? Of course not! Then don’t sign a construction contract without knowing what you’re getting yourself into.

In my years of construction litigation, I’ve heard ever excuse for signing a contract without looking at it first — “I’ve dealt with him before and he’s a good guy”; “I wouldn’t have understood that ‘legalese’ anyways”; “I was too busy”; “It was just a small job. It was no big deal”; and, “I was just a small sub on the project.” Does any of this sound familiar? I hope not, but if it does, I’ll give you tips on what to look for when negotiating your next construction contract.

Over the next several weeks, I am going to publish a series of articles designed to, identify, address and, hopefully, demystify many of the clauses contained within many construction contracts.  This week, I’m going to start with “Pay-if-paid” clauses v. “Pay-when-paid”.

As its name implies, with a “Pay-if-paid” clause, you will get paid when someone else gets paid.  For example, If you are the sub on a particular project; very typically, you will not get paid until and unless the GC gets paid first.  While these types of contracts are not terribly common, you don’t want to find out the hard way — i.e., your request for a progress payment is denied on the basis that the Owner didn’t pay the GC, or your retainage is held for the same reason.

A “pay-if-paid” provision makes payment to a lower tier subcontractor or supplier conditioned on the GC receiving payment from a higher tier party, namely the project owner.  In reality, a “pay-if-paid” provision limits the GC’s liability and shifts the risk of the project owner’s non-payment to the subcontractor.  A typical “Pay-if-paid” clause reads as follows:

“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. Progress payments received from the Owner for 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.”

On the other hand, a “pay-when-paid” clause requires payment to the subcontractor when the GC gets paid. The obligation to pay under the “pay-when-paid” provision is triggered upon receipt of payment from the project owner. Courts in Virginia have interpreted “pay-when-paid” clauses to mean that the contractor’s obligation to make payment is suspended for a reasonable amount of time for the contractor to receive payment from the project owner. This type of provision essentially creates a timing mechanism to make payment, and does not expressly shift the risk of the project owner’s non-payment to the subcontractor.  A typical “Pay-when-paid” clause reads as follows:

“The Contractor shall promptly pay each Subcontractor, upon receipt of payment from the Owner, out of the amount paid to the Contractor on account of such Subcontractor’s portion of the Work, the amount to which said Subcontractor is entitled, reflecting percentages actually retained from payments to the Contractor on account of such Subcontractor’s portion of the Work. The Contractor shall, by appropriate agreement with each Subcontractor, require each Subcontractor to make payments to Sub-subcontractors in a similar manner.”
Naturally, if you are a GC, you would prefer to have a “Pay-if-paid” clause.  And if you are a sub, you would prefer a “Pay-when-paid” clause.  Virginia courts honor both of these clauses, so GC’s and subcontractors face an uphill battle trying to invalidate these clauses.

I hope this helps.  If you have additional comments, concerns or questions, please feel free to reach out to me or consult a construction lawyer in your area.  Next time, I’ll address attorney fee provisions in construction contracts.  Stay tuned.