LEGALLY SPEAKING Virginia Is Latest State to Ban “Pay if Paid” Clauses

LEGALLY SPEAKING

Virginia Is Latest State to Ban “Pay if Paid” Clauses as Efforts to Protect Subcontractors Grow Nationwide

by Kate Lawrence, Lawrence Law, LLC

In the construction industry, “pay-ifpaid” clauses in subcontract agreements are as common as steel-toed boots. These clauses state the general contractor on a project does not need to pay the subcontractor unless and until it has been paid by the project owner for the subcontractor’s work, including any retention the owner withholds until the job is complete.

These agreements were designed to protect the general contractor, ensuring they aren’t responsible for money owed to subcontractors if the money for a project doesn’t come through – while subcontractors assume the risk of not getting paid for work they completed, regardless of how well they performed. Pay-if-paid clauses also commonly appear in agreements between first tier and lowertier subcontractors, meaning the further down the company is in the project chain, the more risk they have of not getting paid.

While controversial, pay-if-paid clauses are enforceable in many states, and excuse general contractors from their payment obligations to subcontractors if the project owner goes out of business, or refuses to pay because they aren’t satisfied with the work of one or more of the contractors. Subcontractors impacted by these clauses must temporarily finance the job and cover up-front material and labor costs until the money trickles down. Considering all the other risks subcontractors take daily, pay-if-paid can be a significant barrier to profits.

My home state of Maryland is currently one of seven states that have ruled pay-ifpaid clauses are valid, along with Arizona, Colorado, Georgia, Florida, Illinois, and Michigan. To shift the risk of owner nonpayment to the subcontractor in Maryland, the subcontract must have an express unambiguous provision shifting that risk (Gilbane Bldg. Co. v. Brisk Waterproofing Co., 585 A.2d 248 (Md. 1991)).

Support is growing nationwide to put an end to pay-if-paid clauses and six states –including California, Delaware, New York, North Carolina, South Carolina, and Wisconsin – have enacted laws declaring these contractual provisions void and against public policy. Virginia will be the next to join this list effective January 1, 2023.

Signed into law by Virginia Governor Glenn Youngkin in April, SB550 shifts the risk of owner nonpayment back to the contractor. Pay-if-paid language is expressly prohibited under the new law, and public contracts must include a payment clause that makes the contractor “liable for the entire amount owed to any subcontractor with which it contracts.” General contractors are still entitled to withhold payments, presumably where there is a good faith dispute over the subcontractor’s compliance with the contract. To take advantage of this exception, private owners and both public and private contractors must notify lowertier subcontractors in writing of their intent to withhold payment and their reasoning. The law also requires private contractors of any tier to pay subcontractors by 60 days of satisfactory completion of the work, or seven days after receipt of payment from the owner or contractor – whichever comes first. If the owner or higher-tier contractor fails to pay within 60 days, the contractor is still responsible for the payment.

Looking ahead, it certainly seems likely more states will pursue their own efforts to ban pay-if-paid language. Subcontractors represent the greater majority who benefit from these laws, and support in numbers is critical to getting the attention of legislators. If you are interested in campaigning for a new law in your state, here are a few suggestions, based on what was successful in Virginia: • Garner support from as many people as possible, including trade groups and companies that pay taxes in districts across your state. The more people you have who are willing to sign letters and call and email their delegates, the better. • Collect as many real-world examples as possible of instances when subcontractors were harmed by pay-ifpaid clauses. • Be sure that small businesses, minority-owned, and women-owned businesses are represented among your supporters. • Find a sponsor for your bill who is passionate about the cause. • Prepare for a strong opposition from general contractors and their supporters. If necessary, be prepared to make some concessions. In Virginia, supporters for the new law agreed to an exception to the ban if a project owner declares bankruptcy. In this instance, a pay-if-paid agreement can still be enforced. • Pursue bills in both sides of your state legislature – the House and the Senate –to increase your odds of success. • Highlight the issue with change orders in your arguments. As long as pay-if-paid clauses are the industry standard, change orders will continue to put subcontractors at greater risk of not being fully paid for their work.

Legislation banning these clauses would give general contractors more motivation to ensure change orders are approved by the project owner, and full payment is received for the additional work.

In my practice, I’ve seen many subcontractors denied payments they have rightfully earned, and with pay-if-paid clauses in place, pursuing compensation in court is an uphill battle. States that have successfully enacted laws to ban this contract language have taken a significant step to protect these business owners, and hopefully we’ll see more states follow suit.

Kate Lawrence is a construction attorney and founding partner at Lawrence Law, LLC. Contact her at kate@lawrencelawllc.com.