What’s in a word? “Pay-if-Paid” or “Pay-When-Paid” provisions—there may be a big difference

Jeffrey W. King Outside General Counsel for the WFCA

Have you ever signed a contract to supply or install flooring that provided you are paid “if” or “when” the prime contractor is paid? Do you include such provisions in your contracts with installers? These provisions are generally understood to shift therisk of an owner not paying from the prime contractor to the subcontractor. The fact,however, is that there may be a significant difference between a paid-when-paid and apaid-if-paid clause.

The courts in most states consider a “pay-when-paid” clause as simply a timingmechanism, and generally will not excuse the prime contractor from paying the subcontractor,whether or not the owner pays the prime contractor. The risk of non-paymentis on the prime contractor, and the courts will generally require payment to the subcontractorwithin a “reasonable time” after the work is completed.

In contrast, courts generally have found that a “pay-if-paid” clause constitutes a conditionprecedent to the subcontractor’s payment. A pay-if-paid provision means exactlywhat it says: The prime contractor has no obligation to pay subcontractors unless theowner first pays the prime contractor. This can create a dilemma for a subcontractor.Since the subcontractor has no contract with the owner, a court will generally hold thatthe subcontractor cannot claim a breach of contract against the owner. Some courts haveheld the subcontractor’s sole remedy is against the prime contractor, who is not obligatedto pay until the owner pays it.

This distinction recently took center stage in a case in Kentucky. The dispute involvedthe construction of a 21-floor luxury condominium. The owner hired Corporex Developmentto design and oversee construction of the condominiums, and Cortex contractedwith Dugan & Meyers Construction (“D&M”) to be the general contractor, who wouldmanage the construction of the condominiums. D&H subcontracted with Superior Steel,Inc. to fabricate and install the steel framing and decking for the fixed price of $1,814,000.Superior, in turn, subcontracted with Ben Hur Construction to erect the steel framingand metal decking for the fixed price of $444,000.

The subcontract between Superior and D&M contained two sections with pay-if-paid language. First the“Claims Payment” provision stated:

No additional compensation shall be paid by the Contractor to the Subcontractor for any claim arising out of the performance of this Subcontract, unless the Contractor has collected corresponding additional compensation from the owner, or other party involved, or unless by written agreement from the Contractor to the Subcontractor, prior to the execution of the Work performed under said claim, which agreement and work order must be signed by an officer of the Contractor.

Second, the “Time of Payment” clause provided that:

Receipt of payment by the Contractor from the Owner for the Subcontractor Work, is a condition precedent to payment by the Contractor to Subcontractor. The subcontractor hereby acknowledges that it relied upon the credit of the Owner, not the Contractor, for payment of the Subcontract Work.

During the project, D&H instructed both Superior and Ben Hur to perform extra work. Both Ben Hur and Superior submitted work orders to D&M, who in turn submitted work orders to Corporex. Ultimately, Corporex refused to pay $124,017 to Superior and $284,295 to Ben Hur for the additional work. In addition, Superior claimed it was owed $195,143.40 for retainage, that is, a portion of the agreed upon contract price withheld until the work is substantially complete.

Superior and Ben Hur filed a lawsuit against the Condominium owner, Cortex and D&M for breach of contract, unjust enrichment and other claims. The trial court entered a judgment for Superior and Ben Hur including an additional $349,241.70 in attorney fees. An appeals court, however, vacated the judgment.

The appeals court held that the contract included a pay-if paid provision. Since D&M was not paid by Cortex, neither Superior and Ben Hur had a claim for breach of contract against D&M. The court also held that neither Superior nor Ben Hur had a contract with Cortex or the Condominium owner, so they could not claim a breach of contract against them, even if Cortex violated its contract with D&M. Finally, the appeals court held that, since the subcontractors had a contract with D&M, their only legal remedy was under that contract with D&M. Superior and Ben Hur could not claim equitable rights, such as unjust enrichment. The two subcontractors appealed to the Kentucky Supreme Court.

The Supreme Court agreed that neither Superior nor Ben Hur had a breach of contract claim against D&M, Cortex or the Condominium owner. The Court ruled that the pay-if-paid provision meant that D&M had to pay the two subcontractors, only if Cortex first paid D&M. Since Cortex did not pay, D&M was not obligated to pay the two subcontractors. Fortunately for Superior and Ben Hur, the Court did find that they had a claim against Cortex and the Condominium developer for unjust enrichment, and remanded the case to enter a judgment.

Given the harsh results of a pay-if-paid clauses, they are viewed with disfavor by courts and will not be enforced if their terms are ambiguous. Courts tend to interpret uncertainties as creating a paywhen-paid clause. For example, an appellant court in Ohio refused to enforce a pay-if-paid clause. The case involved the construction of a swimming pool at a Holiday Inn. AEM Electric Services Corp. was the general contractor and subcontracted with Transtar Electric, Inc. to perform certain electrical work worth approximately $187,000. The subcontracted provided that:

Receipt of payment by contractor from the owner for work performed by subcontractor is a conditionprecedent to payment by contractor to subcontractor for that work.

AEM did not pay Transtar $45,000 that was remaining under the contract, claiming it was not paid the full contract balance by the owner. Transtar sued AEM for the remaining amount due under its subcontract. The trial court granted summary judgment to AEM, finding that Transtar had no remedy against AEM for amounts not paid to AEM by the owner. The court determined that the contract obligated the general contractor to pay the subcontractor, only if it got paid by the owner.

An Appeals Court reversed the trial court, ruling that transferring liability from the general contractor to the subcontractor is disfavored in the law. The court found that nonpayment by the owner is ordinarily the responsibility of the general contractor, who has dealt directly with the owner, and is in the best position to collect funds from the owner. The Court found that the subcontract language was not sufficiently clear and unambiguous to transfer the risk of nonpayment by the owner from the general contractor to the subcontractor. The Court concluded that the clause was a “pay-when-paid” provision, and that AEM must pay Transtar the remaining amount due even though AEM had not yet been paid by the owner for the work.

Similarly, the Florida Supreme Court refused to enforce a pay-if-paid provision, even though the provision in the subcontract was clear and unambiguous. The subcontract, however, incorporated the general contractor’s agreement, which required the contractor to pay its subcontractors before it would receive payment from the owner. The Court held that the incorporation of the general contractor’s payment provision created an ambiguity when read in conjunction with the subcontract’s “pay if paid” provision. Accordingly, the Court refused to enforce the pay-if-paid provision, and held it simply fixed “a reasonable time for the general contractor to pay” the subcontractor.

As states have moved toward protecting the rights of subcontractors, some courts have decided not to enforce pay-if-paid provisions. The courts in New York, South Carolina, Illinois, Wisconsin, and California have declared pay-if-paid provisions to be against public policy, since such clauses are inconsistent with the states’ lien laws. These courts found that, if a pay-if-paid provision does not obligate payment to the subcontractors unless the prime contractor is paid, then the subcontractors would not technically be owned the money, and therefore could not file liens.

State legislators are also rethinking pay-if-paid provisions. North Carolina and Wisconsin have enacted legislation that makes pay-if-paid clauses unenforceable as against public policy. Other states, such as Maryland and Missouri, have enacted legislation limiting such clauses.

On the other hand, several states treat both pay-ifpaid and pay-when-paid provisions as creating condition precedent, so a subcontractor is paid only if and when the prime contractor is paid. Flooring retailers, contractors, and installers in those states cannot take comfort in a paywhen-paid provision.

Every flooring contractor, retailer, and installer should be wary of pay-if-paid and pay-when-paid clauses, and know whether its state treats these provisions differently, that is, whether a contract that provides “pay-if-paid” shifts the risk of non-payment, but a contract that provides “pay-whenpaid” does not. Flooring contractor, dealer, and installer should not sign contracts without reviewing them and understanding these types of clauses, and how they will impact them. Given the potential liability, flooring contractors, retailers, and installers should consult with competent legal counsel to review its basic contracts and any clauses that raise concerns to the retailer, contractor, or installer. ❚

Notice: The information contained in this article is abridged from legislation, court decisions, and administrative rulings, and should not be construed as legal advice or opinion. and is not a substitute for the advice of counsel.

Jeffrey King has more than 35 years’ experience in complex litigation with a focus on contracts, employment, construction, antitrust, intellectual property and health care. He serves as general counsel for WFCA and other trade associations, and is a LEED Accredited Professional. For more information, contact him at (561) 278-0035 or jeffw@jkingesq.com.