Pay When Paid Clauses: Subcontractor Nightmare?
We have talked about it before, but recently I have seen an over abundance of the dreaded "Pay When Paid" clause, and its variants. Therefore, its time to revisit the topic and provide some basic information on these clauses.
Background of the Clause
The general term for this type of contract language is the "Pay When Paid" clause. The clause is likely located in the "payment" portion of your contract with your contractor. The intention is to make a payment due to a downhill contractor, likely a subcontractor (though subs may use the clause with sub-subcontractors and suppliers), conditional upon payment from the uphill contractor or owner.
You mainly see this term in a general contractor's subcontract agreement, whereby the general seeks to make payment to its subcontractor contingent upon receiving payment from the project owner for the subcontractors work.
The goal is to push the risk of non-payment from the owner over and on to the subcontractor, who then has to rely upon its lien rights to seek recovery from the owner.
The Court Rulings and Divergence
Over time the courts have developed a divergence of this term, creating both the "Pay When Paid" clause and the "Pay If Paid" clause.
The difference was thoroughly discussed in our prior article. Briefly, a "Pay If Paid" clause is the ultimate protection for a general contractor. The clause conditions payment upon payment from the owner.
The traditional "Pay When Paid" clause, in most cases, does not have the same effect. This clause merely effects a time for payment, not a risk that payment will not be received. The courts generally call this a "covenant to pay" at a certain time.
A recent article by Walter Duke of Duke Law, PC in Dallas, TX provided the following:
'Pay When Paid' clauses are typically enforceable IF they create a condition precedent and not simply a covenant to pay. A condition precedent is an act or event, which occurs after the making of the contract, that must occur before there is a right to immediate performance and before there is a breach of contract. They basically create a contingency, where a party has no obligation to perform X until condition Y occurs first.
So, if you are a subcontractor this language should be frightening if found in your subcontract. If you are a general contractor, you will want to contact your attorney and ensure that your contract utilizes a "Pay If Paid" clause.
The Terms to Use in Your Contract
Mr. Duke correctly points out that there are no special words that the court has guaranteed will effect a proper condition:
While there are no magic words that are necessary to create a condition precedent, terms such as “if,” “provided that,” “on the condition that,” or some other phrase that conditions performance usually indicate an intent to create a condition precedent.Walter Duke, citing Gulf Const. Co. v. Self, 676 S.W.2d 624, 627 (Tex.App.–Corpus Christi 1984).
Terms such as the ones used above are very helpful, but be certain to draw our these terms in your contract. Utilize an acknowledgment by the subcontractor that he understand that he is assuming the risk of non-payment.
A typical effective clause might read:
Payment to Subcontractor will be made only if, and on the condition that, payment is received by the Contractor, from the Owner, for the work performed by the Subcontractor. Subcontractor understands and acknowledges that it assumes the risk of non-payment from the Contractor, due to Owner's failure to pay.
How to React to The Clause
It all sounds scary, right? As a subcontractor you are likely not willing to assume this type of risk. Unfortunately, when you turn your back on the job, there is always another subcontractor willing to take the risk.
The subcontractor that is willing to be practical and work with the general contractor to scale this clause back to a "Pay When Paid" clause that merely effects the time for payment, may still be able to get the job with a better contract.
If you cannot get a general contractor to bend on its use of conditional payment, then work with them to ensure that you are protected in the event of non-payment. Use two things: (1) proper change orders and (2) the lien laws.
Most contracts require properly authorized, executed and written change orders to ensure payment for additional work. If you find yourself in a situation where you have to perform work that is not in your original job scope - make a demand for a change order before you do the work.
Without this change order, the owner does not agree to your extra work. Read your contract and know how these work.
A lien is your right to make a claim against the owner. In Louisiana, you are entitled to send a notice to the owner demanding that it provide you notice of the filing of any notice of termination or notice of substantial completion. By doing this you can ensure that you file a timely lien to secure your right to payment. Check out our blog for more details on filing liens.
As a general contractor, you will benefit greatly from using this language in your subcontracts. Rest assured that most subcontractors are willing to enter into contracts with this clause.
If you are afraid of scaring away good subcontractors, educate those subcontractors on their right to lien in order to secure a right against the owner for payment. This may calm their unease.
The Wolfe Law Group, LLC drafts custom contracts for owners, general contractors and subcontractors for a flat fee. Contact us today if you have questions about these clauses.
Great post Doug. This law is similar in Virginia with the Pay IF paid versus pay WHEN paid being a big distinction. Like many places however, the distinction is murky.