Common Law Analysis – Pay-if-paid, Pay-when-paid & Liquidating Agreements in Construction Contracts

In a recent decision, Sloan & Company v. Liberty Mutual Insurance Company ("Sloan"), the US Court of Appeals for the Third Circuit has an in depth discussion regarding some technical yet very important clauses found within many construction contracts between general contractor, subcontractors, owner and the surety. Although the court interprets Pennsylvania law, these concepts are good to know for any jurisdiction.

Pay-If-Paid & Pay-When-Paid

The pay-if-paid discussion starts on page 9 and is defined as "a subcontractor gets paid by the general contractor only if the owner pays the general contractor for that subcontractor's work." The court goes on to next define pay-when-paid in contrast to the pay-if-paid. "[A] pay-when-paid clause does not establish a condition precedent, but merely creates a timing mechanism for the general contractor's payment to the subcontractor." The basic difference here is pay-if-paid may never happen if the the owner does not pay the general contractor for the work performed by the subcontractor, in theory. But the pay-when-paid acts more as a timing mechanism for the general contractor to pay the subcontractor, regardless of what the owner has paid for. Generally courts will look to the four corners of the contract between the parties to determine which way to interpret the meaning of the clause. The interesting part of this holding and a common practice in construction contracts is a clause which modifies the pay-if-paid clause to become a pay-when-paid and this was done here by eliminating the condition precedent after a stipulated amount of time.There are many reasons why this may be done but typically many subcontractors will not agree to an absolute pay-if-paid clause, as the end result can place too much of the risk of loss on the subcontractor. Click here for Daniel S. Brennan's The Construction Contracts Book.

Liquidating Agreement

Another technical term that is not often discussed in construction, yet is present in many construction contracts is the mechanism know as a "liquidating agreement" Sloan pg 16. The Sloan court defines a liquidating agreement clause as a "process by which a general contractor may assert the claims of its subcontractors against the owner." This is similar to subrogation in the insurance context. Do not confuse a liquidating agreement with liquidated damages. A liquidating agreement clause can act like a lien, in that it gives causes of action to the subcontractor against the owner where there is no privy of contract. Sloan pg 17. "Liquidating agreements that enable pass-through claims, such as the one in the contract before us, can also serve to limit the subcontractor’s damages to the amount the contractor recovers from the owner. See Carl A. Calvert & Carl F. Ingwalson, Jr., Pass Through Claims and Liquidation Agreements, Constr. Lawyer, Oct. 1998, at 32, 33." Sloan pg 18.

Conclusion

The end result here, is that typically the general contractor bears the risk of loss when the owner does not pay up, but they can use contractual mechanisms to lower that risk and allocate some of it to the subcontractors. Liquidating agreements and pay-if-paid/pay-when-paid clauses, carefully negotiated at the contract phase of construction projects can lead to limiting liability at the end of a project when things do no go as planned. In the Sloan holding, the general contractor did not bear all of the loss but was forced to pay its subs in a proportional manner to the work performed, keeping nothing for itself. Sloan pg 20. Prevent this from happening to your construction company by working through these clauses when forming your next contract. Further reading: California Pay-if-paid Wm. R. Clarke v. Safeco Insurance (distinguished by other jurisdictions); Pay-when-paid. A google search of these terms will provide a wealth of information. Always consult with an attorney before negotiating contracts in the construction industry no matter how large or small the project.
Seth Smiley
About the Author: Seth Smiley
Seth is an attorney licensed to practice in Louisiana and California. He is the managing partner at Wolfe Law Group. To speak with Seth fill out the form on this page. Follow Seth on LinkedIn, Google+, or Twitter.

One comment on “Common Law Analysis – Pay-if-paid, Pay-when-paid & Liquidating Agreements in Construction Contracts”

  • Hi Scott, Thank for your this posting. I thought you might find it interesting that in a local construction matter here in Georgia, the paid-when-paid provision was pivotal. As it turned out the real property owner (a development holding company) wholly owned the general contractor. The real property owner ended up in bankruptcy and the GC did not pay its subs claiming that the subs were not entitled to payment until the GC received payment. Needless to say, there was a great deal of discussion as to alter ego, fraud, etc. After 2 years, the matters were settled out of court.

Leave a Reply