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.

At the trial level in Lantech Construction Co. v. Speed, the court’s ruling reflected this jurisprudence, requiring a property owner to pay for work performed by the contractor in six unwritten change orders. However, the trial court also required the contract or to pay $31k in liquidated damages for failing to finish the project on time.

The contractor’s argument was simple: If the written contract’s sum can be modified orally, so too can the written contract’s time – and that the unsigned change orders requested a change in the contract time & sum.

Going through the line of Louisiana cases regarding oral changes to written construction contracts, the appeals court agreed with the contractor.

…[T]he law is clear that written contracts may be modified by oral contracts and the conduct of the parties, even when the written contract contains a provision that change orders must be in writing. Modification of a written agreement can be presumed by silence, inaction, or implication. The party who asserts that an obligation has been modified must prove by a preponderance of the evidence facts or acts giving rise to the modification. It is a question of fact, therefore, as to whether there were oral agreements that modified the written contract. Oral modifications alleged to be in excess of $500 must be proved by at least one “credible witness” and “other corroborating circumstances.” Only general corroboration is required. Parol evidence is admissible for this purpose.

The court reversed the award of liquidated damages against the contractor, ruling that after application of the contract time extensions the project was not delivered late.

This blog post was originally published on Wolfe Law Group’s topic-specific Louisiana Construction Law Blog.