The information is very helpful to contractors and can be used a resource when a contractor begins the contracting phase of a construction project to help get a better understanding of what is going on within the contract documents.

Prime/Subcontractors Contracts

Contracts between prime/general contractors and their subcontractors make up a vital link in the construction project chain. Here both parties need to negotiate terms to better protect when a dispute arises. A well crafted contract can better protect a prime and/or a sub when default arises. Typically subcontractors are at the mercy of the prime. A good subcontractor will have his attorney review any agreement to make sure that the deal is an even one.

AIA – American Institute of Architects is the most common standard form contracts in the construction industry. AIA contracts are a good starting point and offer contracts for Prime/sub relationships, Architect/owner, Owner/Prime, and any other design professional/contractor relationship that may exist.

• Commonly litigated subcontract provisions

There are a number of provisions which could be contained in a prime/subcontractor contract that need to raise a red flag when present and should be negotiated by either party so as to keep the contract from becoming one-sided.

1. Incorporation by Reference Clauses: (flow-up & flow-down provisions)

• a Flow-down provision in a prime/sub contract will incorporate by reference terms and provisions of the owner/prime contract;
• conversely, a Flow-up provision incorporates the duties owed by the owner to the prime into the prime/sub contract;
• Many times parties enter into these agreements with out ever seeing the referenced document making them susceptible to unknown provisions;
• Enforcement depends on the reciprocality of the provisions and lack of ambiguity

2. Scope of Work Provisions

• Prime contractors want a broad scope of work provision with subs so that they can pin other work to them later on if needed;
• Subs should demand very specific scope of work provisions so as to know exactly what work is expected and what exactly they have bid on;
• This provision can incorporate other documents such as plans and specifications;
• Provision needed for extra work or change order if work called for is outside of the scope;

3. Change Order and Extra Work Provisions

• Very popular area for dispute in construction contracts – changes are always happening
• There should be a clear provision in the contract outlining the process whereby CO’s are made and approved;
• Define change order – modification to work already contemplated by the agreement; (ie different materials)
• Define extra – item of work beyond the original scope of work that is added during construction;
• MAKE SURE change orders and/or extras are in writing;

4. Notice Provisions

• Found in various places within a prime/sub contract
• Very important risk-shifiting devices – can determine a win or loss regarding a claim

5. Indemnity Clauses

• Typically these trickle down the line Owner -> Prime -> Sub
• These are generally enforceable, Subs should be careful and not allow indemnity for negligence of another party
• Insurance can be purchased by prime or sub to cover the indemnity obligation

6. No Damages for Delay Clauses

• Owners and Primes try to insert “no damage for delay” provisions in contracts for protection against unforeseen delays
• Parties want to check all referencing documents to see if this provision is in there

7. LD’s – Liquidated Damages Provisions

• Very helpful provisions because the pre-determine delay damages, usually on a per day basis;
• Enforceable unless determined to be a penalty or if they are a “one- size fits all” provision;
• LD’s are a good way to measure delay damage but can enhance the need for Contractor/Sub to accelerate work to avoid further damage, leading to defects and workmanship issues;
• For LD’s to apply the contractors work must be a substantial factor in the delay;

8. Lien Waivers

• reduce the chance for encumbrances to be placed on the title of the property;
• Usually not enforceable if lien waiver required before work performed;
• A good tool for Prime and Owner to reduce exposure;
• Can be used in an incremental fashion as payments are distributed

9. “Pay-when-paid” v. “Pay-if-paid”

• Pay-if-paid is defined as a subcontractor gets paid by the general contractor only if the owner pays the general contractor for that subcontractor’s work.” Requires a condition precedent.
• 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.

10. Retainage

• Typically 5%-10% of each payment will be withheld by the Owner/Prime until a later date, such as substantial completion
• Its purpose is to keep a pool of money to remedy any defects in workmanship by that sub

11. Termination provisions

• Termination for Cause
• Usually nonpayment, excessive delay, insolvency, or convenience are reasons to terminate the contract

12. ADR Clause (Arbitration/Mediation clauses)

• Arbitration (most popular) – binding way to avoid litigation;
• Mediation – non-binding way to avoid litigation;
• Both can be effective, typically arbitration can be more intimidating due to its binding and no (very limited) ability to appeal

13. Attorney fee provisions

• Very popular as no one likes to pay an attorney!
• Many provisions will say that the unsuccessful party must pay attorney fees but others to be careful will put the burden on one party
• Primes and subs should include an attorney fee provision in all contracts
• Good to be specific on the provision and include for litigation and ADR

14. Forum selection & choice of law

• If working out of state, make sure you know which venue a dispute will be held in;
• This can be a very costly provision

(list partially obtained from the ABA’s Fundamentals of Construction Law)

So it’s no surprise that New Orleans City Business magazine contacted me to discuss how the law can help and hurt subcontractors who are frustrated when waiting for payments to trickle down from the owner.  The article can be found on City Business’ website (subscription required) here:  Subcontractors grow tired of waiting on delayed job payments.

The article’s author, Ben Myers, does a great job of capturing the friction between general contractors and subcontractors on the subject of payment. General contractors complain that getting payment can be complex and time consuming because that’s how money trickles through, and that subcontractors should be taking the risk for their portions of the work.  Subcontractors complain that they are bullied around and “pay when paid” provisions sometimes leave them drowning because of problems the general has completely unrelated to their work.

It’s a real complicated mess – and the article gets both sides on the subject and helps explain the complications.

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.

The legal profession, like many another, tends to become over-professionalized.  We forget that the law is the rule for simple and untaught people to live by.  We complicate and over-refine it as a weapon in legal combat until we take it off the ground where people live and into the thin atmosphere of sheer fiction.

– The Struggle for Judicial Supremacy (1941)

Nail on the Head!

This made me think about all the crazy requirements and legal interpretations out there that may go against conventional logic, and I compiled this Top 3 list.

Number One:  Prevailing Wage Determinations

You’re on a state or federal construction project that requires payment of the prevailing wage, and so you go to the books to determine how much you need to pay your employees.   You separate the employees into categories:  electrician, plumber, helper/laborer….  Sounds easy enough, right?  Wrong.

How do you distinguish between someone who is a plumber and someone who is a plumber helper, for example?   While you may make a distinction in your everyday business, that distinction may not be the same as the US Department of Labor or the state agency controlling your project.   Frequently, in fact, it’s not.

Unfortunately, the laws aren’t very helpful to the folks who need to follow them.  That’s because the laws are a bit ambiguous, and requires interpretation.  And from first hand experience, I can tell you that agencies like the US Department of Labor are currently interpreting these requirements very pro-laborer.

Take a plumber, for example, as defined by the U.S. Department of Labor.   Standard Occupational Classification (SOC) §47-2152 defines a plumber as one who does the following:  “Assemble, install, alter, and repair pipelines or pipe systems that carry water, steam, air, or other liquids or gases…”

Compare this to the plumber’s helper (SOC §47-3015) who: “Help plumbers…by performing duties of lesser skill.  Duties include using, supplying or holding materials or tools, and cleaning work area and equipment…”

What exactly is a “lesser skill?”   What if a licensed plumber points to a pipe and asks the other employee “cut right there,” does this make that other employee a helper or a plumber?   I’ve seen the US Department of Labor interpret this as rendering the other employee a “plumber,” and requiring the higher wage.

Number Two:  Lien and Notice Requirements

The lien laws are there to protect folks, but it seems that every state in the Union is a bit conflicted about who the laws are designed to help.   In some states, the law is construed in favor of the lien claimant and against all other parties.  In other states, it’s the opposite.

Perhaps more confusing that this interpretation preference, however, is the notice requirements for the various states.   In some places, notice must be provided by the subcontractors to the property owner, the theory being that the owner might not know the subcontractors are there.  In other places, however, the notice system is completely reversed, requiring the prime contractors to deliver the notice.   Clearly, the owner should know who the prime contractor is!

What makes this very difficult for contractors is that unlike state legislatures and lawyers, the construction industry does business across state lines very frequently.  In fact, some suppliers and contractors do business in every state.   It’s impossible for these contractors to know the highly-technical and complex laws that apply in each state.    The result?   The law is rendered worthless, and not protecting the parties it is designed to protect.

For great discussions about lien and notice laws across the country, check out the Construction Lien Blog.

Number Three:  Pay When Paid Clauses

Contractors and subcontractors all around the country have heard of “pay when paid” clauses, and they frequently find them in their contracts.  Why are they in the contracts?   Because the parties in a construction project understand the payment chain, and they are agreeing to put the risk of non-payment on each project participant.

However, the law in many states has created an interpretation for “pay when paid” clauses that seems counter-intuitive.  In these states (and there are many), a “pay when paid” clause does not allow a contractor to refuse payment to its subs or suppliers after a “reasonable time” has passed since the subs or suppliers work was completed.  In these states, if such an outcome is desire, the parties must enter into a contract with a “pay if paid” clause.

We’ve written about this phenomenon here: Payment Provisions in Construction Contracts.

We recently blogged about the dangers of using one contract in multiple states. The post used the “pay when paid” provision as an example of why multi-state contracts are problematic.

The provision itself seems pretty clear: one party will get paid when the other party gets paid. It isn’t. Interpretation of this provision varies by state, with some states striking down the provision entirely as against “public policy” and other states distinguishing between “pay when paid” provisions and “pay if paid” provisions. The only way to protect your company against this tricky provision is to consult with an attorney about how these provisions are treated in your jurisdiction.

While interpretation of “pay when paid” provisions differ from state-to-state, there does appear to be one constant about this provision across the country: It doesn’t extend your lien period.

Most states require liens be filed within a certain period after you last worked on the project, or after the project is complete. The fact that you or your company is waiting for payment because the prime or an upper-tiered sub hasn’t been paid is completely irrelevant. The lien period still starts when it starts, and ends when it ends.

As you might imagine, this presents a bit of a Catch-22.

On the one hand, you must file a lien to preserve your right to lien. On the other hand, filing a lien may complicate the payment problems for the prime or upper tier sub (and thus your payment problem), and may cause animosity when negotiations are otherwise calm.

Unfortunately, there is no easy fix for this complication. Each situation should be examined individually, and sometimes, a simple joint check agreement may be the solution. It’s just important to remember that good faith negotiations and waiting for payment under a contractual obligation to do so will not likely extend the lien period, and too much talk could result in the loss of lien rights.

Here are some great resources and articles on Pay When Paid provisions:

- Fourth Circuit Concludes Pay When Paid Clause is Unambiguous and Enforceable

- Pay When Paid or Pay If Paid Provisions

- Is Your Pay When Paid Clause Worthless?

- Contingent Payment Clauses, Use With Caution

This article was originally posted on Express Lien’s topic-specific Construction Lien Blog.

In Virginia, “pay when paid” provisions conditions any payment to a subcontractor on the general contractor receiving payment from the owner.   If the general contractor never receives payment, the general contractor never needs to pay the subcontractor.

In Maryland, however, the “pay when paid” provision is not so strong.   Maryland distinguishes “pay when paid” clauses from “pay if paid” clauses, considering the first type of provision one requiring payment to the subcontractor within a “reasonable time” after work is concluded, and the second type of provision requiring payment only if and after payment is received from the owner.

The subtle difference in the law was a big difference to the general contractor, who was likely using the same contract in both Maryland and Virginia.

While we don’t practice in Maryland and Virginia, the problem here isn’t isolated to those two states.    This problem can arise between any two bordering states.

Our clients in Washington and Oregon frequently work in each other’s state.  Our clients in Louisiana frequently work in Mississippi or Texas.   While “business” between the two states may feel seamless to the business owners, the laws can be drastically different.

When it comes to Louisiana construction companies, they are frequently working in Mississippi.

Out of curiosity, I performed a little research on the treatment of pay when paid clauses in Mississippi to compare it with Louisiana’s treatment of the same. Immediately I went to my two favorite resources for Mississippi Construction Law, and figured our readers could benefit from these two resources and there’s no reason to keep them a secret. So here goes:

Robert Wise
While Robert doesn’t run a construction law blog, he has a bunch of great published articles available for download on his website. Take some of these as examples:

• Mississippi Construction Lien, Bond, Stop Notice, Open Account & Contractor Prompt Payment Claims (pdf)
• Mississippi Construction Bid Mistakes (pdf)
• Mississippi Construction Supplier’s Collection Law Tool Kit (pdf)

Construction Law Toolbox Blog
The Construction Law Toolbox blog is published by Mississippi law firm Robinson, Biggs, Ingram, Solop & Farris, PLLC. The blog provides consistent quality posts about construction law issues that affect those performing construction work in Mississippi. Here are some example posts:

• Do you have coverage under your commercial general liability policy for defective subcontractor construction? (link)
• He who hesitates is lost – Protecting Payment Rights in Mississippi (link)
• Can I Rely on my Subcontractor’s Certificate of Insurance? (link)

Oh, and the result of my pay when paid clause research, thanks to help from Mr. Wise is this:

In Louisiana, “pay when paid” requires payment within a reasonable time, regardless of whether payment was ever received from the property owner. “Pay if paid” clauses, on the other hand, makes payment from the owner an absolute condition precent to payment further down the contracting chain.

In Mississippi, it doesn’t seem to matter how it’s written: pay if paid, pay when paid, etc. The result is the same: payment is due within a reasonable time, regardless of whether payment was ever received from the property owner.

This article was originally posted on Wolfe Law Group’s topic-specific Louisiana Construction Law Blog.

While it’s common practice in the construction industry to provide for partial payments from the contractor to subcontractor as work progresses, in Louisiana, unless the contract specifies otherwise, payment from the general contractor to the subcontractor is not actually due until the project is completed. See LA CC Art. 2550; See also Sacco v. Koepp, 169 La. 789, 793-94 (1930).

Therefore, if such progress payments are desired, it’s important to have a clause clearly providing for these payments in the contract.

A common contract provision in many contractor-subcontractor agreements provides that progress payments are not payable to a subcontractor until the owner pays the corresponding amount to the general contractor. These contract provisions typically come in two varieties, and are commonly referred to as “pay when paid” and “pay if paid” clauses.

“Pay when paid” and “Pay if paid” clauses are designed to shift the burden of owner non-payment from the contractor to its sub-contractors and suppliers. Accordingly, both provisions can be very onerous for the subcontractor – oftentimes preventing payments to a sub or supplier when the Owner is in an unrelated dispute with the general contractor, or merely becomes financially unable to make payments under the contract.

Enforceability of “Pay When Paid” Provisions

“Pay when Paid” provisions and other conditional payment provisions are not favored in courts, and therefore, it’s imperative to carefully draft and review any such provisions in the construction contract.

Hostility towards these types of provisions are fueled by subcontractors and their trade organizations.

Courts in some parts of the country have even gone so far as to call such provisions against public policy and unenforceable. See Capitol Steel Fabricators, Inc. v. Mega Construction Co., 58 Cal App 4th 1049 (2d Dist. 1997). Legislatures in a number of states have considered such provisions as impermissible waivers of the subcontractor’s constitutionally protected mechanics’ lien rights.

In Louisiana, properly drafted “Pay when Paid” provisions are enforceable, but the wording must be clear and unambiguous.

However, even with an enforceable conditional payment provision, Louisiana courts still require payment to the subcontractor within a “reasonable period of time,” thereby watering down the effect of the provision. See Southern States Masonry, Inc. v. J.A. Jones Contr. Co., 507 So.2d 198 (La. 1987). Through this Southern States decision, and similar decisions, the courts re-shift the risk of non-payment back upon the general contractor.

If the parties truly intend for the subcontractor to bear the risk of non-payment, or if payment from the owner is not reasonably certain, this intent should be clearly expressed in the construction contract. In these situations, the contract should have a “Pay if Paid” provision instead of a “Pay when Paid” provision. See C. Bel for Awnings, Inc. v. Blaine-Hays Constr. Co., 532 So.2d 830 (La. App. 4th Cir. 1988).

“Pay When Paid” versus “Pay If Paid”

Although only separated by one word, legally the two provisions are drastically different.

Pay when Paid

This common payment provision stipulates that a general contractor is legally obligated to pay a subcontractor only when it receives a corresponding payment from the owner. As discussed above, however, most courts view such a clause as a timing provision and not the basis for nonpayment.

Accordingly, if payment is never received from an owner, under a “Pay when Paid” payment provision, the general contractor must still make payment to a sub or supplier within a “reasonable time.”

Pay If Paid

“Pay if paid” clauses are more specific than their “pay when paid” counterparts. Unlike the “pay when paid” clause, oftentimes considered a timing provision, the “pay if paid” clause more clearly expresses the parties’ intention to shift the credit risk of owner nonpayment down through the contracting ranks.

Accordingly, payment to the subcontractor is more likely to be contingent on the general receiving payment from the owner under a contract with a “pay if paid” provision than a “pay when paid” provision.

Conclusion

Deciding when payments are due a subcontractor can sometimes lead to long and complicated legal disputes. As such, it’s very important for the parties to clearly express their intent when contracting.

The Wolfe Law Group is experienced in drafting and reviewing construction contracts to clearly reflect the intent of the parties. Contact us today to learn more about how the Wolfe Law Group can be your company’s new legal department.

Related articles

• New Retainage Rules in Louisiana Protect General Contractors (constructionlawmonitor.com)