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Timothy R. Hughes' Articles > Mid-Atlantic Construction
Timothy R. Hughes, Esq.
Hughes & Associates, P.L.L.C.
Whether you are the one
signing the checks or the one collecting them, it pays to understand the
terms of subcontracts.
Determining precisely when subcontractors will be paid and under what
terms they will be paid is a point of emphasis in many subcontracts. Such
terms are sometimes called “pay when paid” and “pay if paid” clauses.
Whether you are a general or a subcontractor, you need to be familiar with
the law applicable to such clauses.
“Pay When Paid” v. “Pay If Paid”
Generally stated, a “pay when paid” clause provides for the timing of a
payment from a general contractor to a subcontractor. Such clauses often
include language which suggests that a general contractor will pay the
subcontractor only when the general contractor has received payment for
the work in question.
In contrast, a pay if paid clause provides that the subcontractor shall be
paid only if the general contractor receives payment. By its nature, the
pay if paid clause is a far harsher clause. A pay if paid clause shifts
the risk of non-payment and insolvency by the owner completely to the
subcontractor.
The Court’s Positions
Many courts struggle with the harsh result of enforcement of pay if paid
clauses. Most courts state that pay if paid clauses are theoretically
enforceable, but are disfavored. An ambiguity may be read into the clause.
A clear clause passing along risk of non-payment to the subcontractor is
likely enforceable in most states.
Virginia courts provide that a clause which states the subcontractor will
be paid five days after the general is paid constitutes a pay when paid
clause. Such a clause does not shift risk of the owner’s non-payment
downstream to the subcontractor. Galloway Corp. v. S.B. Ballard Constr.
Co., 259 Va. 493, 464 S.E.2d 349 (1995). Virginia holds further that a
clause stating the owner’s payment is a condition precedent to the
subcontractor payment is a “pay if paid” clause that is enforceable. Id.
Maryland courts have followed a similar chain of analysis and reached the
same result. Gilbane Building Co. v. Brisk Waterproofing Co., Inc., 86 Md.
App. 21, 585 A.2d 248 (1991). By implication, it appears Delaware applies
the same rule. Worthy Brothers Pipeline Corp. v. Acierno, 1996 WL 527347
(Del. Super. 1996).
Some states have refused to permit the enforcement of such clauses as
being against public policy. North Carolina provides by statute that a
general cannot make the owner’s payment a condition precedent to the
subcontractor’s payment. N. C. Gen. Stat. § 22C-2.
Practical Advice
Whether you are a general or a subcontractor, you should know your risks
and rights before you sign your contracts. You should know exactly what
language is required to meet the standard for pay if paid clauses and
whether they are enforceable in your specific state.
If you are the subcontractor, the availability of bonding and mechanic’s
lien remedies may offer addition protections to alleviate your risk under
these clauses. You may need to be more aggressive about asserting such
rights if you face a “pay if paid” clause. Generals insisting on such
clauses may face increased aggressive tactics from subcontractors filing
lien and bond claims on their jobs. As such, these clauses may eventually
have unintended consequences.
Regardless of the position you occupy, these types of contractual
provisions offer the dramatic potential for shift of risk of non-payment.
In this arena in particular, you need to know and understand the
applicable law and its implications before you sign the deal rather than
after you have a problem on the project.
Timothy R. Hughes, Esq., is the principal of the Northern
Virginia law firm of Hughes & Associates, P.L.L.C. He specializes in
construction litigation, corporate and business related representation,
and complex civil litigation. He may be reached at
tim@hughesnassociates.com.
Printed with permission
from Mid-Atlantic Construction
http://midatlantic.construction.com/opinions/law/archive/0510.asp
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