The state of Massachusetts generally disfavors pay-if-paid clauses in construction contracts. However, they are enforceable under certain circumstances. And even so, the bar is set very high to have such a provision be considered valid. Let’s take a look at the enforceability of pay-if-paid clauses in Massachusetts.
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Contingent payment provisions overview
Pay-if-paid and pay-when-paid clauses are generally known as contingent payment provisions. There is a subtle, yet incredibly important distinction between these two types of clauses. A pay-when-paid provision is a promise to pay within a reasonable amount of time to allow the paying party to get paid by the higher-tiered party. It basically acts as a timing mechanism for payment.
On the other hand, a pay-if-paid provision is much more severe in its application. This is a risk-shifting clause, that establishes a condition precedent to payment. If the condition (payment from the higher-tier) never occurs, then the party won’t be obligated to pay.
Massachusetts approach to contingent payment clauses
Generally speaking, both pay-if-paid clauses and pay-when-paid clauses are enforceable in the state of Massachusetts. In order to be enforceable, these provisions must be clear and unambiguous to the reader.
However, under Massachusetts law, conditions precedent are not favored, and whenever possible, courts will avoid construing provisions to be such unless the intent of the agreement is plainly to the contrary. The courts will solely use the contract language to determine the intent, no evidence of prior negotiations or other dealings will have an impact on this determination.
Enforceability of pay-if-paid clauses on private projects
If the intention to create a condition to payment isn’t clearly established by the terms of the contract, the courts will relegate it to a pay-when-paid clause.
Unenforceable for contracts under the MA Prompt Pay Act
Once the Massachusetts Prompt Payment Act was passed, pay-if-paid clauses have been severely limited. The general rule is if the prompt pay provisions apply to the project, then there is only a very limited circumstance where a pay-if-paid provision will be enforced.
Which contracts do the Massachusetts prompt pay provisions apply to?
The prompt payment regulations apply to every private construction project that has an original contract price of $3M or more; but not to projects that include a 4-unit or fewer residential property. Mass. Gen. Laws §149:29E(e) states that a provision in a contract for construction that makes payment conditioned on the receipt of payment from a third person, who is not a party to the contract, is void and unenforceable. However, the statue then provides two narrow exceptions.
Exceptions to the rule
The first, if the owner refuses to pay due to the subcontractor’s failure to perform the work under the contract and fails to cure the defective work or materials within a timely fashion. This exception isn’t anything particularly unique. In most cases, non-performance and failure to cure/remedy is typically a justifiable reason to withhold payment.
The second scenario where a pay-if-paid clause will be enforceable is a little more complicated. This is if the paying party is or becomes insolvent within 90 days of the submission of the application and the general contractor took specific steps to secure payment. These steps include taking the notice of contract steps before submitting their first pay app, and pursuing a mechanics lien and all other legal options for recovery.
If these exceptions are to apply, they must both be expressly stated within the contract. Subcontractors should read their contracts cautiously.
Enforceable under non-prompt pay contracts
All other contracts, a pay-if-paid clause is still enforceable. However, only if the clause clearly and unequivocally shows that the parties intended to transfer the risk of non-payment to the subcontractor.
In order to have an enforceable pay-if-paid clause it must expressly state that (1) payment to the contractor is a condition precedent to payment to the subcontractor, (2) the subcontractor is to bear the risk of the owner’s non-payment, or (3) the subcontractor is to be paid exclusively out of a fund the sole source of which is the owner’s payment to the subcontractor.
Here’s an example of one such clause that was enforceable:
“Contractor’s receipt of payment from the owner is a condition precedent to contractor’s obligation to make payment to the subcontractor; the subcontractor expressly assumes the risk of the owner’s nonpayment and the subcontract price includes this risk“
This language was found to clearly express the intention of the parties to create a condition precedent to payment. If, however, the provision “fails to unequivocally evince an intent to create a condition precedent or shift the risk of the owner’s nonpayment,” then the Ohio courts will interpret the provision as pay-when-paid.”
Enforceability of pay-if-paid clauses on public projects
As for public projects, the Massachusetts courts severely limited the enforceability of pay-if-paid clauses. This occurred in the case of Framingham Heavy Equip. v. John T. Callahan & Sons, where it was established again that absent clear intent, these will default into timing mechanisms.
In that case, the court declared that a condition precedent can’t be inferred. Rather, the contract must clearly state that payment to the subcontractor is to be directly contingent upon the receipt by the general contractor of payment from the owner.” If it isn’t crystal clear, the provision will default into a pay-when-paid clause that postpones payment for a “reasonable time.”
Measuring reasonable time under pay-when-paid clauses
The ultimate problem here is that the courts have yet to define what a “reasonable time for payment” actually is. The closest the courts have gotten is to conclude that once a pay-when-paid dispute has reached the point of “judicial resolution,” the time has been unreasonable. Essentially the courts are saying if the non-payment dispute has reached litigation, the reasonable time mark has passed. That’s not much to go on.
Construction contracts should always be thoroughly reviewed before signing. However, prudent subcontractors should be particularly aware of any of these contingent payment clauses. Although drafting an enforceable pay-if-paid clause is a difficult task, it’s not impossible (depending on the type of project). Be sure that you know and understand all the payment terms established in your next contract, to ensure you get paid what you’ve earned!