Susan L. McGreevy, a construction law attorney at Stinson Morrison Hecker, LLP, published an excellent article on pay-if-paid clauses in the May/June 2013 Building Profits magazine.

Her analysis is an easy read (as far as legal articles go) because she fights the urge to rattle off a bunch of rules and contract language and instead focuses on the big picture fight behind these popular payment provisions. Unfortunately, the article is only available to those with a CFMA Membership and subscription to Building Profits.

However, we’ll review some of her major points in this post, building upon McGreevy’s overview of the tension between GCs and subcontractors caused by these provisions.

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The Construction Industry Is Unique And A Legal Minefield

Legal issues are often confused with business decisions. CFMA CEO, Stuart Binstock, also a lawyer, published a message introducing Building Profits’ May/June issue, and therein repeats a common warning to those with legal disputes: “no one really wins in litigation.”

“Legal issues are often confused with business decisions,” he explains.

I agree with him a great deal on these two points, but that doesn’t erase the legal complexities inherent in the construction industry. These complexities are summarized nicely by McGreevy in the first paragraph of her pay-if-paid article:

Construction is unlike any other industry, with its own rules (prevailing wage laws, sovereign immunity, storm water runoff retention) and its own vocabulary (substantial completion, retainage, lien waiver, punch list).  The risks inherent in this industry are addressed in contracts that run 20, 40 or 60 pages (or more), which GCs and subcontractors routinely sign without reading or fully understanding. One court went so far as to view construction as second only to the battlefield in the need for coordination of the movement of men and materials ‘in the midst of such chaos and with such limited certainty of present facts and future occurrences.

How incredibly accurate.

This would be support for Supreme Court Justice Oliver W. Conflict and non-payment problems is so inherent in the nature of construction that mechanics lien laws are nearly as old as the United States Wendell Holmes, Jr.’s hypothesis about the complexity of law, which is explained with this quote: “[T]he life of the law has not been logic: it has been experience.”  The construction law field is complex, but Holmes would argue that this is simply a response to the complexity of the industry itself.

Whatever the cause the effect is clear in the modern day construction industry: legal issues are complex, and numerous.

Pay When Paid Provisions Highlight Battle Between GCs and Subcontractors Over Who Bears A Project’s Financial Risk

Perhaps one of the most interesting legal issues in the construction industry regards the pay-when-paid or pay-if-paid provisions. They are so interesting because they frame a journey of bickering between general contractors and subcontractors that spans centuries.

What journey of bickering is that?  Well, GCs want to pay subcontractors only after they received payment, and subcontractors don’t want to finance the project for the GCs.

You may wonder whether this issue is actually centuries old or some recent phenomena of a degrading society. This highlights the one thing about McGreevy’s article that I disagreed with.

Her article suggested that pay when paid provisions arose because “modern times” have taken us away from the “days when a man’s word was his bond and there wasn’t a need for contracts.”  That’s too romantic an outlook to be true.

Controversy was not invented by the Internet, the television, the telephone, the jet engine or anything else – it’s existed since the beginning of time.

Historically, the construction industry is no stranger to conflict. Conflict and non-payment problems is so inherent in the nature of construction that mechanics lien laws are nearly as old as the United States, being introduced by Thomas Jefferson to the Maryland legislature in 1791.  The introduction and shortly thereafter proliferation of these rules were certainly not passed into law as a precaution just in case “a man’s word” lost its utility.  A man’s word has always lacked utility!

The history of the mechanics lien laws are incredibly relevant to the history of pay-when-paid provisions. That’s because the lien laws are an example of the states putting a stake in the ground about who will bear the financial risk on a construction project.

The states protected the rights of suppliers and subcontractors to get paid from the very beginning of US law, and thereafter, GCs have conjured up methods to shift this financial risk off their backs and onto the backs of those further down the contracting chain, thus giving birth to the pay-when-paid clause.

The Battle Between Policy And Contract In Financial Risk Shifting Provisions

McGreevy’s Building Profits article gives an impressive history and overview of the pay-when-paid and pay-if-paid clauses’ history.

She starts with the genesis of the pay-when-paid provision as an attempt to allow GCs to hold payment until they received payment from the owner. This turned into an argument by the GCs that they never needed to pay subs if they [the GCs] weren’t paid.

The courts went along with the GCs at first, but soon started to treat the pay-when-paid provision as a timing mechanism and not a risk-shifting provision. That led GCs to create the more controversial “pay-if-paid” clause, frequently even stating in the contract very clearly that the GC’s payment is a “condition precedent” to the subcontractor getting paid.

How do and should courts handle these types of provisions? This is actually a fairly complicated question because it requires judges to negotiate between public policy in favor of contractual freedom (the freedom to contract for whatever you want) and the policy in favor of subcontractors getting paid for their work and having lien rights (dating back to Thomas Jefferson’s Maryland bill).

Who wins in this policy clash depends on each state’s particular tolerance.

McGreevy’s article suggest that the policy favoring subcontractors’ lien and bond claim rights has the early lead, as many courts and states are nullifying these pay-if-paid clauses outright.

I think she is right about this, and I also think this is the proper outcome.

While the “freedom to contract” is a clear tenant in American law, it is also clearly subjected to public policy considerations. For over 200 years, American law has protected the rights of subcontractors to get paid. It makes sense that this strong policy position cannot be eroded by clever contract drafting.

Nevertheless, the GCs will continue their attempts, and will likely have some success.  So, as McGreevy advises in her article, be careful.