We have seen in recent posts that pay if paid clauses are generally disfavored and subject to strict review by courts. While pay if paid clauses are still enforceable in many states, provided the correct specific language is used, the clear trend is toward treating these clauses with greater scrutiny, or even disallowing them altogether. In some states, however, this has led to some interesting results.
Pay if Paid Clauses Not Allowed to Interfere With Mechanics Lien Rights – But Not Fully Disallowed
In some states, the tension between the statutory protection of mechanics liens and the contractual “risk-shifting” of pay if paid clauses has resulted in a situation where pay if paid clauses are specifically disallowed as regards interfering with mechanics lien rights, but are not explicitly outlawed in all circumstances. You may have noticed in the recent pay if paid infographic that there was a caveat to the declaration that a state had determined pay if paid clauses void – some states have determined all pay if paid clauses void as against public policy in all situations, and some states have made a slightly less broad prohibition against pay if paid clauses, and only disallow them to the extent that the clause would interfere with a claimant’s mechanics lien rights.
Some states in which this approach is taken are: Illinois, Indiana, Kansas, Missouri, and Ohio. The specific statutory provisions are listed below.
Ohio Rev. Code § 4113.62(E): No construction contract, agreement, or understanding that makes payment from a contractor to a subcontractor or materials supplier, or from a subcontractor to a materials supplier, lower tier subcontractor, or lower tier materials supplier contingent or conditioned upon receipt of payment from any other person shall prohibit a person from filing a [mechanics lien].
770 Ill. Comp. Stat. 60/21: Any provision in a contract, agreement, or understanding, when payment from a contractor to a subcontractor or supplier is conditioned upon receipt of the payment from any other party including a private or public owner, shall not be a defense by the party responsible for payment to a [mechanics lien] claim.
Ind. Code Ann. § 32-28-3-18: An obligor’s receipt of payment from a third person may not:
(1) be a condition precedent to;
(2) limit; or
(3) be a defense to;
the provider’s right to record or foreclose a lien against the real estate that was improved by the provider’s labor, material, or equipment.
Mo. Rev. Stat. § 429.005: 1. An agreement by an original contractor, subcontractor, supplier or laborer to waive any right to enforce or claim any [mechanics lien], where the agreement is in anticipation of and in consideration for the awarding of a contract or subcontract to perform work or supply materials for an improvement upon real property, whether expressly stated or implied, is against public policy and shall be unenforceable.
Kan. Stat. Ann. § 16-1803(c): Any provision in a contract for private construction providing that a payment from a contractor or subcontractor to a subcontractor is contingent or conditioned upon receipt of a payment from any other private party, including a private owner, is no defense to a [mechanics lien].
As can be seen by the relatively similar language contained in the foregoing statutes, these states have specifically outlined that pay if paid clauses (and other risk-shifting contractual terms) are not a defense against mechanics liens. However, the prohibition against the clauses do not specify that pay if pay clauses are void on their faces, or could not be a defense to a contractual claim.
What Does This Mean for Parties Needing Payment But Faced With a Pay if Paid Provision?
While the pay if paid clause will not be effective in the face of a properly filed and valid mechanics lien claim, it can be effective as a defense to a breach of contract claim. The answer to this question is relatively simple: File a lien. The best protection in these states is to make sure you comply with all necessary preliminary, and lien, requirements such that you can file a valid mechanics lien. The failure to do so may put you at the mercy of the pay if paid clause. And, since if your lien is invalid – whether for missing a deadline, non-compliance with preliminary notice requirements, or any other reason – your fallback option is a breach of contract claim, the pay if paid clause could ruin your chances to recover the money you are owed.
The lesson, as it generally seems to be, is to make sure your lien rights are protected, and to file your lien.