Pay when paid, and pay if paid clauses are pretty common, but can be misunderstood – both in operation and purpose. Below, I’ll attempt to provide some answers and clarifications to common questions and misconceptions about these contract provisions. First, however, before pay when paid and pay if paid clauses are discussed specifically, the background of the issue giving rise to these clauses should first be mentioned.
The Back and Forth Battle Between Statute and Contract
Getting paid in the construction field can be harder than it is in many other industries. There are many reasons for this, and pay when paid or pay if paid clauses are only the tip of the iceberg. There are also scope of work issues, inspection problems, change orders, and more. All of these things can create payment problems – and that’s before even mentioning the fact that failure rates in the construction industry are some of the highest in any market.
However, America believes that trade contractors and suppliers should be paid for their work, and this belief that people should be paid what they are owed is deeply held in the American construction sector, that people should be paid what they are owed. This is why the mechanics lien instrument was developed. The concept that subs and suppliers (people further down on the payment ladder), deserved to be protected from non-payment above them on the project traces back all the way to Thomas Jefferson.
The offshoot of this is that America believes that GCs and property owners (those at the top end of the payment ladder) should be the ones to bear the burden of a project’s financial risk. Since nobody likes to be forced to shoulder a financial risk, GCs and property owners have, throughout the years, attempted to shift the burden back to the parties below them. Mechanics liens shifted the risk to the parties above (provided certain requirements were met), but many contract provisions have been drafted and inserted into construction contracts in an attempt to shift the risk back down. “No lien clauses”, and “pay when paid” clauses, have been dismissed or severely weakened by most courts.
So, instead of attempting to use pay when paid clauses that were easy for the courts to turn into a “timing mechanism” rather than a “risk-shifting” mechanism, GCs began changing the language to “pay IF paid” provisions. On one hand there are statutory laws protecting subs and suppliers, and on the other hand, there are contract provisions such as pay if paid clauses with which the GCs and property owners attempt to shift the project’s financial risk back down the ladder.
Pay If Paid Clauses: Do They Still Work?
The answer to the question posed in this heading is, like many answers in this arena, “it depends”.
Pay if paid clauses are not dead yet, and they are perfectly enforceable in several states, provided that all the correct boxes are ticked. Most states that still allow pay if paid clauses to be effective require specific language to be included in the clause in order to trigger the shift in payment risk. If the specific language is not included, the clauses will generally be treated as a pay-when-paid timing clause, or be read out of the contract entirely.
These specific language requirements can vary by state, but they generally require the clause to specifically state that the clause is meant to shift the risk of nonpayment to the sub or supplier, and that payment to the GC is a “condition precedent” to payment to the sub or supplier. Many states, however, have decided that pay if paid clauses are either totally invalid, or at least invalid as they interfere with mechanics lien rights. You can see a map providing a quick reference tool by clicking on the thumbnail to the right.
For GCs: Pay if paid clauses are not yet dead, so if your project is in a state that still accepts them, and your clause is drafted strictly in accordance with the specific language required by that state, you can stick to your guns. However, the clear trend is toward disallowing pay if paid clauses, so a drawn out legal battle is probably unwise, and you definitely don’t want to be the party against whom new law is made.
For Subs: You have a good shot at winning…eventually. Pay if paid clauses are strictly construed in your favor, so any tiny drafting mistake can negate the clause entirely (or, at least turn it into a pay when paid timing mechanism). Further, if you performed work in a state in which pay if paid clauses are disallowed, you can be sure to prevail. This is not an excuse to get greedy, however. Just because you will likely prevail doesn’t give the green light to piling up penalties, late fees, etc. A court may provide you interest, fees, and potentially penalties in a successful action, but the legal fight is likely going to be longer, and more difficult than you want, or for which you may be prepared.