This post covers a brief introduction of “pay when paid” and “pay if paid” clauses in construction contracts.
Why Do Pay-When-Paid and Pay-If-Paid Clauses Exist?
Imagine that you’re a general contractor on a huge new housing development. In order for you to complete the job, you have to hire a variety of subcontracts, such as plumbers, carpenters, painters, carpet installers, and framers. All of those subcontractors, obviously, expect you to pay them. But where is all that money going to come from? In all likelihood, you’re first going to need to get the money from the developer and/or property owner. Without it, you’ll be unable to pay your subcontractors.
This puts a general contractor in a difficult position. Don’t pay the subcontractors and you’ll likely be liable for breach of contract – go ahead and pay the subcontractors and you may be paying with money you don’t have (and may never get).
What’s an innocent general contractor to do? Somewhere along the way, one general contractor’s attorney created a work-around. A “pay when paid” or “pay if paid” clause. Both clauses have the same goal: No subcontractor gets paid until the property owners pays the general contractor first.
How Are Pay-When-Paid and Pay-If-Paid Clauses Different?
As discussed above, each state’s interpretation of pay-when-paid and pay if paid clauses are different. However, we can make a few generalizations that highlight the primary difference between a pay when paid clause and a pay if paid clause. (Yes, one little word can make a world of difference for both general contractors and subcontractors.)
The primary difference between these clauses is that a “pay-when-paid” clause is a timing mechanism that merely delays the time in which a general contractor has to pay a subcontractor (without ever extinguishing that responsibility). A “pay-if-paid” clause makes the owner paying the general contractor a condition precedent to the subcontractors getting paid (so if the general doesn’t get paid – neither do any subs).
Explained another way, it’s all about who ultimately bears the risk of owner nonpayment. In contracts with pay when paid clauses, the general contractor bears the risk that the owner will never pay them. In essence, even if the owner never pays the general, the general will have a little more time but will eventually have to find a way to pay the subcontractors or be liable for damages in a breach of contract lawsuit. Pay if paid clauses work the exact opposite way: In these cases, the subcontractor bears the risk of owner nonpayment. If the owner never pays the general contractor, then the general has no obligation ever to pay the subcontractors.
Some States Have Unique Approaches
This post is only a general overview of pay when paid and pay if paid clauses and is not applicable throughout all 50 states. There are many, many different variations depending on which state law we’re evaluating.
For example, we recently wrote a post about Virginia’s unique interpretation of pay when paid clauses and pay if paid clauses and even followed that post up with another discussion of pay when paid clauses in that state. In these posts, we discussed how Virginia uses an interpretation that may be based on the parties’ intent – if the language of the contract is not clear. For example, the court will evaluate if the parties intended to shift the risk of owner nonpayment from the general contractor to the subcontractor. Incredibly, the same contract provision used in several different subcontracts may have different results if the language is not sufficiently clear (depending on each individual subcontractor’s intent).
Another good exception to the generalization about the difference between pay when paid and pay if paid clauses in New York, which quite simply holds that as a matter of public policy the risk of owner nonpayment can never be shifted to the subcontractor. That is, that no matter what the contract says, it will be interpreted as a pay when paid clause, rather than a pay if paid clause. And, as we discuss in yet another article, New York pay when paid clauses are mere timing mechanisms. Other states also have this unique interpretation.
There are many exceptions to the rule, but generally speaking pay if paid clauses shift the risk of owner nonpayment from the general contractor to the subcontractor whereas pay when paid clauses only give the general contractor an extra reasonable amount of time to pay the subcontractors.