Financial Risk and Priority Battles in Construction Industry

Have you ever come across the words “Pay-When-Paid” or “Pay-If-Paid” in your construction contracts?

These provisions are ultimately about determining who will bear the financial risk of a construction project. In other words, if the property owner doesn’t pay, who’s out of luck?

America’s public policy generally favors those lower on the chain when it comes to getting paid in construction. Hence the 200+-year-old mechanics lien, a tool designed to give subcontractors leverage over property owners so that they can collect payment when payment is due.

Pay When Paid

Of course, nobody wants to shoulder financial risk under any situation. Enter the Pay-When-Paid clause. As indicated in the chart below, the phrase pay-when-paid has grown tremendously in popularity and use since the 1980s.

pay-if-paid ngram

A pay-when-paid clause states that party A does not have to pay party B until party A has collected its own payment. (e.g. a general contractor (GC) doesn’t have to pay its subcontractor until the GC has been paid by the property owner). This provision was created to protect GCs from shouldering debt — they won’t have to pay before being paid.

While pay-when-paid clauses can be detrimental to subcontractors and material suppliers, they are not the end-all-be-all. They only decide when you will be paid, not if you will be paid. As added protection, most courts hold that, even when a pay-when-paid clause is agreed to, payment is due down the chain within a “reasonable amount of time.” i.e. GCs can’t withhold payment forever, even if they have not been paid themselves.

Pay-If-Paid

If GCs were finding themselves in debt, then it seems the pay-when-paid clause didn’t entirely achieve its objective. Enter the Pay-If-Paid clause.

The sole objective of a pay-if-paid clause is to shift financial risk down the chain. Using the situation from our previous example, Pay-If-Paid provisions state that a general contractor does not have to pay her subcontractor unless she is paid by the property owner.

The bad news for subcontractors and suppliers: under these circumstances, you could be left unpaid for a job well done.

The good news: most state governments have your back. In the 12 states listed below, pay-if-paid provisions have been outlawed, meaning a court will not enforce them.

  • California
  • Kansas
  • Illinois
  • Indiana
  • Nevada
  • Montana
  • Ohio
  • North Carolina
  • New York
  • South Carolina
  • Utah
  • Wisconsin

In most other states, in order for a pay-if-paid clause to be upheld, courts require clear and specific language—the phrase “pay if paid” is not enough. Here’s an example of sufficient language: “The parties herein explicitly agree that this provision is meant to shift the risk of non-payment.”

Check out our 50-state guide to Pay If Paid clauses to see each state’s policy.

What does this have to do with mechanics liens?

For the most part, not much.

Even in some states where pay-if-paid clauses are accepted in court, they may not be enforceable in cases where a mechanics lien has been filed. Under these circumstances, a pay-if-paid clause may be enforceable as a defense against a breach of contract lawsuit (or other similar claims), but would not stop recovery of payment by enforcement of a mechanics lien.