“Pay When Paid” & “Pay If Paid”

Several weeks ago I wrote a post introducing undertaking a 50-state survey of “pay when paid” and “pay if paid” clauses.  While there are some nationwide trends in how these clauses are interpreted, each state can still have vastly different applications.  Thus, a closer look at how pay when paid clauses are applied by courts in individual states, such as Alabama, is certainly worthwhile.

Pay When Paid Clauses in Alabama Private Contracts

The Supreme Court of Alabama addressed the gamut of issues related to pay when paid and pay if paid clauses in private contracts in Lemoine Co. of Alabama, L.L.C. v. HLH Constructors, Inc. (62 So.3d 1020).  This dispute arose after Vista Bella, a property owner, hired Lemoine as contractor on a construction project.  Lemoine then subcontracted with HLH to perform plumbing work.  HLH sued after Lemoine failed to pay the balance due under the subcontract between HLH and Lemoine.

If pay when paid and pay if paid clauses weren’t hard enough for courts to interpret individually, in this dispute the court had to interpret a contract which contained both:

a final payment, consisting of the unpaid balance of the Price, shall be made within 45 days after the last of the following to occur; [and] … Final payment by [Vista Bella] to [Lemoine] under the Contract on account of the Work

The first part of the above-quoted provision acts like a pay when paid clause because it merely dictates when HLH, the subcontractor, should receive payment, not if it should receive payment at all.  The second part works as the exact opposite, stating that HLH will get paid only if Vista Bella, the property owner, first pays Lemoine, and contractor who then subcontracted with HLH.

As explained below in a discussion of Kruger, pay when paid clauses act as timing mechanisms and do not shift the risk of owner nonpayment from the contractor to the subcontractor, whereas pay if paid clauses mean that payment from the owner to the contractor is a condition precedent to the subcontractor getting paid.  But how should a court rule when both exist (and are at odds with each other) in the same contract?

Interestingly, the Supreme Court of Alabama turns to one of the oldest canons in contract interpretation: Based on the text of the contract itself, what is the intent of the parties?  (Virginia’s unique application of the party intent doctrine in the context of pay when paid clauses is discussed at length in an introduction and discussion posts on the PAID blog.)

Although the court recognized that the pay when paid clause did act as a timing mechanism, the overarching intent of the parties was to shift the risk of Vista Bella’s nonpayment from Lemoine to HLH.  As the contract itself also stated in paragraph 5:

the obligation of [Lemoine] to make any payment under this Subcontract … is subject to the express and absolute condition precedent of payment by [Vista Bella]

The court held that:

Nothing in the subcontract contradicts the provisions of paragraph 5 or indicates that the parties intended to assign the risk of nonpayment in a manner different from that set forth in paragraph 5. Therefore, pursuant to the express terms of the subcontract, the timing mechanism of paragraph 4 is subject to the condition precedent of paragraph 5, and the two paragraphs are not in conflict.

The court’s holding couldn’t be clearer: When a pay if paid clause exists in a contract and that provision does not directly conflict with any other contract provision, a subcontractor such as HLH is not entitled to payment until a contractor like Lemoine receives payment from the property owner.

Pay When Paid Clauses in Alabama Public Contracts

There are no codified statutes governing the interpretation of pay when paid clauses in Alabama.  However, there is a substantial amount of jurisprudence (case law) that sets forth how a pay when paid clause will be evaluated by Alabama courts thanks to several landmark decisions.

The Supreme Court of Alabama interpreted a pay when paid clause in a public contract in Federal Insurance Co. v. I. Kruger, Inc. (829 So.2d 732).  Kruger involves an unpaid supplier and the City of Mobile, who contracted with Harbert (who then subcontracted with Kruger) to upgrade a public wastewater treatment plant.

In its opinion in Kruger, the court was even kind enough to provide the following subheading:

The Pay—When—Paid Clause: Condition Precedent or Timing Mechanism?

In a single well-worded sentence, the Supreme Court of Alabama perfectly summed up the difficulty courts face when interpreting and distinguishing pay when paid and pay if paid clauses.

The first difficulty is actually spotting and identifying the contract provision at hand.  In Kruger, the contract part that gave the court trouble was as follows:

A final payment, consisting of the unpaid balance of the Price, shall be made within thirty (30) days after the last of the following to occur, (a) Purchaser’s receipt of all Products in satisfactory condition, (b) final payment by Owner to Purchaser on account of the Products including retainage, (c) delivery of all guarantees, certifications and information required under the Contract Documents, and (d) delivery of a general release, in a form satisfactory to Purchaser, executed by Seller running to and in favor of Purchaser and Owner.

Due to the word “shall” in the first line and in combination with listed item (b), the court interpreted the provision as a pay when paid clause, not a pay if paid clause.

The court then held that since the provision was a pay when paid clause, “the language of this provision is clear and unmistakable: it is a timing provision and not an express condition precedent to payment.”  In other words, pay when pay clauses only dictate when a subcontractor must be paid, not if a subcontractor must be paid.  Thus, Kruger set forth how pay when paid and pay if paid clauses will be interpreted in Alabama: If a pay when paid clause exists, the contractor bears the risk of owner nonpayment and even if the owner does not pay the contractor still must; but if a pay if paid clause exists, payment from the owner to the subcontractor is a condition precedent (required condition) for the subcontractor getting paid.