Construction contracts, like many contracts, can be lengthy and complicated documents. While these agreements form the foundation for the relationship between the signing parties, they voluminous, and therefore, are rarely thoroughly examined. Even if the contract is examined, if the examination is not done by either an in-house or outside construction attorney, there may be technical legal clauses and/or phrases that have profound effects, but that go unnoticed. While it may not be feasible to hire an attorney to review every contract, construction participants can still help themselves by knowing some of the key things to look out for.
Pay-If-Paid / Pay-When-Paid Clauses
Generally, pay when paid clauses are interpreted as a timing mechanism for payment, i.e. the contractor will pay the subcontractor within a certain amount of days after receiving payment from the owner, rather than a risk-shifting clause. Put another way, contractual language stating a contractor will pay a sub when payment is received from the property owner is not interpreted to mean payment can be avoided indefinitely. Even in the absence of payment from the owner the GC must pay the sub within some “reasonable” time.
However, it worth noting that this type of clause can still delay payment. Whether or not an invoice is due, a pay when pay clause may effectively slow down the obligation of the paying party to actually make that payment. Examples of such clauses include:
AGC 650 8.2.5: Progress payments to the subcontractor shall be made no later than seven (7) days after receipt by the contractor of payment from the owner. If payment from the owner is not received the contractor will make payment to the subcontractor within a reasonable time.
Payment will be made not more than thirty (30) days after the submission date or ten (10) days after the certification or when we have been paid by the owner, whichever is later.
However, on the other hand, pay if paid clauses have been specifically designed in an attempt shift the risk of non-payment. In order for a pay if paid clause to force the courts into enforcing it as a condition precedent to payment (i.e. the contractor must pay the subcontractor if and only if he first receives payment) the clause must be extremely specific, and likely must contain some particular language. If it does so, and the contract was for work performed in a state that allows such clauses, the burden of non-payment is shifted to the lower-tiered party.
These types of clauses are generally viewed unfavorably by courts. In order for a pay if paid clause to have a chance of being enforceable, it must be precise and clear in its wording and in what it is trying to accomplish. This usually means that an enforceable pay if paid clause would use language such as
the contractor’s receipt of payment from the property owner is specifically agreed to be a condition precedent to the contractor’s obligation to pay the subcontractor, and the subcontractor specifically and expressly assumes the risk of the property owner’s nonpayment.
Specific contractual language is mandatory to state that it is understood by both parties that the risk should be shifted. While some states specifically disallow risk-shifting pay if paid clauses, when phrases like “condition precedent” “risk-shifting” or “assumes the risk” are used in conjunction with payment provisions, it would behoove companies to be wary.
; (ii) The ConsensusDOCS; or (iii) The recommended provision from the American Arbitration Association (AAA). After all it’s easier not to re-invent the wheel. However, it’s not uncommon for these provisions to be modified and altered by the company drafting the contract in a manner it feels better protects its interests.
There is debate between lawyers and construction industry participants about the fairness of these provisions to various parties, but in large part, the biggest potential benefit of these provisions is that they are standardized and have reliable interpretations. In other words, if the provision has not been modified, the parties know what they’re getting into and can pretty easily digest the provision and understand its impact. The unfortunate reality, however, is that these contracts and provisions are too frequently edited, or re-edited, for companies to feel secure in knowing what they mean. This defeats the purpose of the standardized contract sets and leaves the parties in a more confused state than before.
The result is the creation and re-creation of thousands of different ADR provision various; each provision containing a nuance slightly different from the other. Unlike the standard ADR provisions which have reached the courts and been interpreted, custom provisions likely have not been ruled upon, and will require a judge or jury to construct it for the first time. This presents an enormous amount of uncertainty.
It’s important, therefore, for construction parties to read the ADR clause contained in their contracts, and know what is required – whether they must submit to binding arbitration, or to mediate and then proceed with arbitration, or something else.
Construction contracts are complex documents, and can substantially alter a company’s rights. It pays to read them carefully, and be aware of clauses that may be detrimental.