Construction contracts can contain all sorts of landmines. To the uninitiated, signing a contract without understanding the repercussions of the certain clauses can spell disaster. One provision, in particular, is a pay-if-paid clause. Each state treats the validity of these differently. Texas does allow pay-if-paid clauses, but with strict requirements and statutory options to challenge their enforceability.
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There are two types of potential contingent payment clauses that could be included in a construction contract. A pay-if-paid clause is meant to shift non-payment risk down the construction payment chain. This is achieved by stating that the contractor will only have to pay its subs only if the contractor receives payment from the owner.
For further reading on contingent payment clauses:
Texas approach to pay-if-paid clauses
The Texas Business and Commerce Code §56.001 defines contingent payment clauses as a provision which provides that:
the contingent payor’s receipt of payment from another is a condition precedent to the obligation of the contingent payor to make payment to the contingent payee for work performed or materials furnished.
Many states have strictly prohibited these types of clauses. In Texas, however, these types of clauses are generally enforceable and are used to provide the GC with an affirmative defense to a claim for non-payment.
Must be clear and unambiguous language
Given the immense potential repercussions of signing a contract with such a clause; they are heavily disfavored by Texas courts. So much so, that courts will strictly construe the provisions, Gulf Construction v. Self 67 SW2d 624. But that doesn’t mean they aren’t.
As long as the language contained within the clause is clear and unambiguous, the clause will be enforceable. The clause must clearly indicate that there is a condition precedent to payment, which means that the payment to the sub is contingent on some event happening beforehand. That triggering event being a payment from the owner.
If the language is deemed to be vague or unclear or merely a promise, it will be deemed a pay-when-paid clause. These clauses basically establish that the sub will be paid within a reasonable time, instead of the harsher result of non-payment.
The chapter regulating contingent payment provisions specifically carve out a few types of contracts that are not covered. These are contracts that are solely for:
- Design services;
- Civil engineering projects such as the construction or maintenance of roads, highways, bridges, etc.; &
- Improvements to or the detached single-family residences, duplexes, triplexes or quadruplexes.
Ways valid pay-if-paid clauses can become unenforceable
Even if the clause is drafted unambiguously, and clearly defines that payment by the owner is a condition precedent, the clause may still be unenforceable.
GC’s performance the reason for nonpayment
This one is fairly self-explanatory. If the reason the owner has yet to pay the GC is due to the GC’s lack of performance, then the pay-if-paid will be unenforceable. Accordingly, if the owner’s nonpayment is due to the payee’ (sub’s) failure to meet their contractual requirements, then the clause will still be enforceable.
Written objection by the sub
Whenever the GC attempts to enforce such a clause, there are some notice procedures provided by statute that allows the sub to challenge the clause. This is done by sending an objection notice to the GC at least 45 days past the submission of the pay application.
Once the GC has received the notice, the burden then shifts to the GC to either pay, reply with reasons they cannot pay, or if the GC fails to provide the requested information, then the pay-if-paid clause is deemed unenforceable.
Existence of a sham relationship
A “sham contract” is defined in Tex. Prop. Code §53.026, it is a long-winded definition, but the gist of it is this. Its all about the appearance of some sort of control over the GC or another party by the owner. It is essentially the appearance of being an independent contractor to disguise an employment relationship.
Unconscionability is another way that an otherwise clear and unambiguous clause can be invalidated. A contract provision can be deemed unconscionable if the enforcement of the clause would be so unfair to the party, that an informed person would never agree to it.
Since the impact of these clauses is severe, they are enforceable but only on rare occasions. Which is why the courts require explicitly clear language. And, even though Texas pay-if-paid clauses they are valid and enforceable, they can be easily defeated with a legitimate objection to prevent their enforcement.