Construction professionals at work

A few weeks ago someone posted an article on the National Association of Credit Management website suggesting that credit professionals should “always check for, eliminate ‘pay if paid’ provisions.”  The article got within striking distance of a good point, but since it treated “pay when paid” and “pay if paid” provisions the same, completely demonized them and set a bright-line rule (to refuse them), the article is unhelpful.

It did inspire me to write this post to discuss the three most important things a credit manager needs to know about these clauses. I’ve written about Pay When Paid clauses extensively in the past. This article aims to help you better understand these clauses and to make good decisions for your company when confronted with them.

Understand The Difference Between Pay When Paid and Pay If Paid

It’s unfortunate that state laws have been so convoluted concerning payment timing clauses because it is a truly tall order to require credit manager to understand each jurisdictions nuance. Nevertheless, the reality is that these laws are confusing and in the wrong circumstances they can be crushing to your claim for payment.

At a very high level there are two types of payment clauses:  “Pay When Paid” and “Pay If Paid” clauses.

Pay When Paid clauses are what I would call the “legacy” clause, as every payment timing provision found in construction contracts used to be this variety. When the parties sign a contract with this type of clause in it they are agreeing that the party providing services or materials (the seller) will not get paid on any open invoices until the buyer receives payment from the party who will owe it.

At a very high level there are two types of payment clauses: “Pay When Paid” and “Pay If Paid” clauses. These clauses have a feeling of unfairness to them, and that is how courts began to look at them. In fact, courts around the country began to rule that these clauses still required the furnishing party to be paid at some point…even if the buying party wasn’t ever paid.  Most states now interpret this “pay when paid” clause this way.

That prompted the construction industry to get more specific with these clauses, and thus the Pay If Paid Clause was born. This clause more specifically states that the “risk of non-payment is on the party furnishing the materials or labor,” and clearly states that if the buying party is not paid on the project than the selling party will never get paid.  The payment to the buyer is a “condition precedent” to the seller getting paid.

Courts fall into one of two camps about this stricter clause.  They either follow the terms and push the risk of non-payment upon the seller, or they deem the clause to be against public policy and void as a matter of law.

When credit managers are reviewing contracts you should look for these clauses.  Determine whether you have a pay when paid or a pay if paid clause, and then figure out what that means for the law applicable to your contract (which is an entirely different confusing issue).

Payment Timing Provisions May Create Problems For Your Lien Rights

Pay when paid or pay if paid clauses create a timeline when you would be owed money under a contract. Pursuant to a strict interpretation of these clauses, if the party hiring you has not gotten paid, then you would not have a legal right to payment. This begs the question: If you don’t have a legal right to payment how can you file a mechanics lien?

Many times payment delay on a construction project will go on for so long that the delay may exceed the time you have to file a mechanics lien. If you’re bound by one of these payment timing provisions, you’ll be left with a bit of a catch-22.  On the one hand your lien rights are expiring, but on the other hand ,you aren’t yet owed any money.

Whether you have the right to file a mechanics lien in these situations will depend on the state’s specific mechanics lien laws and on the state’s treatment of payment timing provisions.

First, with respect to the lien laws, some states write their laws entitling you to file a lien equal to the “value of your work.”  These states do not tie the mechanics lien right to having a due or overdue invoice.  This would obviously be favorable in such a catch-22 situation. If the law affords a legal right equal to the “amount due” to you, then you have a bit of a theoretical hurdle to get over to file your mechanics lien.

Second, with respect to the payment timing provision interpretation, the more liberal the state at reading these clauses the more likely you’ll be found to have legal ground in asserting a right to payment through a mechanics lien.

Practically Speaking These Clauses Will Cause You Problems

I just spilled 850+ words about how these pay-when-paid and pay-if-paid clauses work.  Guess what?  You can almost forget them all.

The reason why is because so few disputes get litigated to the point of a full decision, and even when they do reach a decision, there’s usually enough gray area or ambiguity to make the whole thing a coin toss. Practically speaking, therefore, just the existence of these clauses in a contract causes a problem for credit managers and companies because they will put you into a dispute that has no winners.

If you see one of these clauses in your contract you should think long and hard about agreeing to the terms because of these implications.

Material suppliers should nearly universally reject any such terms, as this industry is typically not asked to subject itself to payment timing provisions.  These provisions should find their way into their credit terms only infrequently, and if a material supplier strikes these terms, that stricken language will almost always be accepted by the other party.  It’s just the way things are.

Subcontractors and tradespeople, however, have a much more difficult time because these clauses are part of the culture. It’s sometimes quite hard to get these provisions stricken, but if it’s difficult to negotiate these clauses out or to reduce their impact, you should really think about whether the contract is worth it.

The clauses very clearly push the risk of non-payment onto you.  Do you want to carry that risk?

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