Pay if paid clauses are generally frowned upon in the construction industry. However, a recent case shows that pay if paid clauses are clearly enforceable in Alabama.
Pay if paid clauses, generally
Pay if paid clauses, by and large, are looked down upon. These provisions attempt to shift the risk of nonpayment down the payment chain. So, when a construction contract contains pay if paid clause, payment won’t be made on that contract until the party releasing payment is paid, themselves.
Often, because pay if paid clauses unduly shift risk onto other parties, these clauses are essentially converted to a pay when paid clause. Meaning, the time for payment is merely shifted, and the risk of nonpayment isn’t actually shifted. Or, in other words: With a pay when paid clause, payment will eventually be made – generally, within a “reasonable time” – even if the party making payment is never paid. But, with a pay if paid provision – no payment means no duty to pay.
More on pay if paid clauses:
Pay if paid clauses in Alabama
Not that long ago, we discussed Pay if Paid and Pay When Paid clauses in Alabama. In that article, we discuss how pay if paid clauses are treated on Alabama private projects and how pay when paid clauses are treated on Alabama public projects. Further, based on another article (which you can read here), we know that pay if paid clauses don’t do particularly well on federal projects.
After a recent case, we also know that pay if paid clauses will also be upheld in Alabama on public projects.
A recent case: Keller Construction v. Hartford
You can read Keller Construction v. Hartford here, courtesy of Justia.
Pay if paid clause included in the subcontract
The City of Spanish Fort, AL (“Spanish Fort”) hired J.F. Pate & Associates (“Pate”) to build a community center. Because this was a public project subject to the Alabama Little Miller Act, Pate was required to secure a payment bond on the project. So, Pate brought on Hartford Fire Insurance Company (“Hartford”) as the project’s surety. Pate also brought on Keller Construction (“Keller”) as a subcontractor. The subcontract between Pate and Keller contained a pay if paid clause.
As the project came to a close, Spanish Fort ultimately didn’t release Pate’s retainage. Included in that retainage was about $12K owed to Keller. Because the contract contained a pay if paid clause, Pate refused to pay Keller. As a result, Keller looked to Hartford, the surety, for payment by making a bond claim. Hartford also refused to pay Keller on the basis of the pay if paid clause.
Keller sued Hartford, claiming that the surety was still responsible for making payment even though the subcontract between Pate and Keller contained a pay if paid clause.
Court allowed the GC and Surety to enforce the pay if paid clause
Much like other Alabama courts have come down on pay if paid and pay when paid clauses, the appellate court came down pretty harshly here. The court found that Pate and Keller’s contract was clear, unambiguous, and that Keller fully understood the risk it was incurring by taking on a pay if paid job. Further, the court found that Keller had even received a more favorable price in exchange for including the pay if paid provision.
The court also noted that Keller’s subcontract explicitly stated that Hartford would only be bound to make payments to the extent that Pate, itself, was responsible for payment. Under the contract, any defense Pate had for not making payment was also available to Hartford.
Ultimately, the court didn’t have much sympathy at all for Keller. The court found for Hartford, stating that Keller fully understood the risks it took on and could not now avoid those risks after they failed to pay off.
Is it fair to allow a surety to utilize a pay if paid clause?
“Fairness” can be elusive. Still, most states have decided that pay if paid clauses are not fair. But, considering Keller’s understanding of the situation, was this outcome fair?
I think so. Unlike some other subs and suppliers, it sounds like Keller came into this project with eyes wide open about the potential for nonpayment due to the pay if paid clause. Keller even had their lawyer review the contract and apparently negotiated a better price because of the extra risk involved. So, unlike some other situations where a customer throws their weight around and forces a pay if paid clause into the contract, it sounds like Keller more or less embraced the clause in this instance. So, the outcome seems relatively “fair.”
On the other hand, taking a macro look at the situation: sureties are brought onto public projects in order to make sure that subs and suppliers are paid. That’s literally the purpose of payment bonds. And, letting a surety use a pay if paid clause as a defense to payment feels a little bit like cheating. But again – it’s what Keller agreed to in their contract.