It may seem that shifting liability down the payment chain is just the way of the world in the construction industry. Often times, that’s the truth (but that’s not the case in our construction payment utopia). The further a party is down the chain, the hairier things get in the event of a payment dispute.
This feature of construction payment is only multiplied when pay if paid or pay when paid terms are included in a contract. We’ve written plenty on the differences between pay if paid and pay when paid provisions, but here’s a quick breakdown: pay when paid provisions merely affect the time of payment. Meaning, an obligation to pay exists as a result of the contract, but that obligation may move in time due to when the contractor is paid by the contractor. A pay if paid provision means that the contractor receiving payment is a condition precedent to the subcontractor being owed payment. In other words, the obligation to pay does not exist at all until the contractor is paid. So, in practice, if the contractor is never paid, the subcontractor is never owed anything.
Drawing a Line on Pay if Paid Provisions
If a pay if paid provision seems harsh and unforgiving, courts tend to agree. Some states have outlawed the use of the provision, but all states generally disfavor the creation of condition precedents such as a pay if paid provision (though oddly enough, Kentucky recently strengthened pay if paid contracts.) In Illinois, as with some other states, even more of a distinction has been drawn: pay if paid contracts may exist in contract claims under certain circumstances, but they cannot preclude a recovery through a mechanics lien.
Illinois Mechanics Lien Statute
Under § 60.21(e) the state’s mechanics lien act,
Any provision in a contract, agreement, or understanding, when payment from a contractor to a subcontractor or supplier is conditioned upon receipt of the payment from any other party including a private or public owner, shall not be a defense by the party responsible for payment to a claim brought under Section 21, 22, 23, or 28 of this Act against the party.
When a mechanics lien is the mode of recovery, a pay if paid contract will not stand in the way of a lien claimant.
We recently discussed an Illinois case that helped illuminate the differences between pay if paid and pay when paid provisions. That case, Beal Bank Nevada v. Northshore Center THC, also goes a long way to describing the scenarios under which a pay if paid claim could survive a breach claim. First, the claim cannot be under the Illinois mechanics lien statute. Next, the question is whether or not the pay if paid provision is in plain, unambiguous language.
In Beal Bank Nevada, the position that the contractor held – no payment was due to subcontractor unless the contractor had been previously paid by the owner- was not supported by the subcontract. Rather than discussing whether or not an obligation to pay the subcontractor existed, the language contemplated the mode and timing of the payment. For this reason, the provision was considered a pay when paid contract rather than a pay if paid contract. It may seem like semantics, but this is a crucial point. Because the provision was merely a timing mechanism, the contractor actually owed the subcontractor payment. Under a pay if paid contract, no such obligation would exist at all.
The court was very clear: unless a pay if paid provision is extremely clear in its intent, it will not be upheld as creating a condition precedent. That is not to say that the words “pay if paid” must actually be used, but if the language cannot be clearly and unambiguously read to state that no payment will be made unless a contractor has first received payment, Illinois pay if paid provisions will not stand. Still, even those contractors who expressly agree to a pay if paid contract will not be barred from bringing a mechanics lien claim.
Pay if paid contracts may not be completely outlawed in Illinois, but subcontractors won’t be blindsided with a pay if paid provision so long as they pay attention to the content of their construction contracts. The difference between pay if paid and pay when paid provisions is more than just a few letters, it could be difference between getting paid and going empty handed. Luckily for subcontractors and suppliers, mechanics liens can overcome even the clearest Illinois pay if paid provisions. This is just one more example of how filing a mechanics lien is a great way to ensure payment while avoiding the cost and uncertainty of litigation.