Pay if paid clauses are design to shift the risk of non-payment to lower tier parties on a construction project. The purpose, in states in which such clauses are allowed, is to obligate a contractor to pay its subcontractor only if the GC has received payment first. This means that absent actual payment to the GC, the GC is not required to pay their subcontractors. However, these clauses are disallowed in many states, and are looked upon with some disfavor even in the states in which they are allowed. When available, the language of these clauses must be specific and very clear, at the risk of the clause being invalidated completely, or turned into a mere “timing mechanism” for payment rather than a risk-shifting mechanism, to avoid payment altogether. To keep with that trend, Michigan courts recently limited the applicability of pay if paid clauses when involving extra-contractual work.

Background of the Case

This case arises from a United States Army Corps of Engineers (USACE) project. The USACE  contracted the Veterans Enterprise Technology Services, LLC (VETS) as the prime contractor. LaSalle Group, Inc. (LaSalle) entered into a subcontract with VETS. LaSalle, in turn, hired multiple sub-subcontractors including Macomb Mechanical, Inc. (Macomb) to handle plumbing and mechanical work to the tune of $270,000. The work was supposed to take 6 months, but due to complications, ended up taking 15 months to complete. Throughout the process, and a change in project scope, LaSalle refused to sign change orders that presumably would have modified the contract to memorialize the changes to the project and payment due to Macomb. Upon LaSalle’s failure to pay Macomb the amount due for the work, Macomb filed a breach of contract action.

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The Court’s Decision

Originally, Macomb’s breach of contract claim was dismissed based on two specific clauses of the contract, the “no damages for delay” clause, and the “pay if paid” clause. Macomb appealed the lower court’s dismissal of the case, and the appellate court in Macomb Mechanical, Inc. v. LaSalle Group, Inc., No. 319357 did not reach the exact same conclusion.

This article will not specifically discuss the court’s findings related to the “no damage for delay” clause, but instead will take a look at the decision related to the “pay if paid” clause. Michigan allows for the enforcement of pay if paid clauses provided they are specifically stated that payment to the contractor is a condition precedent to payment to the sub. The court noted a previous decision in Berkel & Co. Contractors v. Christman Co., 210 Mich. App. 416 supporting that point:

Berkel next argues that even if considered operative, a “pay when paid” clause is merely a provision that postpones payment for a reasonable amount of time, not indefinitely. Again, we disagree. As indicated earlier, the trial court quite properly found that Christman was not required to pay Berkel until it received payment from the owner. Failure to satisfy a condition precedent prevents a cause of action for failure of performance. Lee v Auto-Owners Ins Co, 201 Mich 39, 43; 505 NW2d 866 (1993). The contract contains no language limiting the condition precedent to any “reasonable time.” Christman fulfilled any condition that required it to take active measures to collect the money due, as evidenced by its action against the owners. [Id. at 419-420.]

While the court determined that the clause at issue here was worded specifically enough to enforce as to payments under the contract, this type of contractual clause is necessarily limited to amounts due under the contract. So, while the appellate court did not reverse the lower court’s decision that the specific pay if pay clause a tissue could apply (and did apply to the $21,589.20 due for work indisputably performed under the contract), it did reverse the decision that the pay if paid clause applied to amounts that were arguably not covered by the original contract.

The court noted that Macomb raised a genuine question of material fact as to whether the additional $172,049 of its requested compensation fell outside the bounds of the original contract. The work giving rise to the claim for that amount was covered by the change orders that were never signed. While Macomb agreed that the work would have been considered part of the contract if the change orders would have been signed, Macomb contented that the failure of LaSalle to sign the change orders rendered the work covered to become extra-contractual work that is not covered by the sub-contract. While the court did not make any determination as to whether or not that was actually the case, it agreed that Macomb raised an issue of fact that needed to be determined by the lower court upon remand of the case.

Takeaways

There are a couple of interesting takeaways from this case: 1) Pay if paid clauses remain enforceable in Michigan if explicit, and 2) pay if paid clauses in a contract are only applicable to work done pursuant to that contract. While this second point makes a lot of sense in a vacuum, its application in this case is especially interesting and potentially ironic. LaSalle presumably refused to sign the change orders because it did not want to be obligated to pay for the extra work, but by refusing to sign the change orders it may have accomplished exactly the opposite. If the work would have been covered by the contract, the pay if paid clause would have controlled, since the change orders were not signed, the pay if paid clause may not apply. Just like always, it pays to be fair – a lesson that LaSalle may have benefited from in this case.

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Michigan Court Limits Applicability of Pay If Paid Clauses
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Michigan Court Limits Applicability of Pay If Paid Clauses
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Pay if paid clauses shift the risk to lower tier construction parties. The applicability of the clause is limited. Make sure you understand your contract.
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