The top down payment structure in the construction industry creates plenty of problems. Parties are worried about shifting liability first and foremost, keeping the industry from a better, more collaborative landscape. As a result, pay when paid and pay if paid contracts have crept into the forefront of construction payment. Luckily many states have invalidated the use of pay if paid contracts, and you can keep track of them with this infographic. Kentucky, however, is not one of those states. The Kentucky Court of Appeals has struggled with lien law in the past, so it should come as no surprise that the Court made a mess of them again.
The Kentucky Court of Appeals recently decided that two subcontractors may have no lien rights following from extra work performed on a project. The extra work was not done subject to any written contract which compounded their problems. But the subcontractors were verbally supported by the contractor who instructed them to keep track of their material and labor costs. However, the agreements between the contractor and the subcontractors stated that all change orders must be in writing and also included pay-if-paid provisions. Ultimately, hundreds of thousands of dollars in extra work was performed but not paid for. Two subcontractors, Superior Steel and Ben Hur Construction filed liens.
How did the Appellate Court screw up pay if paid?
At trial, a jury found that the subcontractors were owed over $400,000 and that both the property owner and the general contractor were liable. On appeal, the Court found that the pay if paid provisions in the subcontract were not given their due weight.
The Court found that the pay if paid contracts created a condition precedent that needed to be met before payment from the general contractor to the subcontractors was due. Attempting to borrow from Ohio and Virginia law, the Court rested its analysis on shaky ground. Ohio statute prohibits pay if paid contracts from barring the filing of a mechanics lien. According to Ohio Rev. Code § 4113.62(E):
“No construction contract, agreement, or understanding that makes payment from a contractor to a subcontractor or materials supplier, or from a subcontractor to a materials supplier, lower tier subcontractor, or lower tier materials supplier contingent or conditioned upon receipt of payment from any other person shall prohibit a person from filing a [mechanics lien].”
Virginia, on the other hand, takes a unique stance when it comes to pay if paid and pay when paid clauses. Cases involving these clauses are treated on a case by case basis in Virginia, and courts hone in on the intent of the parties.
So the court here based its interpretation on pay if paid clauses on a state with irregular law on the subject and a state that recently got pay if paid wrong in a decision that may be contrary to state law. Meanwhile there was no mention of the strong public policy considerations against pay if paid contracts. A position embraced, on some level, by every state in the nation.
American Subcontractors Association weighs in
In an amicus brief filed by the American Subcontractors Association (ASA), the group weighed in on the issue. The ASA noted specifically that pay if paid provisions do no apply to extra work and that the provisions are not in line with Kentucky public policy. According to the ASA, because the extra work performed was not done subject to the contract that contained the pay if paid wording, the provision should not apply. As for public policy concerns, the ASA claims that pay if paid contracts are void under Kentucky’s Fairness in Construction Act. The purpose of the Act is to provide security to unpaid parties to construction projects by giving lien rights to certain parties. The Act calls for liberal application in order to better protect the interests of injured parties, voiding any provision which “purports to waive, release or extinguish rights provided” by the Act with few exceptions. KRS 371.405(2)(b).
While the rest of the country seems to either disfavor or downright prohibit pay if paid contracts, the Kentucky Court of Appeals seems to think they’re perfectly fine. Hopefully the Supreme Court of Kentucky will weigh in.