Understanding the Pay-When-Paid Clause
Reviewing all your contracts can seem time-consuming and tedious, but it is important to check every clause to prevent any unwelcome surprises. If you are like many other subcontractors, you might skim your contracts quickly before providing your signature. And even if you do read every word, you may not notice some technical phrases and terms. But one provision you should keep an eye out for is the pay-when-paid (or pay-if-paid) clause.
Sometimes a prime contractor can avoid paying a subcontractor or supplier when a contingent payment or pay-when-paid clause is included in the subcontract. This phrase usually states that the prime contractor has no duty or obligation to pay the subcontractor or supplier until the prime contractor receives payment from the owner.
In most cases, pay-when-paid clauses are a matter of timing. They do not eliminate risk for the prime contractor, but they designate the deadline by which the prime contractor must pay subcontractors. The purpose of the clause usually is to protect prime contractors from assuming debt. For instance, the phrase might read: “The Subcontractor shall be paid within ten (10) days after the Prime Contractor receives payment for subcontract work from the Owner.”
The Importance of Wording
Not all states allow contingent payment clauses. But in states that do, such a stipulation is permitted only if it is specifically worded. For example, the pay-when-paid clause must make it crystal clear that payment to the subcontractor is conditional upon the prime contractor having received payment from the owner. If the wording is unclear, courts will likely find the provision ambiguous and hold that payment must be received within a reasonable timeframe.
If you are a material supplier or subcontractor, pay-when-paid clauses can be frustrating because they cause cash flow delays for you. However, these clauses do not entirely eliminate the prime contractor’s obligation to pay you. In the long run, pay-when-paid stipulations may cause annoying payment delays, but they do not create real financial risk.
More concerning are pay-if-paid clauses. These stipulations are designed to shift the risk of nonpayment from the prime contractor to subcontractors or suppliers. They are generally so specific that the contractor is required to pay the subcontractors and suppliers if and only if the prime contractor is paid. These clauses excuse the contractor from ensuring that subcontractors and suppliers are paid and shift the burden of possible nonpayment to those lower on the payment chain. With these contract stipulations, it is possible for subcontractors and suppliers never to be paid for completed work.
Many courts do not view these clauses favorably. And in some states, pay-if-paid clauses are considered void and unenforceable. Therefore, it is in your best interest to know your state’s laws and be prepared for any contingency clauses you encounter.
Both pay-when-paid and pay-if-paid clauses can be problematic, so look out for them. If you receive a contract that includes either of these contingent payment stipulations, pause and consider your options. If it is a pay-when-paid clause, you can request that the phrase be amended or removed. That decision is up to you, depending on the scope of work you are agreeing to and your relationship with the prime contractor. However, if you see a pay-if-paid clause, you may want to insist on its removal from the contract.
If you have questions about any contract terms, do not hesitate to ask for legal assistance. The experienced construction attorneys at Cotney can review your contracts and give you advice about making any necessary revisions to protect your company.
Disclaimer: The information contained in this article is for general educational information only. This information does not constitute legal advice, is not intended to constitute legal advice, nor should it be relied upon as legal advice for your specific factual pattern or situation.