Kent B. Scott | Babcock Scott & Babcock
Introduction. Contingent payment clauses provide parties involved in a construction project with a contractual method for determining who will absorb losses that may occur if the owner fails to pay for work performed on the project. In Utah, the law remains unsettled in this area, though some statutes clarify the treatment of contingent payment clauses in certain cases.
Contingent Payment Clauses. One type of contingent payment clause, called a “pay-when-paid” clause, requires a contractor to pay a subcontractor or supplier within a reasonable period of time for work or material furnished to a project. These clauses do not shift the risk of owner nonpayment to the subcontractor or supplier. If the owner fails to pay the prime contractor, the prime contractor is still liable to pay its subcontractors and suppliers. A pay-when-paid provision might read, “Prime shall pay subcontractor within ten days of receipt of payment from owner.” Pay-when-paid clauses are generally accepted because the risk of loss due to nonpayment is retained by the upper-tier contractor, who the courts view as the party in the best position to evaluate the risk of dealing with a particular owner.
Pay-if-paid clauses, the second type of contingent payment clause, provide more protection to the prime contractor. This type of contingent payment clause conditions the subcontractor’s payment on whether the prime contractor has been paid by the owner. A pay-if-paid clause shifts the risk of loss due to owner nonpayment from the upper-tier contractor to the lower-tier contractor. A pay-if-paid clause may read: “The subcontractor assumes the risk of the owner’s nonpayment to the prime contractor and the subcontract price reflects this risk. Payment to the prime contractor will be a condition precedent to any funds being due the subcontractor.”
Pay-if-paid clauses are not as widely accepted as pay-when-paid clauses. Some courts have interpreted a pay-if-paid clause as if it were a pay-when-paid clause, thereby keeping the risk of nonpayment in the hands of the upper-tier contractor. A limited number of states have prohibited the use of pay-if-paid clauses. In states where pay-if-paid clauses have been enforced, courts will generally enforce only clauses that use specific words or otherwise clearly demonstrate that the contracting parties intended to shift the risk of nonpayment.
While an enforceable pay-if-paid clause prevents a subcontractor from recovering unpaid funds from the prime contractor, the subcontractor may still be able to pursue other means of recovery, such as a mechanic’s lien.
Contingent payment clauses in Utah. Utah has yet to determine many of the legal issues surrounding pay-if-paid and pay-when-paid clauses. The Utah legislature has enacted some statutes, though, relating to these clauses that provide contracting parties with some direction.
In Utah, contingent payment clauses are generally not enforceable against mechanics’ liens, though they may be enforceable in residential contracts. The Utah Legislature has enacted Utah Code section 13-8-4(3) which provides, “The existence of a contingent payment contract is not a defense to a claim to enforce a mechanics’ lien [but this section] does not apply to private construction work for the building improvement, repair, or remodeling of residential property…” According to this statute, in most cases, even though a subcontract agreement may include a contingent payment clause that would otherwise bar the subcontractor or supplier from recovering from the prime contractor, that subcontractor may still pursue a mechanics’ lien claim against the property. This statute does not extend this protection to residential contracts, but the subcontractor or supplier may still have a claim against the Residential Lien Recovery Fund.
Additionally, Utah law states that, when a subcontractor may be entering into a contract that includes a contingent payment clause, the subcontractor may request from the contractor financial information prior to signing the contract that the contractor has received from the owner regarding: (1) the project financing, and (2) the owner’s financial situation. This allows the subcontractor to evaluate the risk that it may be assuming.
Conclusion. Contingent payment clauses are common in the construction industry. They allow parties to allocate the risk of an owner’s nonpayment as part of the contract. As the applicability of contingent payment clauses in Utah is generally undecided, members of the construction industry should be aware of the potential vulnerabilities and benefits of entering contracts that include them. A contractor should seek legal counsel when determining the effect of contingent payment clauses that have been or will be included in their contracts.