Pair of Cases Concerning Pay-if-Paid Provisions

Katherine E. Kohm | The Dispute Resolver | June 23, 2016

Within the last month, two decisions with two outcomes were issued concerning “pay-if-paid” provisions. Observe that a “pay-if-paid” provision is a true condition precedent in that a general contractor is not required to pay its subcontractor unless and until it receives payment from the owner.  A different result flows from a “pay-when-paid” provision which only allows the general contractor a reasonable time to pay the subcontractor after receiving payment from the owner, but the risk of non-payment from the owner is not shifted to the subcontractor.

In Midlantic Fire, LLC v. Ernest Bock & Sons, Inc., No. DC–8529–14, 2016 WL 3093075, at *1 (N.J.Super. Ct. June 3, 2016), the pay-if-paid clause stated:

Payment by Owner to the General Contractor for the work/materials invoiced by the Subcontractor/Supplier shall be a condition precedent to General Contractor’s obligation to pay Subcontractor/Supplier. Accordingly Subcontractor/Supplier agrees and understands that it shall bear the risk of non-payment by the Owner and shall be entitled to no compensation from the General Contractor in the event of non-payment by the Owner for its work/materials.
The plaintiff subcontractor installed a fire protection system in accordance with drawings and plans supplied by the defendant general contractor.  Subsequent to installation, the general contractor learned that the sprinklers interfered with structural supports that needed to be installed.  The subcontractor issued a change order, which was approved by the general contractor.  The subcontractor performed the changed work.  When the general contractor submitted the invoice for payment, the owner declined to pay because there was a “lack of communication [and] coordination” between the general contractor and subcontractor. The general contractor, citing the pay-if-paid provision, then refused to pay the subcontractor.   The plaintiff subcontractor prevailed at trial, and the defendant general contractor appealed the application of the pay-if-pay by law.

Applying Pennsylvania law, per the contract, the court affirmed in favor of the subcontractor because “courts are reluctant to enforce a conditional payment provision against an unpaid subcontractor that is not responsible for the condition giving rise to the payment defense” and because “parties to a contract have an implied duty not to frustrate conditions precedent to their performance” (citing Quinn Constr., Inc. v. Skanska USA Bldg., Inc., 730 F. Supp.2d 401, 420 (E.D.Pa.2010)).  Because the subcontractor had relied on the plans and drawings submitted by the general contractor and therefore because all coordination among subcontractors was the general contractor’s responsibility, the subcontractor was not responsible for the non-payment. Rather the defendant general contractor’s own error spurred the need for the change order and the owners refusal to pay the change order. As such, the pay-if-paid provision was inapplicable and the general was required to pay the subcontractor.

In A. Zahner Company v. McGowan Builders, Inc., No. WD 78063, 2016 WL 2994022, (Mo.App. Ct May 24, 2016), the pay-if-paid stated:

[Subcontractor] agrees that [the general contractor] will not be responsible to make any payment, progress or final, to [subcontractor] for any and all of the goods identified in this Purchase Order unless and until [general contractor] receives payment for such goods from the Owner of the project . . . . If Subcontractor is not paid within 45 days of when a pay application is submitted, Subcontractor may stop the Work of this Subcontract until payment is received . . . .
The trial court had concluded that the above provision was ambiguous because the “unless and until” language was a condition precedent to payment shifting the risk of non-payment to the subcontractor whereas the “stop the Work” sentences “eased the burden” of risk to the subcontractor.  The appellate court disagreed and instead held that the entire provision could be read harmoniously. That court held that altogether the provision simply “distributes financial risk between the parties and provides both [with] a measure of financial protection.”  In sum, the general contractor did not need to pay if owner did not pay.  As its recourse, the subcontractor did not need to continue work if it was not paid.  As such, the appellate court concluded that the pay-if-paid provision was applicable and remanded the case for fact-finding — whether the owner indeed did not pay the general contractor.

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