Sam DeBaltzo | Tonkon Torp
Almost every subcontract I see includes some type of “pay-if-paid” provision, meaning the general contractor (GC) is not required to pay the subcontractor until and if the GC receives payment from the owner. The precise language of the provision changes from contract to contract, but arises out of some variation of the following:
“Receipt of payment from Owner is a condition precedent to GC’s obligation to make payment to Subcontractor.”
At first glance, subcontractors hesitate to agree to this type of a provision – their contract is with the GC and not the owner after all. I sympathize with this impression, and agree with my clients that if they can get it removed, the better. However, many times a GC is unwilling to budge on this point, and the subcontractor will have to accept the provision in order to proceed with the contract. In this post, I will identify ways to reduce exposure when this provision is required.
My first and relatively simple suggestion: don’t work for free. For clarity, far too many subcontractors are willing to continue their work despite not receiving monthly progress payments. A contractor’s obligation to pay may be reliant on receiving funds from the owner, but if those funds do not arrive, subcontractors need to be willing to halt work and (assuming they’ve retained the right to do so) exercise their right to lien. The longer a subcontractor works without pay, the more costs there are to fight about down the road.
Second, as to addressing the contract provision itself, I advise clients to seek the following remedies:
1. Make it Related Solely to Subcontractor’s Work: While it may be reasonable for the GC to withhold or delay paying a subcontractor if the owner is dissatisfied with the subcontractor’s work, the subcontractor should not suffer as a result of the failures of others. Accordingly, a provision similar to the following should be considered:
“GC may withhold or delay making payment to subcontractor for subcontractor’s work if the owner withholds or delays making payments to GC solely due to owner’s dissatisfaction with subcontractor’s work.”
2. Exclude GC’s Default or Unrelated Work: If the GC is unwilling to accept the above provision, then the subcontractor can rightfully point out that its right to payment should not be held hostage to an unrelated fight between the owner and GC. Accordingly, I advise clients to seek a provision providing that, if funds are delayed by owner due to the GC’s default of its contract with owner (but subcontractor has duly completed its portion of the work), the GC cannot delay payment to the subcontractor.
As an additional note to the above, subcontractors should clarify that a GC’s default includes failure of the GC’s other subcontractors as well. Subcontractors may be forced to take the risk of nonpayment by the owner, but they should not take added risks of the GC and fellow subcontractors’ non- or deficient performance.
3. Make the Provision “Pay-When-Paid” Where Possible: There’s a difference between “pay-if-paid” provisions, meaning a subcontractor only gets paid if and only if the GC gets paid, and “pay-when-paid” provisions, meaning a subcontractor gets paid when but not if the GC gets paid. With pay-if-paid provisions, if the owner goes bottom-up and never pays the GC, the subcontractor cannot go to the GC for payment. In comparison, pay-when-paid provisions condition the timing of the subcontractor’s payment on the GC being paid by the owner; however, the subcontractor has not agreed to waive rights to payment if the owner fails to pay. Instead, a subcontractor can still seek payment from the GC after a reasonable time, determined on a case-by-case basis.
As some reading this might be thinking, “how do I know when a provision is pay-if-paid compared to pay-when-paid?” Catching the difference can be tough and all phrasings are unique, so reach out to your attorney – it’s worth the call!
The reality is these provisions are becoming more and more common, and subcontractors will often have to accept the qualification on their payment right. However, by recognizing this provision and potential pitfalls, a subcontractor can at least enter an arrangement with its eyes open. That knowledge can help save disappointment down the road.
When one of your cases is in need of a construction expert, estimates, insurance appraisal or umpire services in defect or insurance disputes – please call Advise & Consult, Inc. at 888.684.8305, or email experts@adviseandconsult.net.