Christopher M. Wise | The Dispute Resolver
Obviously, subcontractors prefer to be paid within a reasonable time, but the issue of what constitutes a “reasonable time” has been a conundrum many states have tackled over the years. From “pay-if-paid” to “pay-when-paid” provisions, states have either adopted one, both, or neither of these commonly controversial, heavily negotiated provisions. Recently, the California Court of Appeals has ruled on a “pay-when-paid” provision that might set the groundwork for subcontractors in other states arguing that “paid-when-paid” provisions should be against public policy.
Distinguishing Between Provisions
Both “pay-if-paid” to “pay-when-paid” provisions ultimately determine who will bear the financial risk of a construction contract. A “pay-if-paid” provision makes “payment by the owner to the general contractor a condition precedent to the general contractor’s obligation to pay the subcontractor for the work the subcontractor has performed.”1 Under a “pay-if-paid” provision, the risk of non-payment falls on the subcontractor if the owner refuses to pay the general contractor. Many states, including California, have concluded that “pay-if-paid” provisions are unenforceable because they indirectly waive or forfeit the subcontractor’s mechanic’s lien rights in the event of nonpayment by the owner.2
Under a “pay-when-paid” provision, the general contractor agrees to pay the subcontractor within a period of time after the general contractor is paid by the owner.3 Thus, under a “pay-when-paid” provision, the risk of non-payment falls on the general contractor. While a “pay-when-paid” provision is not a condition precedent, there is an implied understanding that the subcontractor has an unconditional right to payment within a reasonable time. While many states depart as to whether “pay-when-paid” provisions are enforceable, the underlining issue for a “pay-when-paid” provision is what constitutes a “reasonable time.”
Crosno Construction, Inc. v. Travelers Casualty & Surety Co. of America
On April 17, 2020, the California Fourth Appellate District Court of Appeals ruled against enforcing a “pay-when-paid” provision that would postpone the plaintiff’s right to recover under a payment bond for an indefinite time period. The underlining issue was whether a surety may defend a public works payment bond action by invoking an expansive “pay-when-paid” provision in a construction subcontract that defers payment for an indefinite period of time.4
North Edwards Water District (District) selected Clark Bros., Inc. (Clark) as its general contractor on a public works project to build an arsenic removal water treatment plant. Clark hired subcontractor Crosno Construction (Crosno) to build and coat two steel reservoir tanks.5 The subcontract contained a “pay-when-paid” provision that stated:
“If Owner or other responsible party delays in making any payment to Contractor from which payment to Subcontractor is to be made, Contractor and its sureties shall have a reasonable time to make payment to Subcontractor. ‘Reasonable time’ shall be determined according to the relevant circumstances, but in no event shall be less than the time Contractor and Subcontractor require to pursue to conclusion their legal remedies against Owner or other responsible party to obtain payment, including (but not limited to) mechanics’ lien remedies.”6
A dispute arose between Clark and District halting the project. Crosno sought to recover payment owned under the public works payment bond that Clark had obtained for the project.
The Court focused on whether postponing Crosno’s right to recover under the payment bond until Clark’s litigation against the District concluded would result in an unreasonable impairment of Crosno’s statutory payment bond remedy. Crosno never executed a waiver and release required to validly “waive, affect, or impair” its payment bond rights. Applying precedent, the court reiterated that postponing payments:
“. . . earned by a subcontractor, itself without fault, until a dispute between the contractor and the owner is resolved, perhaps months or even years later … gives no reasonable assurance that such a dispute would ever be resolved. If the contractor lost the dispute, the contractor would be required to pay his subcontractor creditor from other funds. If the contractor won the dispute, the contractor would be required to apply all or a substantial part of the money he receives toward his subcontract obligations. . . the contractor’s interest would seem more likely to benefit from avoidance of any settlement with the owner.”7
A “reasonable time,” in this case, would include an indefinite timeframe. In fact, the litigation between Clark and District had already reached the two-year mark prior to this ruling. For many subcontractors, managing business in the wake of the COVID-19 crisis is difficult enough. If subcontractors were to be forced to wait until contractor-owner litigation were resolved prior to receiving payment, most subcontractors would fail to survive.
Conclusion
Crosno reminds lawyers representing subcontractors that the purpose behind a public works payment bond is to provide subcontractors a sufficient means of payment. This distinct remedy to public works subcontractors is in addition to the protection payment bonds provide in the event of a defaulting contractor. Moreover, Crosno provides a subtle reminder of the importance of drafting specific waiver and releases. Generally, a waiver and release of payment bond rights can be enforceable to the detriment of the subcontractor. While many states differ on their enforcement of “pay-if-paid” and “pay-when-paid” provisions, arguing the element of reasonableness to protect otherwise disadvantaged subcontractors caught in-between contractor-owner litigation might be your best option.
1 Wm. R. Clarke Corp. v. Safeco Ins. Co., 15 Cal. 4th 882, 885 (1997).↩
2 Id. at 886.↩
3 Chapman Excavating Co. v. Fortney & Weygandt, Inc., 2004-Ohio-3867, ¶ 22 (Ct. App.).↩
4 Crosno Constr., Inc. v. Travelers Cas. & Sur. Co. of Am., Nos. D075561, D075562, 2020 Cal. App.at *8-9 (Ct. App. Apr. 17, 2020).↩
5 Id. at 1-2.↩
6 Id. at 4-5.↩
7 Id. at 17-18 (citing Yamanishi v. Bleily & Collishaw, Inc., 29 Cal. App. 3d 457, 463 (1972).↩