Paid “if” or “when” – the bane of a lower tier contractor

When it comes to getting paid, two questions are of the utmost importance – How much? and When? There are many ways to delay, shift and otherwise avoid obligations to make timely payments to lower tier entities utilized by general contractors. One of the more troubling tactics involves making payment obligations to subcontractors contingent upon receipt of payment from the owner. Depending upon the payment language within the contract, a subcontractor could potentially assume the risk of non-payment regardless of their limited contact with the owner.

            The courts recognize two types of payment clauses: paid-when-paid and paid-if-paid. Under a paid-when-paid clause, when so much time has passed that any further delay in payment would be unreasonable, the contractor must pay the subcontractor, notwithstanding the lack of payment from the owner. This timing mechanism prevents shifting the risk of nonpayment from contractor to subcontractor. Conversely, a paid-if-paid clause explicitly shifts the risk of nonpayment to the subcontractor by stating in the contract language that payment from the owner is a condition precedent to the contractor’s obligation to pay the subcontractor.  If the contractor does not recover from the owner, the contractor owes nothing to the subcontractor.

            On occasion, contractors replace the standard paid-when-paid language found in AIA and AGC form documents to paid-if-paid language – making subcontractor payment contingent upon receipt of payment from the owner.  In construction contracts, payment clauses are often subject to litigation and can result in the court deciding the implications of the contract language.  In these cases, the intent of the parties is the primary consideration.  If the contract terms are clear, the court cites nothing but the original agreement to determine the parties’ intent.  However, if the contract language is ambiguous, the court will look beyond the agreement when determining the intent of the parties.

            Unfortunately, even when the payment terms are clear, there can still be issues with final payment. These situations often arise at the end of a project. For example, after a project is completed, an owner has outstanding issues and decides not to release retention to the contractor until the issues are resolved. If the issues have nothing to do with the quality or timeliness of the subcontractor’s work, is the subcontractor entitled to payment? Depending on the breadth of the payment language, the answer is – possibly.  Including language in the contract that addresses this type of situation could help to avoid this potentially contentious circumstance and  also protect the subcontractor in the event of the owner’s financial inability to pay.

            In the case of a bonded project, can the surety use such contract language as a defense to a payment bond claim?  While generally a surety is entitled to raise all of the defenses that its principal (contractor) may have, some courts have questioned this defense on the basis that it eliminates a claim that a subcontractor would otherwise have under the bond law, and as such is against public policy.  While these holdings have been made in other jurisdictions, this specific question has yet to be addressed by the Pennsylvania courts. As such, whether or not a surety can take advantage of this contract term in Pennsylvania remains to be seen.

            Ultimately, both contractors and subcontractors should diligently draft and review payment language within their contracts, ensuring the terms align with their business expectations and risk allocation. Otherwise, in the case of litigation, final payment decisions could be left to the courts.  If you wish to discuss the details of this article or need assistance dealing with a payment condition, contact David Raves at 412.242.4400 or [email protected].