Contingent payment clauses

Many contractors and subcontractors examine their contracts carefully for time of performance and payment provisions, but overlook other serious financial risks inherent in their contracts. One of those commonly overlooked financial risks, contingent payment clauses, is discussed below..

Most general contractors seek to avoid making payments to a subcontractor prior to acceptance by the owner or architect of the subcontractor’s work and receipt of progress or final payment from the owner. This results in the use of contingent payment clauses. An example: Subcontractor agrees and specifically acknowledges that contractor has no duty or obligation to pay subcontractor for any work, pursuant to this agreement, until contractor has been paid by the owner. All payment provisions are subject to the condition precedent that contractor shall receive payments from the owner for all progress or final payments covering the amounts payable to subcontractor on account of work performed pursuant to this agreement.

General rules

Delayed payment clauses are generally considered either “pay if paid” or “pay when paid.” In most jurisdictions, these clauses will be construed as pay-when-paid clauses and therefore determine the time of payment only. In other words, the subcontractor gets paid when the contractor gets paid. Most courts shy away from conditions precedent whenever possible and hold that contingent payment clauses simply measure the time period during which the payment must be made. When no time period for payment is specified, a reasonable time is implied.

Under a pay-when-paid clause, the contractor must pay a performing subcontractor even if the owner does not pay the contractor.

However, some delayed payment clauses are construed as pay-if-paid whereby the subcontractor gets paid only if the contractor gets paid by the owner. Clauses using specific words such as “condition precedent” or “subcontractor assumes the risk of non-payment by owner” create an enforceable pay-if-paid clause.

Generally, pay-if-paid clauses shift the risk of an owner’s non-payment from the general contractor to the subcontractor while pay-when-paid clauses only affect the timing of payment. The trend of courts to avoid the harsh enforcement of a pay-if-paid clause continues. In the T.M.S. Mechanical Contractors Inc. v. Millers Mutual Fire Insurance Co. of Texas case, the U.S. Court of Appeals for the Fifth Circuit held that a conditional payment clause may not be used by a surety to defeat a Miller Act suit of an unpaid subcontractor. Cases in New York and California, such as the West-Fair Electric Contractors v. Aetna and Wm. R. Clarke Corp. v. Safeco, have held that contingent payment clauses would not defeat a subcontractor’s lien rights as a matter of public policy. The courts of most states, unless clearly drafted, do not favor contingent payment clauses, and their demise continues. However, if clear language provides that a subcontractor’s right to payment is subject to the condition precedent of the owner’s payment to the prime contractor, most courts will enforce the clause. For examples, see Christman Co. v. Anthony S. Brown Development Co. or Harvey Concrete Inc. v. Argo Construction & Supply Co. and Printz Services Corp. v. Main elect Ltd. Words couching payment in terms of “on,” “when,” and “after” indicate a pay-when-paid intent, as opposed to “subject to,” “upon the condition,” or “subcontract assumes the risk of owner’s failure to pay contractor.”

The dispute over contingent payment clauses will continue. It is essential that subcontractors and suppliers obtain legal advice on the treatment of payment clauses in the states in which they operate. A few states, such as Wisconsin, North Carolina and Illinois, have enacted statutory protections, but with those limited exceptions, a contingent payment clause can prevent a contractor’s obligation to pay subcontractors.