If you are in the business of hiring subcontractors—or if you are a subcontractor yourself—you know how messy things can get when a project owner fails to pay a bill. Revenues drop, tensions flare, and each party is left wondering if and when they will ever be compensated for their work. This sort of situation strains not only the relationship with the project owner, but the relationship between the general contractor and his/her sub.
Contractors attempt to mitigate the problem of delinquent owners through the use of contractual payment clauses. Payment clauses are provisions in subcontracts that address how and when a subcontractor gets paid. While the language of these provisions varies from contract to contract, they often fall into one of two broad categories: “pay-if-paid” and “pay-when-paid” clauses. On their faces, these clauses appear very similar. Courts, however, treat the two quite differently.
A “pay-if-paid” clause conditions payment to a subcontractor on the contractor’s receipt of funds from the project owner. Put differently, if the owner of a project refuses or delays to pay the contractor, that contractor is not obligated to pay his/her sub unless and until he/she receives payment. This arrangement is the result of specific contractual language, which—for example—might provide that “Subcontractor acknowledges that Contractor shall be under no obligation to make any payments to Contractor for any work performed hereunder unless and until Contractor receives all subject funds from the Owner for the work which Subcontractor performs under this Agreement.” The emphasized “unless and until” language creates a condition precedent (i.e., a condition that must occur before a duty to perform under a contract arises) that is the distinguishing feature of a “pay-if-paid” clause—namely, that the contractor must receive funds from the owner before there is any obligation to pay the subcontractor. While there are no “magic words” required to create a “paid-if-paid” provision, the language must clearly demonstrate the parties’ intent to create a condition precedent.
By contrast, a “pay-when-paid” does not condition payments to a subcontractor on the contractor’s receipt of payment from the project owner. Instead, a “pay-when-paid” clause merely creates a timing mechanism for the payment. For example, a “pay-when-paid” clause might provide that “Contractor will pay Subcontractor for work performed hereunder within thirty (30) days after Contractor receives all subject funds from the Owner for the work which Subcontractor performs under this Agreement.” While, at first glance, this language is similar to the sample “pay-if-paid” clause included above, its lack of an express condition precedent makes it very different—at least in the eyes of the law. For this reason, courts view “pay-when-paid” clauses as relating only to the timing of payment, and not whether the subcontractor is actually entitled to that payment. Accordingly, where a “pay-when-paid” clause controls the relationship between the parties, a subcontractor is entitled to payment from the contractor within a reasonable period of time, regardless of whether the contractor is ever paid by the project owner.
Where you stand on the foregoing payment clauses depends on where you sit. Undoubtedly, “pay-when-paid” clauses are better for subcontractors, as they ensure at least some payment for services performed. Conversely, “pay-if-paid” clauses favor general contractors inasmuch as they protect against an owner’s non-payment. Whichever your stance, it is important to understand the difference between the two. As is often the case with contract law, a few words can make all the difference. If you have any questions, please contact one of our attorneys at Hamburg, Rubin, Mullin, Maxwell & Lupin, P.C.