Terms and timing of payment are critical. A subcontractor that cannot manage cash flow is doomed. For terms of payment, most construction contracts use either a pay-when-paid or a pay-if-paid clause. Understanding the often subtle difference between the two is important for understanding when a subcontractor can expect payment.
1. Pay-when-paid.
A pay-when-paid clause is a timing mechanism that states that payment is due to a subcontractor within a certain time period after a contractor receives payment from the owner. A pay-when-paid clause, however, does not condition payment to a subcontractor on the contractor’s receipt of funds from the project owner. Sloane Co. v. Liberty Mutual Ins. Co., 2009 WL 2616715 (E.D.Pa. 2009)(“pay-when-paid” clauses “merely create a timing mechanism for a contractor’s payments to a subcontractor and do not condition payments to a subcontractor on the contractor’s receipt of those payments from the project owner.”)
2. Pay-if-paid.
Conversely, under a paid-if-paid clause a contractor’s receipt of payment from the owner is a strict condition precedent on payment to a subcontractor. Courts hold that a pay-if-paid clause in a subcontract shifts the risk of loss, from non-payment by the owner, to the subcontractor. Id.; Fixture Specialists, Inc. v. Global Construction, LLC., 2009 WL 904031 (D.NJ. 2009). Depending on the jurisdiction, a contractor may have to wait indefinitely for payment to a contractor to happen before it is paid, or it merely must wait only a “reasonable period” of time before it pursues payment from a contractor.
3. Telling the difference between the two.
The differences in the language used in a pay-when-paid verse a pay-if-paid clause are often subtle and requires careful analysis of the subcontract’s language. Most courts agree that in order for a payment clause to be construed as the more onerous pay-if-paid clause, whereby payment to the contractor is a condition precedent to payment to the subcontractor, there must be clear language showing the intention of the parties to shift the risk of non-payment. Id.; Seal Tite Corp. v. Ehret, Inc. 589 F.Supp. 701 (D.NJ.1984); Lafayette Steel Erectors, Inc. v. Roy Anderson Corp., 71 F.Supp.2d 582, 587 (S.D.Miss.1997); Mrozik Constr., Inc. v. Lovering Associates., Inc., 461 N.W.2d 49, 51 (Minn.Ct.App.1990) ; Watson Constr. Co. v. Reppel Steel & Supply Co., 123 Ariz. 138, 598 P.2d 116, 119 (Ariz.Ct.App.1979).
Sometimes it is easy differentiate between to the two clauses. If words such as “condition,” “if and only if,” or “unless and until” are used in describing when payment to a subcontractor is due, then the clause is most likely a pay-if-paid clause. Sloan Co., supra, at *5. However, courts have also construed payment clauses as pay-if-paid clauses when less obvious language is used. For example, one court held that a payment clause that stated “disbursement will be processed as funds are received” constituted a pay-if-paid clause as payment was conditioned on the contractor’s receipt of the funds. LBL Skysystems (USA), Inc. v. APG-America, Inc. 2005 WL 2140240 (E.D.Pa. 2005). Moreover, some courts have held that key words such as “condition precedent” are not alone dispositive and the courts must look to the entire subcontract in order to determine whether the parties intended to shift the risk of non-payment to the subcontractor. Sloan Co, supra, at * 6. Therefore, while a majority of courts give heavy weight to key words such as “condition precedent,” it is important to review the entire subcontract before concluding that a clause is a pay-if-paid rather than the more forgiving pay-when-paid variety. Of course, if possible, the safest bet would be to not agree to any payment terms that use the words “condition,” “if and only if,” or unless and until.”
Knowing what your rights to payment are important. As you can see, the difference between waiting indefinitely for payment and being able to pursue payment immediately sometimes hinges on few key words. Therefore, you need to scrutinize each subcontract carefully. Next week we look at termination for convenience clauses.
Wally Zimolong
Wally represents contractors (and subcontractors) and developers. His clients build and develop residential, commercial, and industrial properties nationwide. Wally enjoys working with the owners of the businesses he represents because they tend to be entrepreneurs and all around interesting people.
