Contractors frequently hire subcontractors to perform many aspects of a construction project. In some cases, all of the work is performed by subcontractors. In order to pay the subcontractors for their work and materials, the contractor typically anticipates receiving payments from the owner for the work performed. Contractors will sometimes seek to transfer the risk of delayed payment onto the subcontractors by adding a “pay when paid” clause into the contracts between the contractor and the subcontractors.
Such clauses often lead to legal disputes between contractors and subcontractors. The question that typically arises is whether the contractor must pay the subcontractor if the owner never pays, and when is payment due.
Broadly speaking, many payment clauses in construction contracts fall into one of two categories: “pay-if-paid” or “pay-when-paid.” When a property owner fails to pay for subcontracted services or materials, understanding the nature of the contractor and subcontractor’s compensation arrangement is among the first steps involved in determining which party bears the risk of non-payment.
With a “pay-if-paid” clause, the subcontractor bears the risk of non-payment. If the contractor does not receive payment from the property owner, then it is not required to pay the subcontractor for material supplied or services rendered. This type of clause obviously favors the contractor substantially; and, in contract negotiations, subcontractors must consider whether they are willing for payment to be contingent upon the property owner satisfying its financial obligations to the contractor. Both parties should also carefully consider what collection measures the contractor should be required to undertake before it can deny payment to the subcontractor.
Under a “pay-when-paid” clause, the subcontractor is entitled to payment within a specified period of time after payment by the property owner; or, if the property owner does not pay, within a reasonable time after the completion of the subcontractor’s services. As a result, unlike a “pay-if-paid” clause, a “pay-when-paid” clause does not shift the non-payment risk to the subcontractor. The contractor is entitled to wait for payment according to the terms specified in the parties’ agreement; but, if it becomes clear that payment is not forthcoming, the subcontractor is still entitled to the agreed-upon compensation. In other words, the subcontractor can demand payment from the contractor prior to the contractor receiving payment from the owner, and even if the owner never pays.
“Pay-if-paid” and “pay-when-paid” clauses are not the only options available. Under varying circumstances, it can be in one or both parties’ best interests to negotiate an alternate payment provision.
When structuring the terms of payment, contractors and subcontractors should ensure that their agreements are as clear as possible, as ambiguous payment provisions tend to be ripe for litigation. Contractors and subcontractors should also be aware that prime contracts with property owners can include acceptance rights, lien waivers, prohibitions on “pay-if-paid” and “pay-when-paid” clauses, and other provisions that may limit their options; and, in any case, they should enter into their agreements with a clear understanding of the risks involved and the remedies (if any) available.
If you are preparing to negotiate an agreement for a construction project in the Jacksonville area, or if you are facing a potential payment dispute under a construction contract, we encourage you to contact us for a confidential consultation. To discuss your needs with one of our construction attorneys, please call (904) 737-4600 or send us a message online today.