5 Ways to Attack a “Pay if Paid” Clause
Kegler Brown Construction Law Newsletter March 20, 2019
“Pay when Paid” in many jurisdictions – including Ohio – means that while timing of payment may be delayed, there still is obligation to pay the sub within a reasonable period of time. In contrast, “Pay if Paid” (frequently utilizing words like “if” and “condition precedent”) means that not only timing, but also entitlement to payment can be derailed if payment is not received by the contractor from the owner. This difference can be the difference between eventually receiving payment or nothing at all.
But if a sub finds that it is confronted with a “Pay if Paid” clause in the subcontract, there are potential defenses available to seek to avoid the disastrous ramifications of such a clause.
1. “Pay if Paid” Violates Public Policy.
Some states have statutes making “Pay if Paid” clauses void and an unenforceable due to public policy, while others have court decisions invalidating these harsh clauses. For example, New York and California have determined that “Pay if Paid” clauses are unenforceable as they adversely affect lien rights.
2. “Pay if Paid” Clause is Ambiguous.
In most places, a “Pay if Paid” clause must be clear and unambiguous to be enforceable. Any contrary provision in the subcontract might be utilized to suggest a lack of clarity or ambiguity that could invalidate the clause. And the clause itself must be crystal clear using terms like “if” and “condition precedent.” Some clauses even go so far as expressly describing that the sub is assuming the credit risk of non-payment by the Owner.
3. “Pay if Paid” Clause is Unenforceable Under the Prevention Doctrine.
The prevention doctrine stands for the proposition that you cannot prevent a party from satisfying a condition that is a requirement for a blameless party to recover. In other words, a contractor cannot fail to perform causing an owner to refuse to pay and then hide behind the “Pay if Paid” clause in refusing to pay a subcontractor who had nothing to do with it. Pennsylvania cases have held that the prevention doctrine keeps a general contractor from enforcing a “Pay if Paid” clause when the subcontractor played no role in the non-performance. A Pennsylvania Court recently found that the “Pay if Paid” clause was unenforceable when delay on the part of the contractor was a factor in withholding payment (Connelly Construction v. The Travelers, 2018 WL 3549281).
4. The Lesser Amount Paid by the Owner is the “Amount Due” or “Monies Due” Under the “Pay if Paid” Clause.
“Pay if Paid” clauses often are written to state that payment of the “amount due” or “monies due” from the owner is a condition precedent to the obligation to pay the sub. One Ohio Court held that a subcontractor might beat the “Pay if Paid” clause by arguing that the “monies due” were the reduced sum recovered by the general contractor (after deductions). In that circumstance the “Pay if Paid” clause would not bar recovery by the sub, even if full payment was not made (Kalkreuth Roofing v. Bogner, 1998 WL 666765).
5. Condition Your Bid Upon Equitable Subcontract Language and Take a Negotiating Stand Against “Pay if Paid.”
Some savvy subcontractors condition their bids upon “acceptable subcontract terms” and have taken a stand against assuming the risk of “Pay if Paid” clauses.
The best way to avoid the negative ramifications of a “Pay if Paid” clause is by not agreeing to one in the first place. In that way, the smart subcontractor can avoid the risks and costs associated with challenging a “Pay if Paid” clause in court.