N.Y. High Court Finds “Pay if Paid” Clause Unenforceable
Kegler Brown Construction Newsletter February 1, 1996
"Pay when Paid" subcontract agreements are structured in a way that payment from the general contractor to the subcontractor is conditioned upon prior receipt of payment from the owner to the general contractor. Ordinarily, the subcontract will state that payment is due to the subcontractor within a certain period of time after receipt by the general contractor of payment from the owner. Such a conditioning of payment in a subcontract is known as a "Pay when Paid" clause.
Ohio courts have traditionally interpreted "Pay when Paid" provisions as an unconditional promise to pay, with the time of payment being postponed until the happening of a certain event, or after a reasonable period of time has elapsed if such event does not take place. Thomas J. Dyer Co. v. Bishop Int's Eng'g Co., (C.A. 6, 1962), 303 F.2d 655; Power & Pollution Services v. Suburban Piping (1991), 74 Ohio App. 3d 89. That means that the general contractor must pay within a "reasonable time" if the triggering event does not occur —not that the general contractor need not ever pay the subcontractor in the event of non-payment by the owner.
However, recently many general contractors have begun inserting "Pay if Paid" provisions in their subcontracts, stating something to the effect that the subcontractor assumes the risk of non-payment by the owner and payment by the owner to the general contractor is a condition precedent to payment by the general contractor to the subcontractor. In this way, the general contractor is attempting to insulate himself from any liability to the subcontractor at any time in the event of non-payment by the owner.
Court decisions in other states have upheld the validity of "Pay if Paid" provisions if they unambiguously express the intention of the parties to shift the credit risk to the subcontractor. Southern States Masonry v. J.A. Jones Construction, (LA. 1987), 507 So. 2d 198, 206; Gulf Construction v. Self, (Tex. App. 13 Dist. 1984) 676 S.W.2d 624, 627; Statesville Roofing & Heating v. Duncan, (W.D.N.C. 1988), 702 F. Supp. 118, 121. Although no Ohio court in a reported case has yet ruled on such a "Pay if Paid" provision, it is likely that it would be found enforceable in view of the decision in the Dyer case if it clearly stated that the credit risk of the possible insolvency of the owner was being transferred from the general contractor to the subcontractor.
However, the New York Court of Appeals recently found that such a "Pay if Paid" clause in Gilbane's subcontracts was unenforceable under New York law on a project where a payment bond was provided. This decision hinged on New York's mechanic's lien law which prohibits the waiver of lien rights without payment. New York's highest court ruled that a "Pay if Paid" clause which forces the subcontractor to assume the risk of owner non-payment is void and unenforceable as against public policy as set forth in New York's lien law and allowed full recovery by the subcontractor against Gilbane and its bonding company. West-Fair Electric Contractors v. Aetna, 1995 N.Y. LEXIS 4448.