It’s a common scenario in construction: the owner pays the GC, who then pays the subs, but because the subs have contracted with the GC rather than the owner they look to the GC for payment. And unless the subcontract says otherwise, the GC must pay for their performance regardless of whether the owner pays the GC.
Many subcontracts do say otherwise. GC’s are understandably reluctant to risk liability to their subs despite nonpayment by owners, and often try to pass the risk of owner default down to their subs by making their obligation to pay contingent upon receipt of payment for their work from the owner. The law will enforce that risk-shifting if the sub has clearly and unambiguously agreed to assume the risk of an owner default.
In this regard, courts frequently distinguish “pay-when-paid” clauses from “pay-if-paid” clauses. A "pay-when-paid" clause typically provides that the GC will pay the sub within X days of receiving payment from the owner. Some contractors mistakenly assume that this shifts the risk of nonpayment to the sub (reasoning that if the GC never gets paid, the sub has to wait forever plus X days before its payment falls due!), but most courts view these provisions as timing mechanisms rather than permanent excuses not to pay, and will require payment to the sub eventually regardless of whether the owner pays the GC. By contrast, a "pay-if-paid" clause makes receipt of payment from the Owner a condition precedent to the GC’s obligation to pay a sub. (An example might be “Contractor shall have no obligation to pay Subcontractor unless Contractor has first been paid by the Owner for Subcontractor’s work, receipt of which payment by Contractor is a condition precedent to any right of Subcontractor to be paid for its work.”)
There is an important qualification to this, one which arises most often in the context of change order disputes: the GC must make a good faith effort to get paid by the owner for the sub’s work. And it must do so even if it disagrees that the sub is entitled to extra payment. This principle was in play in Seaward Const. Co., Inc. v. City of Rochester, 118 N.H. 128 (1978). In that case, a contract to lay sewer pipe for the city provided that “All monies due under the Contract are subject to the receipt of said monies by said Rochester Housing Authority from the Federal Housing and Urban Development Agency (HUD)” and "Payment to said Seaward Construction Company, Inc. is contingent upon receipt of funds by the Rochester Housing Authority.” The price per installed foot depended on the depth, and when a dispute arose over how deep 920 feet of pipe was laid, the city refused to pay Seaward the higher price, pointing out that it had received no money from HUD to do so. The Court acknowledged that “the agreement is perfectly clear that the city will not be required to expend its own funds for payment,” but also held that “the city was under an implied obligation to make a good-faith effort to obtain funds from HUD to pay the plaintiff.” The Court ruled that the city would be liable “unless it proves that, given a reasonable time, it has made a good-faith effort to obtain the funds from HUD and it has been unsuccessful.”
Broadly worded “pay-if-paid” clauses can conceivably shift risk the risk of nonpayment even onto subs whose work is acceptable to the owner. If the owner refuses to pay the GC due to some separate breach not involving a particular sub, will a “pay-if-paid” clause avoid the GC’s obligation to pay that sub? That depends on the intent of the parties. Rather than leave it to chance, this scenario should be addressed in the subcontract.
Because subcontract terms only bind the parties to the agreement, a “pay-if-paid” clause will not protect an owner who hasn’t paid the GC for the sub’s work from direct liability to the sub on principles of unjust enrichment. (The Merrimack County Superior Court so ruled in 2011 in Axenics, Inc. v. Turner Construction Company, No. 217-2010-CV-5001). I’ll address this in a future blog.
Many subcontracts do say otherwise. GC’s are understandably reluctant to risk liability to their subs despite nonpayment by owners, and often try to pass the risk of owner default down to their subs by making their obligation to pay contingent upon receipt of payment for their work from the owner. The law will enforce that risk-shifting if the sub has clearly and unambiguously agreed to assume the risk of an owner default.
In this regard, courts frequently distinguish “pay-when-paid” clauses from “pay-if-paid” clauses. A "pay-when-paid" clause typically provides that the GC will pay the sub within X days of receiving payment from the owner. Some contractors mistakenly assume that this shifts the risk of nonpayment to the sub (reasoning that if the GC never gets paid, the sub has to wait forever plus X days before its payment falls due!), but most courts view these provisions as timing mechanisms rather than permanent excuses not to pay, and will require payment to the sub eventually regardless of whether the owner pays the GC. By contrast, a "pay-if-paid" clause makes receipt of payment from the Owner a condition precedent to the GC’s obligation to pay a sub. (An example might be “Contractor shall have no obligation to pay Subcontractor unless Contractor has first been paid by the Owner for Subcontractor’s work, receipt of which payment by Contractor is a condition precedent to any right of Subcontractor to be paid for its work.”)
There is an important qualification to this, one which arises most often in the context of change order disputes: the GC must make a good faith effort to get paid by the owner for the sub’s work. And it must do so even if it disagrees that the sub is entitled to extra payment. This principle was in play in Seaward Const. Co., Inc. v. City of Rochester, 118 N.H. 128 (1978). In that case, a contract to lay sewer pipe for the city provided that “All monies due under the Contract are subject to the receipt of said monies by said Rochester Housing Authority from the Federal Housing and Urban Development Agency (HUD)” and "Payment to said Seaward Construction Company, Inc. is contingent upon receipt of funds by the Rochester Housing Authority.” The price per installed foot depended on the depth, and when a dispute arose over how deep 920 feet of pipe was laid, the city refused to pay Seaward the higher price, pointing out that it had received no money from HUD to do so. The Court acknowledged that “the agreement is perfectly clear that the city will not be required to expend its own funds for payment,” but also held that “the city was under an implied obligation to make a good-faith effort to obtain funds from HUD to pay the plaintiff.” The Court ruled that the city would be liable “unless it proves that, given a reasonable time, it has made a good-faith effort to obtain the funds from HUD and it has been unsuccessful.”
Broadly worded “pay-if-paid” clauses can conceivably shift risk the risk of nonpayment even onto subs whose work is acceptable to the owner. If the owner refuses to pay the GC due to some separate breach not involving a particular sub, will a “pay-if-paid” clause avoid the GC’s obligation to pay that sub? That depends on the intent of the parties. Rather than leave it to chance, this scenario should be addressed in the subcontract.
Because subcontract terms only bind the parties to the agreement, a “pay-if-paid” clause will not protect an owner who hasn’t paid the GC for the sub’s work from direct liability to the sub on principles of unjust enrichment. (The Merrimack County Superior Court so ruled in 2011 in Axenics, Inc. v. Turner Construction Company, No. 217-2010-CV-5001). I’ll address this in a future blog.
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