By Bridget McCrea
Brent Dezember has seen more than his fair share of “pay-if-paid” clauses inserted into his firm’s work contracts lately. Credit the shaky economy and challenging conditions in the construction industry with creating an environment where more general contractors (GCs) use these clauses to delay subcontractor payments if and when the project owner can’t or won’t pay the GC on time.
“We’re seeing pay-if-paid clauses in more of our larger, longer-term contracts,” says Dezember, president at Bakersfield, Calif.-based StructureCast. “In fact, nearly all of these contracts include these clauses.”
The thing is, Dezember’s state doesn’t even recognize the clauses as legally enforceable, but that doesn’t stop the GCs from at least trying to write them into their contracts. The hope is that if it really comes down to it, the precaster would rather wait to get paid than spend the money and time going to court.
“Even though the state of California doesn’t recognize pay-if-paid clauses, which wouldn’t stand up in the court of law,” Dezember explains, “all of the larger contracts we’ve been dealing with lately do include them.”
An increasing number of precasters are dealing with pay-if-paid clauses, which are governed differently according to state law. In general, the clauses state the GC is not required to pay the subcontractor unless – and until – the project’s owner pays the GC. The clauses aren’t problematic until it comes time for the subcontractor – particularly the one that’s located in a state that recognizes pay-if-paid clauses as legal – to collect the money that it’s owed.
Pay-if-paid clauses are usually worded like this one, from the Associated General Contractors of Washington:
It is agreed that as a condition precedent to any payment by Contractor to Subcontractor hereunder the Contractor must first receive payment from the Owner for the Work of Subcontractor for which payment is sought. Subcontractor specifically agrees that it is relying upon the Owner’s credit (not the Contractor’s) for payment, and Subcontractor specifically accepts the risk of non-payment by Owner.
A number of states have ruled that pay-if-paid clauses are unenforceable as a violation of public policy, but a few of the states continue to recognize the clauses or certain variations of them as valid, including Arizona, Colorado, Georgia, Florida, Illinois, Michigan and Maryland. On the other hand, both New York and California have invalidated such clauses. Most recently, Massachusetts enacted a new law eliminating pay-if-paid provisions and reasonable time periods for processing project payments to subcontractors.
Yet GCs continue to include the clauses in their contracts, regardless of whether the verbiage will ultimately stand up in the court of law. “I believe they all know that they can’t enforce the clauses, but most of the GCs we’re working with on large projects are telling us that it’s a non-negotiable point,” Dezember laments. He has occasionally turned to California’s lien law to collect on overdue payments from GCs and circumvent the pay-if-paid terms spelled out in the contracts.
“When things get to be 30 to 45 days past due,” says Dezember, “we file a lien and tend to get paid pretty quickly.” To let GCs know in advance that it’s aware of its rights in California, the StructureCast team also strikes the clauses from the contract, cites the state code regarding pay-if-paid clauses and includes that information with the signed contract.
Nationally, a high number of subcontractors are making similar moves, and/or signing the contracts in the interest of keeping the business pipeline filled. The American Subcontractors Association (ASA) of the Carolinas refers to such clauses as the “dark side of the industry,” and says that even those subcontractors doing work in states like New York and North Carolina – where pay-if-paid provisions are not enforceable – are “bound to run into the clauses … which should not be taken lightly.”
“The proliferation of the pay-if-paid clause is a cause for alarm,” the ASA states in a recent member newsletter. “Besides being a heavy-handed and exculpatory contract clause, pay-if-paid also is an affront to the professionalism of construction contractors and subcontractors. There is no other industry in which a pay-if-paid clause would be taken seriously. The mere act of offering or accepting a pay-if-paid clause without seeking alternative language sets the construction industry apart – and not in a positive way.”
Chuck Babbert is pretty used to seeing pay-if-paid clauses in the contracts that come across his desk these days. As president of sales for E.C. Babbert in Canal Winchester, Ohio, Babbert says he automatically strikes through such clauses, and has “never entered into a contract knowing that there would be a pay-when-paid or pay-if-paid clause in it.”
But that doesn’t mean Babbert’s team isn’t grappling with the same issues that many subcontractors have to deal with when it comes to getting paid on time. In some cases, customers wait out E.C. Babbert’s net 30-day payment terms and then use excuses like, “But wait, we haven’t been paid by the owner yet!” to avoid paying on time.
“It’s amazing how many customers apply for credit, knowing that we have 30-day payment terms, and then turn around and tell me that they’re not paying until they get paid,” Babbert explains. “That sounds a lot like pay-when-paid to me.”
Recently, for example, Babbert says his firm signed on to complete a job for a “very good” customer that just moved all of its precast work over to E.C. Babbert from a local competitor. Written right into the customer’s purchase order terms was a pay-when-paid clause that the precaster’s sales rep struck through before sending the document back to the customer.
Babbert doesn’t expect the customer to raise a fuss over the issue, nor does he think that a pay-when-paid arrangement will negatively impact the precaster’s ability to collect. “It shouldn’t create too much of a headache, because we have a relationship with this customer,” says Babbert, “and it should have regular draws to pay us.”
Contingency payment clauses (or customer-initiated “we pay when we get paid” rules) do create headaches for E.C. Babbert when the precaster is the first company on the job site to set up underground utilities and other infrastructure components. Getting customers to stick to the firm’s net-30-day payment terms can be challenging in such cases.
“When you’re the first on the site – and if the contractor is getting paid only for structures installed at the time of submission for the draw – proof of payment can be a sticking point,” Babbert explains. “Still, it’s not as difficult as collecting when a pay-if-paid or pay-when-paid clause is applied.” In such cases, Babbert says his firm turns to Ohio’s prompt pay act, which requires GCs to pay their subcontractors within 10 days, or incur an 18% interest charge on the balance.
“We’ve actually had to use the prompt pay rule with customers in the past; mention it and it tends to get the customer’s attention pretty quickly,” says Babbert. “The law provides us with some leverage when customers tell us that they haven’t been paid, when in reality they have received their compensation.”
Andrew W. Daniels, a partner with LeClairRyan in Boston, represents a large number of general contractors, owners, construction managers, design/builders, subcontractors and manufacturers in a variety of business and complex litigation matters.
To precasters looking for help in this area, Daniels says a good first step is to find out exactly how the clauses are viewed in the state where the work will take place (and not just your “home” state, since any lawsuits will need to be filed in the state where the business was conducted).
Some states, like West Virginia and Florida, enforce pay-if-paid clauses under the legal “freedom to contract” doctrine, says Daniels. Others, like California, don’t recognize the clauses at all, based on the fact that they go against public policy.
Other states, like North and South Carolina, and Wisconsin, approach the issue from a statutory standpoint – based on the assumption that subcontractors lack the leverage necessary to negotiate specific contract terms – and as such, have made contingency payment clauses unenforceable.
Once you’ve determined the respective state’s rules regarding contingency payment clauses, Daniels says a simple move is to work only in states where the conditions are favorable to subcontractors. This may not be possible if your home state doesn’t fall into that category, he acknowledges, but it can help precasters do a more targeted job of picking projects in neighboring states.
“Know the laws of the states that you are working in, and use that information when you’re bidding on projects,” says Daniels. Also understand that there are no “guarantees” when it comes to the application of the law, and that one state’s interpretation of pay-if-paid may differ from the next. “Just because there is a pay-if-paid provision in the contract doesn’t mean it is enforceable.”
Subcontractors should also include suspension-of-work clauses in their contracts, according to Daniels, who sees this as a particularly smart move for any precaster whose state enforces pay-if-paid clauses. “If the contract states that the payment terms are net 30, and if you don’t get paid because of the pay-when-paid clause,” Daniels explains, “you want to make sure that you have the right to stop working.”
Finally, Daniels says precasters should demand an “open book” environment when it comes to the owner’s ability to cover the project costs, especially if there’s a chance that a pay-if-paid clause will be enforced. “If you take the risk of entering into an agreement that includes this clause,” says Daniels, “then you want to make sure that the money is out there, and that the owner can pay.”
But what about the GCs who don’t use the pay-if-paid clause, and instead simply avoid paying their bills until they get a check from the owner? Daniels says most courts will state that any pay-if-paid clause has to be unambiguous (i.e., clearly stated in the contract).
“The typical payment contingency clause states that the GC doesn’t have the obligation to pay the subcontractor until paid by the owner,” says Daniels. “If that expressed condition isn’t included in the contract, then the GC’s attempt to avoid paying won’t fly.”
Bridget McCrea is a freelance writer who covers manufacturing, industry and technology. She is a winner of the Florida Magazine Association’s Gold Award for best trade/technical feature statewide.