By: Paul R. Fitzgerald, Esq.
A common provision in a construction contract is the “pay-if-paid” clause. The purpose of a pay-if-paid clause is to permit the general contractor to withhold payment from its subcontractor unless and until the general contractor’s application for payment is accepted and paid by the project owner. From the general contractor’s perspective, this clause is not only reasonable, but necessary. If the general contractor has not been paid for its subcontractor’s services, the general contractor will not want to pay its sub out of its own pocket.
From the subcontractor’s perspective, however, pay-if-paid clauses unfairly shift the risk of nonpayment to the sub, especially when the sub is not responsible for the owner’s failure to make payment to the general contractor. Moreover, the general contractor is almost certainly in a better position than the sub to exert pressure on a nonpaying owner (although the sub should not hesitate to exercise his mechanic’s lien rights in order to facilitate prompt payment).
Pay-if-paid clauses impose such an unfair burden on subcontractors that several states have barred their use entirely. In other states, a pay-if-paid clause must be clearly and unambiguously worded in order to excuse a general contractor’s payment obligations to its subs. In the absence of such clear language, the provision will be interpreted as a “pay-when-paid” clause, which does not relieve the general contractor of the duty to pay its subs but merely postpones payment for a “reasonable time.”
This article discusses the difference between pay-if-paid and pay-when-paid clauses. The article also addresses how these clauses have traditionally been interpreted by Connecticut courts, and how a recent Connecticut Superior Court decision represents a departure, with troubling implications for subcontractors. The article concludes with practical suggestions for both general contractors and subcontractors to consider when drafting contracts which contain contingent payment provisions.
Pay-when-paid vs. pay-if-paid: Pay me later vs. pay me never.
As a general rule, it is the general contractor, not the subcontractor, who assumes the risk of nonpayment from the project owner. Connecticut courts typically will not enforce a “pay-if-paid” clause unless payment by the owner is made a “condition precedent“ to payment by the general contractor of its sub. The term “condition precedent” should itself appear within the contract, in plain and unambiguous language.
However, and somewhat confusingly, even when payment is expressly made a “condition precedent” in a subcontract, some Connecticut courts have construed these provisions as “pay-when-paid” clauses. The difference is significant: a pay-if-paid provision excuses the general contractors’ payment obligations to its subcontractors entirely, whereas a pay-when-paid clause merely postpones the general contractors’ payment obligations for a “reasonable time.”
Connecticut courts have traditionally held that a contingent payment provision is a pay-when-paid clause- even if the term “condition precedent” is present– if any of the following factors apply:
- if the payment provision is ambiguous;
- if it is still possible that the owner will pay the general contractor;
- if the other terms of the subcontract did not indicate that the parties intended to absolve the general contractor of its obligation to pay the sub;
- if the provision does not specifically address the risk of the owner’s insolvency;
- if the general contractor has not provided evidence that it has been unable to obtain final payment from the owner; and/or
- when the conduct of the general contractor is the cause of the owner’s failure to make payment.
In one Connecticut Superior Court decision, the court applied the above factors to the following provision and determined that the clause was a pay-when-paid provision, not a pay-if-paid provision:
The Contractor shall have no liability or responsibility for any amount due or claimed to be due to Subcontractor except to the extent Contractor actually receives funds from Owner specifically designated for disbursement to the Subcontractor as receipt of such funds from the Owner are specifically made a condition precedent to the Contractor’s obligation to make payments to Subcontractor hereunder.
In another Superior Court decision, the court held that the following provision was also a pay-when-paid clause, despite the use of the term “condition precedent,” because the language in the article was “somewhat ambiguous:”
Subcontractor expressly agrees that payments by Owner to General Contractor for Work performed by Subcontractor is an express condition precedent to any payment by General Contractor to Subcontractor and that General Contractor is under no obligation to make any partial, final or retainage payments to Subcontractor … until and unless General Contractor has been paid by Owner. Subcontractor agrees to accept the risk that it will not be paid for Work performed by it in the event General Contractor, for whatever reason, is not paid by Owner for such Work.
But, language that explicitly assigns the “credit risk for owner nonpayment” to the Subcontractor is critical. The following is an example of a contingent payment provision which has been interpreted as a “pay-if-paid” clause by a Connecticut court:
Progress payments to the Subcontractor for satisfactory performance of the Subcontractor’s Work shall be made only to the extent of and no later than fifteen (15) working days after receipt by the Contractor of payment from the Owner for the Subcontractor’s work. The Subcontractor agrees that the Contractor shall be under no obligation to pay the Subcontractor for any Work until the Contractor has been paid by the Owner. The payment provisions of this Agreement are subject to the condition that the Contractor receive, in good funds from the Owner, progress payments in at least the amounts payable to the Subcontractor on account of Work done by the Subcontractor on this Project. The Subcontractor expressly acknowledges and agrees that payments to it are contingent upon the Contractor receiving payment from the Owner. The Subcontractor expressly accepts the risk that it will not be paid for Work performed by it if the Contractor, for whatever reason, is not paid by the Owner for such Work. The Subcontractor states that it relies primarily for payment for Work performed on the credit and ability to pay of the Owner and not of the Contractor, and thus the Subcontractor agrees that payment by the Owner to the Contractor for work performed by the Subcontractor shall be a condition precedent to any payment obligation of the Contractor to the Subcontractor.
The takeaway from these and other Connecticut cases is that even when there is clear “condition precedent” language, Connecticut courts have been reluctant to enforce the provision in a way that shifts the burden of nonpayment entirely unto the sub. Courts have been far more likely to give the general contractor a reasonable time to collect payment from the owner. That all changed with Electrical Contractors, Inv. v. 50 Morgan Hospitality Group, LLC, No. X07HHDCV186088917S, 2019 WL 2305068 (Conn.Super. April 30, 2019).
ECI v. 50 Morgan: a subcontractor owed an undisputed amount, a general contractor unwilling to bring a claim against the project owner, and a pay-if-paid clause.
The facts underlying this recent Connecticut Superior Court case may be disturbingly familiar to many subcontractors. The general contractor on a privately-owned construction project claimed that although it had sought payment from the project owner for its subcontractors’ work, the owner had failed to release payment. As a result of the nonpayment, numerous subs filed mechanic’s liens on the property and filed breach of contract claims against the general contractor. Significantly, the general contractor did not file its own lien or lawsuit against the owner, despite allegedly being owed a substantial sum itself.
The general contractor did not deny that its subs were owed money, but instead sought summary judgment on the basis that the subs’ claims against the general contractor were barred by a purported “pay-if-paid” provision. The provision, which was only a single sentence, read as follows:
Subcontractor expressly agrees that payment by the Owner to General Contractor is a condition precedent to General Contractor’s obligation to make partial or final payments to Subcontractor as provided in this paragraph.
The general contractor did not introduce any evidence that it had made any attempt to obtain payment from the owner beyond merely forwarding the subs’ payment applications to the owner. The general contractor also did not show that its own conduct was not the cause of the owner’s failure to make payment.
Despite the brevity of the clause and its similarity to other clauses which have been deemed pay-when-paid clauses by prior Connecticut courts, the court in this case granted summary judgment in the general contractor’s favor. The subs were therefore left to pursue their claims against an owner whose sole asset was a property that was badly underwater.
How to handle pay-if-paid clauses in the wake of ECI v. 50 Morgan.
Until the Connecticut Supreme Court definitively rules on the enforceability of pay-if-paid clauses, contractors and subcontractors in Connecticut will be left to negotiate these provisions without any clear guidance. So far, there simply is a disagreement among various trial courts as to how to handle these “payment is a condition precedent” clauses. However, there are steps that both general contractors and subs should take to protect their respective interests.
General contractors seeking to enforce a pay-if-paid clause should ensure that the clause is carefully drafted to make payment by the owner a condition precedent to payment by the general contractor, and also to clearly “shift the risk of nonpayment” to the sub. The more detailed the provision, the more likely a court will be to shift the risk of nonpayment to the sub.
Subcontractors who do not wish to assume the risk of the owner’s nonpayment should attempt to strike any pay-if-paid provision from their contracts before signing the contract. At the very least, such provisions should be modified to give the general contractor a reasonable time to obtain payment from the project owner, but not eliminate the general contractor’s liability to the sub entirely in the event of an owner default. If the sub has contracts with his own suppliers and sub-subcontractors, he should incorporate the pay-if-paid clause into those agreements. If the sub is unable to strike or modify a pay-if-paid provision and he believes payment may be a problem, he should seriously consider passing on the project entirely.
Finally, it is important to note that Connecticut has enacted a law which allows subs to sue a private project owner directly for late payments after providing notice of nonpayment to the owner. The law, which was enacted with the help of the Connecticut Subcontractor’s Association, is known as the Fairness in Construction Financing Act, Connecticut General Statutes §42-158i et seq. The Act applies to private commercial and industrial construction contracts valued at more than $25,000.00, as well as residential contracts with more than four units. The Act was enacted in part to eliminate the problem encountered by many subs with pay-if-paid clauses. For a greater discussion of the Act, see our prior newsletter on the topic.
Conclusion
Pay-if-paid and pay-when-paid clauses are the source of much uncertainty in Connecticut. Subcontractors should be very wary of such provisions, especially in the wake of ECI v. 50 Morgan. If you have questions regarding pay-if-paid or pay-when-paid clauses, please call MKRB at 860-522-1243.
Michelson, Kane, P.C.
