Contingent Payment Clauses: Enforceable? Negotiable? Worth the Risk?
There is no easy answer to the question of whether contingent payment clauses are worth the risk, but understanding the nature of the law and the factors that should be considered can help you make an informed decision.
By Matt Meaker
As their name implies, “contingent payment” clauses make payment to a subcontractor contingent on some event. Typically, such clauses take one of two forms: “pay-when-paid” and “pay-if-paid.”
A pay-when-paid clause links the timing of a subcontractor’s payment to when the owner pays the general contractor. A pay-if-paid clause dictates that a subcontractor will get paid only if the owner pays the general contractor.
Although contingent payment clauses are not included in standard subcontract forms produced by either AIA or ConsensusDocs, they do appear in many of the non-standard subcontracts that subcontractors are asked to sign. If these sorts of provisions are not included in the two most frequently used and accepted standardized forms in the construction industry, why has almost every subcontractor seen such a clause in a subcontract presented to them?
It’s about mitigating risk. In drafting a contract, risks are generally allocated to the parties that are in the best position to manage them. In examining the risk of an owner failing to make a payment, the general contractor — not the subcontractor — is in the best position to evaluate and mitigate that risk. The general contractor can contractually require the owner to provide financial information to demonstrate the owner’s ability to finance and pay for the construction. While there may be other reasons for their inclusion, contingent payment clauses in subcontracts reflect a further effort by a general contractor to mitigate its risk — in this instance, of claims from a subcontractor — in the event of non-payment by the owner.
The existence of a contractual provision does not make it enforceable. Considering the frequency with which they are found, are contingent payment clauses enforceable within subcontracts? A good lawyerly answer is, “It depends” — on the type of clause, and on the state in which the contract is being evaluated.
With regard to pay-when-paid clauses, for over 30 years most state courts have found that payment cannot be indefinitely withheld from a subcontractor based upon a pay-when-paid provision. Instead, payment should be made to a subcontractor within a reasonable time after the satisfactory completion of the work.
As for pay-if-paid clauses, courts in many states — including Arizona — are willing to enforce them only if there is contractual language demonstrating the parties’ unequivocal intent that the subcontractor is to be paid only if the general contractor is paid. Determining the parties’ “unequivocal intent” involves a standard that varies from state to state.
In a 1997 Arizona case, L. Harvey Concrete v. Argo Constr. & Supply Co., the Arizona Court of Appeals held the following clause to be clear enough to be enforceable against the subcontractor:
“[S]ubcontractor agrees as a condition precedent to payment … that the owner shall have first paid the payment … to the contractor, and that payment for either progress payments or final payment is not due and owing to the subcontractor as provided for herein until the owner has made such payment to the contractor.”
Other states, including California and New York, have held that pay-if-paid clauses are a violation of public policy and are therefore void.
A subcontractor curious as to whether these clauses are enforceable in a given state should refer to “Contingent Payment Clauses in the 50 States,” an American Subcontractors Association publication that is free to ASA members. It provides a summary of the basic status of the law in each state and is a good resource, especially for subcontractors who work in more than one state.
In the event a contingent payment clause is included in a subcontract presented to a subcontractor, does the subcontractor have to accept it without question? Of course not. Every business owner needs to decide what things they are going to negotiate and what things they are going to live with.
If a subcontractor is confronted with a contingent payment clause and wants to propose alternative language, ASA’s recommended language is the following:
“Subcontractor does not accept the risk of Customer’s receipt of payments from any source, and in no event will payments to Subcontractor be based upon or subject to Customer’s receipt of payment for Subcontractor’s work.”
In a negotiation over the removal of a contingent payment clause, a subcontractor should consider making the following points:
- The subcontractor’s credit risk is with the general contractor and not the owner.
- Such a clause results in the subcontractor financing the project. The subcontractor is a builder, not a banker.
- Contingent payment clauses are void in some states, and it is unclear whether the proposed language would be enforceable in your state.
The above are some of the items referenced in the ASA’s Subcontractor’s Negotiating Tip Sheets available to ASA members. The tip sheet provides some good hypotheticals for a subcontractor to consider in preparing for a negotiation with a general contractor over a contingent payment clause.
WORTH THE RISK?
During the recession, a number of subcontractors took on jobs that they would have turned down during better times. In so doing, they assumed considerable risks, sometimes to their detriment. While, even in the best of times, risk is inseparable from business ownership, managing risk is key to profitability.
The risk in taking on a project under a contingent payment clause is that, if the owner does not pay the general contractor, you are left with obligations to suppliers; determining whether there is a breach due to non-payment; weighing the costs of taking legal action; and finding new jobs for which you will get paid.
What should a subcontractor consider in evaluating the risk?
- Determine whether a contingent payment clause is enforceable under the controlling law.
- Evaluate the owner and consider conducting your own credit check of the owner to determine for yourself the likelihood of potential default.
- Consider your relationship with the general contractor. Some subcontractors worry that pushing back on a contingent payment clause will sour a relationship that may have taken years to develop.
- Consider whether you can bear the risk of not getting paid on all or a portion of the project.
There is no easy answer to the question of whether contingent payment clauses are worth the risk, but understanding the nature of the law and the factors that should be considered in making the decision can help you make an informed decision.