Construction Contracts - "Pay-if-Paid" - Some Considerations

Recent Developments in Construction Contracts – “Pay-if-Paid” Our office has seen an uptick recently in general contractors making use of “Pay-if-Paid” contracts with subcontractors. Because these contracts differ in significant ways from more standard contracts, a few items are worth thinking about, when contemplating the use of “Pay-if-Paid.” Broadly speaking, general contractors must assure that if they desire the benefit of “Pay-if-Paid” they have the clause properly drafted. Correspondingly, subcontractors should take extra precautions in assessing credit risk when entering into such agreements. This kind of contract is not always obvious at first glance. The usual way it’s framed relies on the contract law concept of “conditions precedent.” This term essentially means that there is a condition to the contract that must be met before a certain related contract duty can be enforced. The “Pay-if-Paid” condition can often be phrased as making receipt of payment by the Contractor from the Owner for the Subcontract Work a condition precedent to payment by the Contractor to the Subcontractor. In essence, the condition shifts the risk of non-payment from the general contractor to the subcontractor. The desire to shift this risk makes sense, especially in the immediate aftermath of the recent housing and economic downturns. Although a few states have invalidated this condition, either by court decision or by statute, generally they are enforceable. In Utah, every indication points to the condition being upheld as enforceable. If you see a contract that says something like this, the meaning is that the Contractor has no legal obligation to pay the Subcontractor until the Owner first pays the Contractor. Another effect, though, is that the Subcontractor may not know when it has a right to demand payment from the Contractor. The effect of a “Pay-if-Paid” clause raises another interesting question: how does it alter lien rights? Fortunately for subcontractors, Utah law appears to allow for liens to be filed despite the open question of whether any immediate obligation exists between Contractor and Subcontractor. An important question for a subcontractor to ask is how well you trust the party to the contract. “Pay-if-Paid” puts the burden on subcontractors to ask for the contractual ability to learn of payment by the general contractor, or to otherwise assuage credit concerns. When assuming the risk of Owner non-payment, without being a decision-maker on the Owner-General Contractor agreement, care must be taken to avoid unwieldy credit risks. For general contractors, the question of “Pay-if-Paid” raises corresponding issues of whether to impose such agreements, what concessions may be countenanced to assuage subcontractor credit concerns, and how to address lien situations that can arise. Likewise, it is crucial for a general contractor to assure that reliance on a “Pay-if-Paid” clause is based on carefully drafted contract language that will be enforced. If you’ve had a positive or negative experience related to “Pay-if-Paid,” we welcome your comments. For follow-up information, or advice regarding your specific situation, feel free to reach out to the team at Freedom Legal for a consultation at info@freedomlegal.com or at (801) 373-3366.