One of the most important parts of a construction contract is the payment section. It is critical to pay very close attention to the terms in this section because there are some common terms that can result in you never getting paid – even if you have completed the work on time and according to the project specifications. Specifically, there are two provisions of special concern. These provisions are commonly known as “pay-when-paid” and “pay-if-paid” provisions. These clauses attempt to shift all of the risk for payment for the project to the subcontractor.
A typical “pay-when-paid” clause might read: “Contractor shall pay subcontractor within seven days of contractor’s receipt of payment from the owner.” Under such a provision in a construction subcontract, a contractor’s obligation to pay the subcontractor is triggered upon receipt of payment from the owner.[i] In Minnesota, this type of clause creates a timing mechanism where the contractor’s obligation to make payment is suspended for a reasonable amount of time for the contractor to receive payment from the owner, but it does not expressly shift the risk of the owner’s nonpayment to the subcontractor.[ii]
A typical “pay-if-paid” clause might read: “Contractor’s receipt of payment from the owner is a condition precedent to contractor’s obligation to make payment to the subcontractor; the subcontractor expressly assumes the risk of the owner’s nonpayment and the subcontract price includes this risk.”[iii] These provisions are the most concerning because it is possible that the subcontractor could never get paid if the owner becomes insolvent and never pays the general contractor. A “pay-if-paid” provision in a construction subcontract is meant to shift the risk of the owner’s nonpayment under the subcontract from the general contractor to the subcontractor. In Minnesota, a “pay-if-paid” provision must expressly and unequivocally state that the risk of owner insolvency is being shifted to the subcontractor for this provision to be enforceable. Otherwise, the provision will be treated like a “pay-when-paid” provision, focusing on timing of payment and not shifting the risk of payment.
The main concern with the “pay-when-paid” and “pay-if-paid” provisions is that the subcontractor has no power over the conditions under which the owner is obligated to pay. The fact that a subcontractor may be forced to wait indefinitely or forgo payment entirely under circumstances that the subcontractor cannot control has led many courts to be quite hostile to these clauses.[iv]
Another concern about these “pay-when-paid” and “pay-if-paid” provisions is whether they impact a subcontractor’s mechanic’s lien rights. In Minnesota, contract provisions that require a contractor or subcontractor to waive the right to a mechanic’s lien before being paid are void and unenforceable.[v] So far, Minnesota courts have not decided whether “pay-when-paid” or “pay-if-paid” provisions have the effect of requiring waiver of a subcontractor’s mechanic’s lien rights in violation of the Minnesota mechanic’s lien statute, rendering the provisions void and unenforceable.
There are similar concerns about these provisions where there is a surety and a payment bond for the project. Does the surety get the benefit of the “pay-if-paid” provision? Courts are somewhat mixed on this question. Some courts have held that the purpose of a payment bond is to pay the contractors and subcontractors, should the owner not be able to. Enforcing a “pay-if-paid” provision contradicts the entire purpose of a payment bond. Accordingly, a surety should not get the benefit of any “pay-if-paid” provisions.[vi] Other courts have ruled that a contract is a contract and the “pay-if-paid” also applies to the surety.[vii]
The magic question is what does a subcontractor do when the subcontract contains a “pay-when-paid” or “pay-if-paid” provision? It is always safest to assume that the provision is enforceable because one never knows what a judge or arbitrator will decide later. If possible, attempt to negotiate the provision out of the contract. If that is not possible, take a long and hard look at the owner and the general contractor. Contact other subcontractors and find out if the general contractor has a good reputation for paying, and paying on time. Do the same for owners. Ask about payment bonds. Ask about project financing. If the subcontractor is taking the risk of owner insolvency, the subcontractor is entitled to information about whether there is sufficient funding for the project. Pass on the project if it doesn’t smell right. You will definitely save significant time and money in the long run.
About the Writer:
Patrick Noaker is an attorney with the Noaker Law Firm LLC who aggressively represents construction contractors in the courtroom and arbitration. Patrick can be reached at his office: 601 Carlson Pkwy, #1050, Minnetonka, MN 55305, (612) 839-1080, email@example.com.
[i] MidAmerica Construction Management, Inc. v. MasTec North America, Inc., 436 F.3d 1257, 1261 – 1262 (11th Cir. 2006).
[ii] Mrozik Const. v. Lovering Associates, 461 N.W.2d 49 (Minn. Ct. App. 1990).
[iii]MidAmerica Construction Management, Inc. v. MasTec North America, Inc., 436 F.3d 1257, 1261 – 1262 (11th Cir. 2006).
[iv] See Lemoine Co. of Alabama, LLC v. HLH Contractors, Inc., 62 So.3d 1020 (Ala. 2010); William R. Clarke Corp. v. Safeco Ins. Corp.. 938 P.2d 372 (Cal. 1997); Southern States Masonry, Inc. v. J.A. Jones Constr. Co., 507 So.2d 198 (La. 1987); Kawall Corp. v. Capolino Design & Renovation, 388 N.Y.S.2d 346 (N.Y.App.Div. 1976); West-Fair Electric Contractors v. Aetna Cas. & Sur. Co., 661 N.E.2d 967 (N.Y. 1995); Mrozik Const. v. Lovering Associates, 461 N.W.2d 49 (Minn. Ct. App. 1990).
[v] Minn. Stat. § 337.10, subd. 2; see also Kraus-Anderson Constr. Co. v. Superior Vista, LLC, 2010 WL 2650481 (Minn. App. 2010).
[vi] Moore Bros. Co. v. Brown & Root, Inc., 207 F.3d 717 (4th Cir. 2000); OBS Co. v. Pace Constr. Corp., 558 So.2d 404 (Fla. 1990).
[vii] BMD Contractors, Inc. v. Fidelity and Deposit Company of Maryland, 679 F.3d 643, 656 (7th Cir. 2012).