December 11, 2020 Construction Law 101

Pay-if-Paid vs. Pay-When-Paid Clauses

Craig L. McCloud

Pay-if-Paid (“PIP”) and Pay-when-Paid (“PWP”) clauses are contractual conditional- payment provisions primarily intended to shift risk of loss related to non-payment downward to lower-tier subcontractors.  Jurisdictional enforceability of PIPs vary wildly from almost complete blind recognition to absolute legislative and/or judicial prohibitions. PIPs are customarily viewed extremely disfavorably; as the transfer risk downward to the lower-tiered subcontractors is usually viewed as inequitable and patently unfair. In contrast, PWPs are viewed, not so much as a legal tool for non-payment, but as a timing instrument for the payment of downstream-subcontractor, within a reasonable timeframe after completion and as a traditionally-accepted means of risk sharing. These clauses require the careful analysis of two distinct, yet important, competing legal theories: contract vs. equity.

 

Pay-if-Paid (“PIP”)

PIP describes a clause in which the upstream contractor’s (usually the Prime/GC) payment obligation(s) to pay downstream subcontractors’ claims is/are triggered ONLY, if and after, the receipt of payment, in full, from a higher-tiered contractor or Owner, for the lower-tiered subs’ work. PIP clauses are customarily viewed as HIGHLY disfavored and EXTREMELY inequitable. Generally, this is because PIP clauses are an instrument to pass risk downward through the subcontracting levels, which are generally the entities/individuals most likely to suffer the greatest from such risk increase (e.g. the “too big to fail” analogy: the socialization of risk downward across all levels of subcontractors). There is the perception that PIP clauses unfairly/unreasonably shift credit risk to downstream subs, who are most usually not in privity.  The obligation of Prime/GC to pay downstream subs is triggered ONLY after the Prime/GC’s receipt of payment, in full, from Owner for the relevant work billed to Owner from Prime/GC, for work which included the work performed by the lower-tiered subs.

Pay-when-Paid (“PWP”)

PWP clauses establish the required payment timeliness of upstream contractor’s payment obligation to pay lower-tiered subcontractors is triggered only after the upstream contractor is paid. The trigger for obligation will typically have timing provisions associated with the clauses. PWP clauses normally lack explicit language requiring the Prime/GC’s receipt of payment as a condition precedent for the payment of the relevant lower-tiered subcontractor’s work.  The underlying theory behind PWP clauses is to establish and/or increase protections for higher-tiered contractors against claims by lower-tiered subs.  PWP clauses normally have explicit “timing provisions” which outline the relevant payment trigger(s).  If the timeliness directives are absent, “murky”, or ambiguous; anticipate the upper-tier payment obligation(s) downstream due and payable within a reasonable time after such lower-tiered subs’ work is completed.    PWP clauses will fall into one of two categories: A) Clause which does not require the Prime/GC/higher-tiered sub to receive payment, in full, for the relevant lower-tiered subs’ work before payment for same, as an express condition precedent; OR B) an intended PIP which the relevant payment clause(s)/term(s) is/are “murky” and/or ambiguous which provides the Court with an “out”  (i.e. not to enforce the intended PIP).

PIP vs. PWP

Some jurisdictions invalidate these voluntary and freely negotiated contractual terms automatically by legislation (e.g. prompt pay statutes) or judicial decisions (e.g. contrary to public policy or as an infringement of subcontractor’s mechanic’s lien rights). Conversely, some state courts have upheld these clauses as valid contractual terms containing an expressly-stated condition(s) precedent. Other state courts fall somewhere in the middle of the previously-stated decisions and require the upstream contractor to pay the downstream sub within a reasonable time; regardless of whether the higher-tiered contractor is paid or not. Courts have viewed higher-tiered contractors as better suited to shoulder advanced payments (i.e. economic protections for the “little guy”).  The higher the level of a contractor; the higher the likelihood of the contractor reasonably bearing the burden of any relevant payment default or significant delay. See below chart for a sliding analysis reflecting the theory and enforceability of PIP and PWP.

PIP  VS.  PWP

(Hybrids = Judicial recognition of the Parties’ right-to-contract, but “applying” quasi-protections for the “little guy”)

“Purely Contractual”

Hybrid 1

         Hybrid 2 

“Level-Playing Field”

Right to Contract:

Valid contractual provisions

“freely” negotiated between the Parties will not be interfered with (e.g. “the freedom to contract”).

Uphold and enforce the PIPs; only, if explicit, clear, and unambiguous.

The Courts will (normally) actively attempt to find a “creative” way to not enforce PIPs, but will ONLY enforce, if “bulletproof”.

Views PIP and PWP as mutually inclusive and recognizes the resulting “merged” clause as only an implied guarantee of payment within a reasonable time after lower-tier subs’ completion of the relevant work.

Fundamental Fairness/Equity:

Void as a matter of public policy, regardless of the language included in the clause; via legislative acts (prompt pay acts, mechanics lien, etc.); or prior judicial decisions.

 


Even with the pressure of these contingent pay agreements, Prime/GCs must seek payment from Owner reasonably; within its normal course of business; and in accordance with its historical billing and pay app submissions upstream. Good faith is/should always be maintained; in such a way the GC/Prime is acting on behalf of its downstream subs. (i.e. customary due diligence). Most times, GCs/Primes are seen as “the captain of the ship” and in charge of the crew/everyone onboard (i.e. the lower-tiered subs) which higher standards and responsibilities are inherently assigned by the Courts. As a result, Courts are normally unwilling to assign blame or responsibility to subs that maintained equitable clean hands during the events and/or circumstances which led to the relevant underlying condition causing nonpayment. While pure economics sometimes seem to control and direct the decisions of the Prime/GC; they (Prime/GC) must be acutely aware of maintaining good working relationships with their downstream partners. Any ambiguities in these clauses will be construed against the GC/Prime and, at a minimum, convert an intended, contingent payment provision (i.e. PIP) into a clause guaranteeing payment to a downstream sub, within a reasonable time after completion (i.e. PWP). For public policy purposes, most jurisdictions will invalidate PIP and PWP clauses, in so much, as they interfere, frustrate, and/or prohibit any lower-tiered subcontractors’ exercise of their statutory mechanics’ lien rights or violate other statutory directives (e.g. prompt-pay laws/acts). Courts actively try to “equal the playing field” somewhat by not enforcing PIP clauses on equitable grounds, in an attempt, to provide a shield to the “little guy” from the “big guy’s” deep pockets and more competent and able legal team.

Beware/Special Attentions:

  • Prompt Payment Laws/Acts (PPL): Outline requirements and timing of payments due; interest for late payments; and protections for “good faith” billing disputes.
  •  Does your jurisdiction have any PPL’s? If so, what are their scope and specifics?
  • Are the relevant PPLs applicable to Private and Public projects? Or just public?
  • Presence of any Choice of Law provisions?
  • “Prevention Doctrine”: estoppel theory utilized to prevent the application and subsequent enforcement of the relevant condition payment clause(s) due to “questionable” behavior by an upstream contractor.
  • Higher-tiered contractors must not frustrate or “hinder” fulfillment of a condition precedent and must act diligently; in good faith; and in accordance with industry standards in pursuing payment and working on behalf of their downstream subs.
  • As Prime/GC’s are in the premier position to work closely with the Owner during the duration of the Project to alleviate, remediate, and/or cure any deficiencies, issues, and/or concerns which might later lead to default and/or serious delays in payment.

 

Key Takeaway for the Neophyte-Construction Practitioners:

  • PIP and PWP payment provisions are extremely jurisdiction sensitive.  A new practitioner should be mindful to perform adequate research to achieve an understanding of the current jurisdictional treatment of these contractual clauses. 
  • PWPs are viewed by most Courts as timing tools and NOT as a risk transfer scheme and/or to bypass responsibility/obligation for payment downstream.
  • PWP clauses will be void of any explicit language establishing the requirement of the upper-tiered contractor to be paid, if full, as a condition precedent before the obligation to pay the lowered-tiered subs.
  • Make yourself familiar with your specific jurisdictional positions of both clauses and whether they are viewed as one-in-the-same (i.e. mutually inclusive) or separate, standalone (i.e. mutually exclusive) with varying obligations and duties of the upstream contractor (i.e. Prime/GC) downstream to the relevant downstream subs.  While there are two distinct ends of the spectrum on these clauses, as reflected in the table above, jurisdictions vary widely and often depart from a pure-contracting theory analysis and push into the quasi-contractual equitable realm.
  • These clauses are not impossible to get a firm grasp on; if you are willing to dig into the current case law and relevant statutory scheme(s).
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Craig L. McCloud

McCloud Law Group, Lexington & Columbia, KY, YLD (Steering Committee) and Division 1 (Litigation & Dispute Resolution (former YLD-Liaison))