December 02, 2015 Articles

Surety's Defense Against "Pay-If-Paid" Construction Clauses

By Michael Jay Rune II and Dana Chaaban

Under contract formation, the majority of transactions, services, and/or liabilities may be contracted based upon the parties' "freedom to contract." Ordinarily, in construction, a general contractor bears the risk of an owner's potential insolvency. However, over the years, general contractors have begun to negotiate a shift in the distribution of risk from the general contractor to the subcontractor by making the general contractor's receipt of payment from the owner a condition precedent to the general contractor's ultimate payment to the subcontractors. These clauses may be enforceable even though a subcontractor has fully performed its obligations under the subcontract. These provisions, coined "pay-if-paid," typically consist of some variation of the following:

Subcontractor agrees that Contractor shall be under no obligation to pay Subcontractor for any work performed or materials or equipment furnished for this Project unless and until Contractor has been paid therefor by Owner, and the making of any and all progress and final payments and the amount thereof are expressly subject to this condition precedent. Subcontractor states that it relies primarily on the credit and ability of Owner to pay and not upon Contractor's credit or ability, and further, expressly accepts the risk that it will not be paid for work performed by it in the event that Contractor, for whatever reason, is not paid by Owner for such work.

Generally, contractual language that eliminates the general contractor's duty to pay a subcontractor for its completed work is disfavored. In California, New York, North Carolina, and Wisconsin, such clauses are prohibited altogether; while in other jurisdictions, these clauses are limited through judicial interpretation. See Wm. R. Clarke Corp. v. Safeco Ins. Co. of Am., 938 P.2d 372, 380 (Cal. 1997); West-Fair Electric Constr. v. Aetna Cas. & Sur. Co., 661 N.E.2d 967, 971 (N.Y. 1995); N.C. Gen. Stat. § 22C-2; Wis. Stat. § 779.135(1).

Premium Content For:
  • Litigation Section
Join - Now