Pay-if-Paid: What It Means for Subcontractors
Subcontractors Unite! Do not sign a subcontract that shifts the risk of non-payment by the owner on you. My advice is to strike out such provisions in any proposed subcontract and negotiate a reasonable time in which the Contractor has to pay regardless of whether the Owner pays.
Contractors are always trying new ways to “shift the risk” of non-payment by the Owner. What this means is that General Contractors do not want to pay a subcontractor or supplier unless the Contractor has received payment from the Owner.
This is true even when there is no objection to the work performed or material supplied.
Contractors first tried inserting “pay-if-paid” and “pay-when-paid” provisions in their subcontracts. The provision can be as simple as stating: “Contractor will pay Subcontractor within 7 days of Contractor’s receipt of payment by the Owner”, or as specific as, “It shall be a condition precedent to Contractor’s obligation to make each payment to Subcontractor (including but not limited to progress payment, final payment, payment for extra work or changed work), if the funds for such payment have first been paid by the Owner to Contractor.”
The Legislature took care of the “pay-if-paid” provision with the contingent payment clause statute that allows an unpaid Subcontractor to reject the enforcement of the provision when the reason for non-payment by the owner has nothing to do with the work of the Subcontractor. Knowledge of Chapter 56 of the Texas Business and Commerce Code is essential.
Chapter 56 does not apply to a “pay-when-paid” clause if the payment is to be made within a reasonable time. The problem is that “reasonable time” is not defined in the statute.
To get around the “pay-when-paid” reasonable time standard, Contractors are now defining “reasonable time” in the subcontract.
A typical definition might be as follows:
In the event of non-payment by the Owner, the parties agree that Contractor shall pay Subcontractor within a reasonable time. For the purposes of determining the timing of payment under these circumstances, the parties acknowledge and agree that a reasonable time for payment to Subcontractor is within 30 days after Contractor has exhausted all available rights and remedies in connection with recovery of payment from the Owner.
When considering how long the litigation process can take including appeals, Subcontractors could be waiting up to 10 years for payment under this definition. When negotiating the timing of payment, I would suggest the following:
In the event of non-payment by Owner, Contractor acknowledges it will be obligated to pay Subcontractor with a reasonable time for work completed in accordance with the Contract Documents, and for which Owner has no complaint. A reasonable time period for non-payment to Subcontractor shall be 120 days from the date Subcontractor submitted its application for payment, or 90 days from the date the project reaches substantial completion, whichever occurs first.
However, Contractors have devised an even more sinister way to avoid payment. They are now getting the Subcontractor to assume the risk of non-payment by the Owner and accepting the risk that the Owner may not pay for the work performed. This language could be devastating in a suit to collect the amount owed for canopies installed at a project.
A typical provision might say:
It is agreed by the parties that, if payment from the Owner for all or a portion of the Subcontract work is never received by Contractor, then Contractor will never have any obligation to pay the Subcontractor for such portion of the work not paid by Owner. Subcontractor expressly assumes the risk of Owner nonpayment.
Never agree to such a provision. The Contractor is always in the best position to determine the financial strength of the Owner, or the Owner’s creditworthiness. It is the Contractor who has met with and worked with the Owner concerning the plans and construction budget.
The risk of non-payment by the Owner should always fall on the Contractor because it is the Contractor who can elect not to contract with the Owner if the Owner lacks funds or credit.
In many instances a Subcontractor elects whether or not to subcontract on a job because of the Contractor’s reputation. Most Subcontractors do not elect whether or not to subcontract on a job because of the reputation of the Owner. Most often the Subcontractor has no intimate knowledge about the Owner.
Murray | Lobb, PLLC. represents subcontractors in their negotiations with contractors and helps in collecting payment for work performed and materials supplied to a construction project.