Contingent Payment Clauses, Revisited

What is the most important event in the life of a construction project? Being paid, of course. You do the work, you should be paid. Right? Not so fast. When the project owner fails to pay, many general contractors fall back on contingent payment clauses to avoid liability to their subcontractors. In many cases, however, reliance on these clauses is unjustified.

There are two variations on the contingent payment theme: “pay-if-paid” and “pay-when-paid.” Each type is designed to shift the general contractor’s risk of non-payment by an owner to its subcontractors. A true pay-if-paid clause operates as an absolute condition precedent to payment. In other words, the general contractor’s obligation to pay its subcontractor does not arise unless it receives payment from the owner. Pay-when-paid clauses, on the other hand, merely dictate the timing or manner of payment. They do not act as a condition of the general contractor’s liability.

We all know that the death of pay-if-paid was greatly exaggerated last year in the Texas Legislature. Consequently, careful review of the language used in contingent payment clauses is warranted each time a new contract is considered. And the proliferation of proprietary contract forms means the language of individual clauses may vary widely from one contract to the next. But while identifying a contingent payment clause may be easy, deciphering its meaning is usually a bit tricky. Consider the following example:

When the owner or his representative advances or pays the general contractor, the general contractor shall be liable for and obligated to pay the sub-contractor up to the amount or percentage recognized and approved for payment by the owner’s representative less the retainage required under the terms of the prime contract. Under no circumstances shall the general contractor be obligated or required to advance or make payments to the sub-contractor until the funds have been advanced or paid by the owner or his representative to the general contractor.

At first blush, this wording appears to favor a pay-if-paid interpretation, blocking any hope of payment to the subcontractor until the general contractor actually has the money in its hands. In addition, the owner on this project had filed for bankruptcy protection, thus foreclosing any chance of future payment. A Texas court, however, found this clause to be a covenant rather than a condition precedent. It was a pay-when-paid clause dealing only with the “terms of payment” or “manner of payment.” That is, the provision operated to postpone payment for a reasonable period of time, in order to allow the general contractor to procure funds from the owner, but not indefinitely.

The key to cracking the code is the intent of the parties to the contract. Because most courts recognize that the insolvency of an owner is a normal credit risk borne by the general contractor, any attempt to shift that risk to subcontractors must be evidenced by a clear, express, and unequivocal condition. Conditions, however, especially those that result in forfeiture, are not favorites of the law. While no particular words are necessary for the existence of a condition, terms such as “if,” “provided that,” “on condition that,” or some other phrase that conditions performance, usually connote an intent for a condition rather than a covenant. Otherwise, requiring a subcontractor to wait for payment for an indefinite time until the general contractor has been paid by the owner, which may never occur, is to give an unreasonable construction to a payment provision which the parties did not intend at the time the contract was executed.

The bottom line? Know your contract terms and consult with your attorney!

This article was originally published in the June 2006 issue of Dallas/Fort Worth Construction News, and is reprinted with permission.