Subs and suppliers
expect to be paid on time. That’s a problem when an owner is slow to pay the prime
contractor. So what are you supposed to do about slow-pay? The obvious answer is
a “pay-if-paid” clause in your subcontracts. With “pay-if-paid,” a prime contractor
doesn’t have to pay subs until paid by the owner. That’s legal in about half of
all states. If you’ve never used a “pay-if-paid” contract clause, keep reading.
There’s a lot to learn.
True “Pay-If-Paid”
“Pay-if-paid”
comes in two flavors. True “pay-if-paid” means the prime contractor never has to
pay a sub if the owner never pays the prime. Of course, subs and suppliers can still
use the lien law to collect from the owner. But the prime contractor has no obligation
to pay subs until the owner pays. That works in 24 states: AL, AR, AZ, CO, CT, DC,
FL, GA, ID, KS, LA, MD, MI, MO, NE, NH, NJ, OH, OR, PA, RI, TX, VA, and WV. True
“pay-if-paid” requires very specific contract language, such as:
Contractor may withhold payment for work
done by Subcontractor (including retainage) until Contractor has been paid for that
work by Owner. Payment by Owner is a condition precedent to payment of Subcontractor
for work completed. Subcontractor acknowledges reliance on the credit of Owner for
payment, not the credit of Contractor.
In those 24 states,
a true “pay-if-paid” contract usually won’t affect lien rights. Subs can still file
a lien and collect in full from the owner. If the job is covered by a payment bond,
a “pay-if-paid” contract may relieve the surety from liability on the bond. But
be careful. A prime contractor who settles with an owner by compromising the claim
of a subcontractor may have to pay the sub in full in spite of the “pay-if-paid”
agreement.
“Pay-When-Paid”
When a “pay-if-paid”
clause isn’t absolutely clear about the owner’s payment being a condition precedent,
courts in those 24 states will consider it a “pay-when-paid” contract. That’s the
second flavor. “Pay-when-paid” means the prime contractor still has an obligation
to pay subs – eventually. As long as the prime contractor is trying to collect,
the subs have to wait. But the prime remains liable to subs for what’s due.
Seven states void
“pay-if-pay” agreements but permit “pay-when-paid” contracts: DE, IL, IN, KY, MA,
SC, WI. If you like “pay-when-paid,” here’s a typical contract clause:
Contractor will not unreasonably withhold
payment to Subcontractor for Work done by Subcontractor once Contractor has been
paid by Owner for that Work.
Both “pay-if-paid”
and “pay-when-paid” clauses are void in four states: CA, NC, NV, and NY. In those
states, the prime contractor has to pay subs when due, even if not yet paid by the
owner.
And the other
16 states? It’s too soon to be sure. No court in those states has been asked to
decide the issue and the state legislatures have not spoken.
Caution. This
is a capsule summary. There are exceptions. For example, rules for payment can vary
with the type of construction (res or non-res), the owner (public or private) and
the value of the work. My suggestion: Be sure your contracts are going to work the
way you expect. Construction Contract Writer makes that easy, no matter where you
live and work. The trial version is free.
