The Pay-when-paid Dilemma
| Publication year | 1996 |
| Pages | 79 |
1996, November, Pg. 79. The Pay-When-Paid Dilemma
This is the first article in a new specialty law column sponsored by the CBA Construction Law Committee, which was created in January 1996 to address the unique and varied needs of practitioners working in this field. This column will appear four times per year. The column editor and the Committee encourage submissions of articles and topic ideas in any area of construction law.
Similarly, a subcontractor wants to pay its sub-subcontractors and suppliers only after it has been paid. On the other hand, a subcontractor, sub-subcontractor, or supplier wishes to be paid as soon as services/goods are provided, regardless of when or how the recipient of the services/goods is paid or has funds.
To attempt to resolve this dilemma and achieve a preferable position, a general contractor may place a "pay-when-paid" provision in its subcontracts.(fn1) Similarly, each payor below the general contractor may insert similar clauses in its contracts. The importance of such clauses lies not only with respect to when the contractor must pay its subcontractors, but also whether a subcontractor can terminate or suspend work for nonpayment. This article discusses the minority and majority approaches to enforcement of pay-when-paid language, policy considerations, the effects of such clauses on a surety's payment bond obligations, and Colorado cases that have flirted with the issue. The article refers only to the general contractor/subcontractor relationship, but applies also to lower levels in the construction contract chain.
A pay-when-paid provision refers to payment language in a subcontract that affects the timing of payment obligations of a general contractor to its subcontractors. Generally, the prime contractor inserts the clause with the intention that it will not have to pay the subcontractor unless and until it has been paid by the owner for the work for which the subcontractor seeks payment. However, the legal consequences of such a provision are difficult to determine and often depend on the precise language in these clauses.(fn2)
A minority of courts have held that such a provision creates a condition precedent that makes the general contractor's obligation to pay the subcontractor completely contingent on the general contractor's receipt of payment from the owner;(fn3) payment by the owner becomes a condition precedent to any payment obligations the general contractor may have to its subcontractors. These courts hold that such a clause transfers the risk of nonpayment by the contractor to the subcontractor and relieves the general contractor of any duty to pay its subcontractors until the general contractor is paid. In contrast, the majority of courts hold that pay-when-paid language does not make payment by the owner to the general contractor a condition precedent to the general contractor's duty to pay its subcontractor. Rather, such language merely allows the general contractor a reasonable time in which to pay its subcontractors, regardless of whether the contractor ever receives payment from the owner.(fn4)
There is no Colorado case that deals directly with the legal effect of a pay-when-paid clause. Potential problems for a general contractor attempting to transfer the risk of nonpayment by the owner completely to the subcontractor include: (1) problems of proof about the intentions of the contracting parties in agreeing to the clause; (2) that such an allocation of risk may violate the public policy of Colorado as set forth in its lien laws or otherwise;(fn5) (3) a subcontractor's defense of unconscionability of the clause; and (4) surety concerns.
A minority of courts hold that a pay-when-paid provision creates a condition precedent to any obligations of the general contractor to pay its subcontractors.(fn6) The argument in favor of enforcing such provisions is simply that the subcontractor's rights should be governed by plain language of the subcontract.(fn7) An example of the clear language that in some jurisdictions postpones payment to a subcontractor until the general contractor is paid can be found in DEC Electric v. Rafael Construction
No funds will be owed to the subcontractor unless the General Contractor is paid by the owner in accordance to the sworn statement. The subcontractor fully understands that in the event of nonpayment by the owner to the General Contractor, the subcontractor has legal recourse against the owner through the Mechanics Lien Laws or other legal procedures for their correct monies due.(fn9)
Contract language such as this has convinced a number of courts that the subcontractor bears the risk of nonpayment by the owner in the circumstances presented.
Despite the allure of the "plain language" approach, the majority of the courts that have considered pay-when-paid clauses hold that such provisions set only a reasonable...
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