26.6 Payment Issues
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26.6 PAYMENT ISSUES
26.601 The Significance of Payment. Payment(s) to subcontractors and suppliers typically lag behind their performance of trade work or their supplying of materials for a project. Frequently a subcontractor will submit its progress payment application monthly based on work completed by the 25th day of the month and estimated work to be completed through the end of month. The general contractor submits its monthly progress
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payment application, along with those of the subcontractors and suppliers, for the project owner's processing and payment. Depending on the timing of payment terms in the subcontract or purchase order, a subcontractor or supplier will have 30 days of work in place or materials supplied (and frequently more) before receiving payment for the billed work.
For private works projects, the project owner and general contractor may have used the American Institute of Architects (AIA) contract forms. Concerning payments by the contractor to its subcontractors and suppliers, Articles 9.6.2 through 9.6.5 of the AIA A201-2017 provide:
9.6.2 The Contractor shall pay each Subcontractor, no later than seven days after receipt of payment from the Owner, the amount to which the Subcontractor is entitled, reflecting percentages actually retained from payments to the Contractor on account of such Subcontractor's portion of the Work. The Contractor shall, by appropriate agreement with each Subcontractor, require each Subcontractor to make payments to Sub-subcontractors in a similar manner.
9.6.3 The Architect will, on request, furnish to a Subcontractor, if practicable, information regarding percentages of completion or amounts applied for by the Contractor and action taken thereon by the Architect and Owner on account of portions of the Work done by such Subcontractor.
9.6.4 The Owner has the right to request written evidence from the Contractor that the Contractor has properly paid Subcontractors and material and equipment suppliers amounts paid by the Owner to the Contractor for subcontracted Work. If the Contractor fails to furnish such evidence within seven days, the Owner shall have the right to contact Subcontractors to ascertain whether they have been properly paid. Neither the Owner nor Architect shall have an obligation to pay or to see to the payment of moneys to a Subcontractor, except as may otherwise be required by law.
9.6.5 Contractor payments to material and equipment suppliers shall be treated in a manner similar to that provided in Subparagraphs 9.6.2, 9.6.3 and 9.6.4.
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Section 37 of the Virginia General Conditions of the Construction Contract for Capital Outlay Projects also addresses contractor payments to subcontractors and suppliers by incorporating the statutory Prompt Payment Act:
37. PAYMENTS BY CONTRACTOR (§ 2.2-4354, Code of Virginia).
Under § 2.2-4354, Code of Virginia, the contractor is obligated to:
(a) Within seven (7) days after receipt of amounts paid to the Contractor by the Owner for Work performed by the Subcontractor or Supplier under this Contract,
(1) Pay the Subcontractor or Supplier for the proportionate share of the total payment received from the Owner attributable to the Work performed by the Subcontractor or the materials furnished by the Supplier under this Contract; or
(2) Notify the Subcontractor or Supplier, in writing, of his intention to withhold all or a part of the Subcontractor or Supplier's payment with the reason for nonpayment;
(b) Pay interest to the Subcontractor or Supplier on all amounts owed by the Contractor that remain unpaid after seven (7) days following receipt by the Contractor of payment from the owner for Work performed by the Subcontractor or materials furnished by the Supplier under this contract, except for amounts withheld as allowed under subsection (a)(2) of this Section.
(c) Include in each of his subcontracts a provision requiring each Subcontractor to include in each of its subcontracts a provision requiring each subcontractor to include or otherwise be subject to the same payment and interest requirements with respect to each lower tier subcontractor. Each Subcontractor shall include with its invoice to, or request for payment from,
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the Contractor, a certification that Subcontractor has paid each of its suppliers and lower tier subcontractors their proportionate share of previous payments received from the Contractor attributable to the Work performed or the materials furnished by it under this Contract.
In contrast to the AIA A201 terms, a contractor subject to the Virginia General Conditions will incur a penalty if it fails to make timely payment to its subcontractors or suppliers, or timely notify the subcontractor(s) or suppliers of its withholding all or part of a payment.
Barring waiver or other legal excuse, a failure to pay a subcontractor or supplier as due can be a material breach of the subcontract or purchase order. 283
26.602 Contingent Payment Clauses. Contingent payment clauses, sometimes characterized as "pay-when-paid" or "pay-if-paid" clauses, come in a variety of terms, but all seek to make payment to a lower-tier subcontractor or supplier conditional on payment first being received from a higher-tier party, typically the project owner paying the general contractor or construction manager. Under Virginia law, these clauses are enforceable as written pursuant to the principle of freedom of contract. 284 When considering these clauses, courts will look for expressions such as "condition precedent," "assumption of risk of non-payment," "risk of non-payment is on the subcontractor," or similar terms that demonstrate the parties' intent to shift the risk of the owner's nonpayment or insolvency from the general contractor or construction manager to the subcontractor or supplier.
Whether a particular clause creates a condition precedent to payment to a subcontractor or trade contractor depends on the intent of the parties as construed from the words they employed in the clause. 285 Words such as "if or "condition" and phrases such as "only if and to the extent," "subject to the
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express condition precedent," "if and only if," or "unless and until" can be sufficient to create a condition precedent to payment if the parties clearly and unambiguously expressed that to be their intention. 286
Virginia courts will enforce a pay-if-paid subcontract clause if it is clear and unambiguous but not if there is an ambiguity in the clause. 287 In Galloway Corp. v. S.B. Ballard Construction Co., 288 the Virginia Supreme Court found the subcontract payment clauses at issue to have a latent ambiguity that allowed the introduction of parol evidence to determine the intention of the parties. Based on the general contractor's evidence and testimony, the court concluded that, in each of the disputed subcontracts, the general contractor intended that the subcontract payment clause provide an absolute "pay-when-paid" defense. However, the contract contained a latent ambiguity in that it failed to anticipate the project owner's insolvency and likewise failed to establish unambiguously that the other parties understood the payment terms as a "condition precedent" to payment. In regard to the subcontractors' apparent intent, the court came to two different conclusions. One of the subcontractors cited earlier "progress payments" received from the contractor as evidence that it understood the payment terms to require progress and final payments within a reasonable time, regardless of the project owner's payments to the contractor. The general contractor's failure to pay that subcontractor within a reasonable time was a breach of that subcontract.
In contrast, the court found that the evidence of the other subcontractors demonstrated a mutual understanding with the general contractor that the clause provided an absolute "pay-when-paid" defense. Consequently the general contractor did not breach those subcontracts when it failed to pay the subcontractors after the project owner's insolvency and default in payments to the contractor.
In Universal Concrete Products Corp. v. Turner Construction Co., 289 the U.S. Court of Appeals for the Fourth Circuit considered a disputed contingent payment clause. The plaintiff subcontractor acknowledged that the payment provision of the subcontract was, on its face, an unambiguous contingent payment clause. The provision stated:
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The obligation of Turner to make a payment under this Agreement, whether a progress or final payment, or for extras or change orders or delays to the Work, is subject to the express condition precedent of payment therefore by the Owner. 290
The unpaid subcontractor attempted to avoid the "facially unambiguous" payif-paid terms by contending that the incorporation by reference of the prime contract into the subcontract rendered the subcontract clause ambiguous and unenforceable. The court rejected this argument, first observing that, pursuant to Virginia law, "pay-if-paid" clauses are valid "where the language of the contract in question is clear on its face." 291 The court further noted that a contractor and subcontractor may create a valid pay-if-paid clause by including in their contract an express condition clearly showing that to be the intention of the parties. In this case, the parties did not have to argue whether the "pay-if-paid" clause in the Turner-Universal subcontract was clear or unclear because they had acknowledged that it was facially an unequivocal pay-if-paid clause.
The subcontractor (Universal), citing paragraphs 6.1.3 and 9.6.2 of the AIA A121 document that was part of the Turner-Owner prime contract incorporated into the subcontract, argued that Turner and the owner contemplated Turner's paying Universal before invoicing the owner. 292 The court rejected this argument, finding that the particular AIA A121 clauses related only to the amounts of payment, and not to when those amounts...
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