The Enforceability of Paid When Paid Clauses in Construction Contracts
| Publication year | 2021 |
| Pages | 257 |
64 CBJ 257. The Enforceability of Paid When Paid Clauses in Construction Contracts
The current downturn in private construction projects has engendered a cautious attitude throughout the industry. Numerous projects have been stalled due to the insolvency of the Owner, lack of continued financing, or both. It is therefore becoming more commonplace for Subcontractors not to receive full payment for services rendered and materials supplied that are not (seriously) questioned for their conformance to the contract documents. In this new climate it is even more important for Subcontractors, especially lower tier Subcontractors, to ensure that they will receive payment regardless of financial difficulties encountered by the Owner prior to completion of the project.
This task is complicated by the Subcontractor's distance from the Owner. Although the General Contractor has the opportunity to assess the Owner's financial condition and to negotiate directly with the Owner, Subcontractors by definition have no direct contractual relationship with the Owner. Indeed, General Contractors as a rule will jealously guard their relationship with the Owner from any intrusion by the Subcontractor. To compound matters, Subcontractors routinely are required to sign standard form agreements to obtain desirable jobs, and have little or no bargaining power with regard to the material terms of these agreements. Thus, Subcontractors have little opportunity to ensure that the Owner will be timely with its payments.
Theoretically, the Subcontractor's inability to assess or influence the Owner directly is not important. The Subcontract Agreement typically is entered into between the Subcontractor and General Contractor, and the Owner is in privity only with the General Contractor. Under textbook principles of contract law, the financial condition of the Owner should be of no consequence to the Subcontractor who has a contractual right of payment against only the General Contractor. Practically speaking, however, the Owner's default under its obligations to the General Contractor can have a tremendous impact on the General Contractor's ability to meet its obligations to the Subcontractor. More importantly, standard form Subcontract Agreements widely used in the industry contain clauses which link payment received by the General Contractor from the Owner to payments ultimately to be made by the General Contractor to the Subcontractor. These clauses, known as "paid when paid" clauses, rarely are negotiable and are viewed as a standard feature of any substantial construction contract. The extent to which these clauses will be enforced by the courts is of tremendous importance to Subcontractors.
The General Contractor's intent in making a paid when paid clause part of its contracts with its Subcontractors is obvious: whatever reason the Owner may have for withholding payment from the General Contractor, the General Contractor does not want to be obligated to pay out money that it has not yet received. The Subcontractor's concerns are equally obvious: if the Subcontractor has performed certain of its work satisfactorily, it should be paid, regardless of the fact that the Owner is not paying the General Contractor for reasons unrelated to the Subcontractor's performance. (fn1) An analysis of decisions by courts across the country reveals that the courts generally tend to balance these competing interests within the confines of traditional principles of contract law when they are asked to enforce a paid when paid clause. Such analysis should provide guidance for Connecticut courts and practioners in dealing with this issue.
The American Institute of Architects has created the most widely used form contracts, known as "AIA" contracts. AIA Document A201, entitled "General Conditions of the Contract for Construction," generally is a part of the Contract Documents governing the Owner-Contractor relationship, and therefore is routinely incorporated by reference into the standard form agreement between Contractor and Subcontractor. See AIA Document A401, at paragraph 16.1.2. In the 1987 edition of AIA Document A201, paragraph 9.6.2. governs progress payments and provides in relevant part:
The Contractor shall promptly pay each Subcontractor, upon receipt of payment from the Owner, out of the amount paid to the Contractor on account of such Subcontractor's portion of the Work, the amount to which said Subcontractor is entitled, reflecting percentages actually retained from payments to the Contractor on account of such Subcontractor's portion of the Work.
AIA Document A401 directly governs the relationship between the Contractor and Subcontractor. The 1987 Edition of Document A401 contains the following relevant provisions:
11.8.1 [Substantial Completion] When the Subcontractor's Work or a designated portion thereof is substantially complete and in accordance with the requirements of the Prime Contract, the Contractor shall ... make prompt application for payment for such Work. Within 30 days following issuance by the Architect of the Certificate of Payment covering such substantially completed Work, the Contractor shall, to the full extent allowed in the Prime Contract, make payment to the Subcontractor.
12.1 [Final Payment] Final payment, constituting the entire unpaid balance of the Subcontract Sum, shall be made by the Contractor to the Subcontractor when ... the Contractor has received payment from the Owner. If, for any cause which is not the fault of the Subcontractor ... the Contractor does not receive timely payment ... final payment to the Subcontractor shall be made upon demand.
The Associated General Contractors of America has prepared form contracts that are also commonly used in the industry. Paragraph 5.2.5 of the Subcontract for Building Construction (1984 edition) provides as follows:
5.2.5 TIME OF PAYMENT. Progress payments to the Subcontractor for satisfactory performance of the Subcontractor's Work shall be made no later than seven (7) days after receipt by the Contractor of payment from the Owner for such Subcontractor's Work.
Similarly, Paragraph 5.3.3 of the form contract provides, in pertinent part:
5.3.3 TIME OF PAYMENT. Final payment of the balance due of the contract price shall be made to the Subcontractor ... (b) within seven (7) days after receipt by the Contractor of final payment from the Owner for such Subcontractor's Work.
The foregoing language from typical standard form contracts will be explored under the developing case law in an effort to delineate probable outcomes if these clauses are tested in the Connecticut courts. Connecticut courts have not dealt squarely with the issue of the enforceability of paid when paid clauses in any reported decisions, and so any conclusions regarding the attitude of the courts toward these clauses will be tentative.
Although no Connecticut court has discussed the interpretation of paid when paid clauses in any comprehensive manner, paid when paid clauses have been involved in at least two reported decisions.
In Star Contracting Corp. v. Manway Const. Co., (fn2) the court considered a contract provision which stated: "In any event, payment will not be made by the Contractor to the Subcontractor until the Owner has made payment to the Contractor for the work." The plaintiff in Star was seeking recovery against a surety, alleging non-payment by the principal debtor under a construction contract. The court did not analyze the "paid when paid" clause because another court had previously determined that the clause constituted a condition precedent to the accrual of debt against the principal debtor. The analysis supporting this determination is not reproduced in Star, nor is the earlier decision reported. However, because it had already been determined that the principal was not obligated under the contract, the Star court held that the surety could not be held liable. Thus, Star provides no real guidance for the interpretation of paid when paid clauses.
In Mayfair Roofing and Renovating Company v. Ramco Technologies, Inc., (fn3) the Appellate Court was presented with a claim based upon a paid when paid clause. In Mayfair, the plaintiff was a subsubcontractor who brought an action to recover payment from the defendant subcontractor. The defendant sub-contractor instituted a third party action against the general contractor, alleging that it had not been paid for the plaintiff's work, and that if the defendant was obligated to the plaintiff, that the general contractor must also be obligated to pay the defendant for that same work. The trial referee determined that the defendant was obligated to the plaintiff because the work was completed to the satisfaction of the defendant,' but that the general contractor was not obligated to pay the defendant because the work was not performed to the general contractor's satisfaction. (fn5)
The defendant challenged the General Contractor's reliance on a paid when paid clause that was incorporated into the parties' contract by reference (fn6) After noting the differing language and factual circumstances of the case in contrast to the general case law construing paid when paid clauses, the Court found that because there was ample evidence to sustain the trial referee's finding that the General Contractor was not obligated by its contract to pay the defendant, there was no error in not "relaxing" the enforcement of the paid when paid clause (fn7)...
To continue reading
Request your trial