The subcontract contingent payment clause: how does it affect the construction industry?

• Author: Leiby, Larry R.
• Position: Florida

A contingent payment clause in a subcontract is the clause that provides that the subcontractor assumes the risk of owner nonpayment. Such clauses are favored by contractors for the ostensible purpose of managing the risk of owner nonpayment. Subcontractors are often forced to accept the risk of owner nonpayment in a subcontract with a contingent payment clause even though they can least afford to accept that risk. Nonpayment for construction work will create practical problems regardless of legal issues. A smaller subcontractor may not have the option of slowing down or stopping work in the face of nonpayment, whether there is a legal right to get paid, and has an even worse choice in continuing to perform without payment.

Which Clause?

Florida courts have held that the issue of whether a subcontract transfers the risk of owner nonpayment is an issue of law (contract interpretation). (1) Any ambiguity in the language will preclude enforcement of the clause as creating a contingent payment obligation and leave it as a time of payment clause. A time of payment clause requires payment to the subcontractor within a "reasonable time" in order to allow the contractor some time to receive payment from the owner. Courts are not clear on any particular period being a reasonable time for payment. (2) The "reasonable time" for postponing payment has been defined to be the time within which the general contractor is actively pursuing collection, while there remains a reasonable likelihood that the general contractor will actually collect the payment due from the owner. (3) Two Florida courts have been the most beneficent in the country to the subcontractor with respect to when payment is due under a time of payment clause. One Florida court has held that 1) reasonable time occurred as of the writing of the appellate opinion, but was still a fact issue. (4) The second court held that 2) 90 days from completion of the work was a reasonable time (however, the reasonable time of 90 days was agreed between the parties in that case). (5)

A contingent payment clause (6) in a subcontract clearly communicates that the subcontractor assumes the risk of owner nonpayment. (7) Courts have generally held that where there is a contract with an enforceable contingent payment clause, the subcontractor may not avoid or get around the contingency in the express subcontract by making an equitable claim for unjust enrichment. (8)

Effect of the Subcontract Contingent Payment Obligation

* Owners--In most cases the owner's goal is to obtain the completed construction promptly so that the owner can occupy, rent, use, live in, or sell the completed construction. Generally, the owner wants the job completed as soon as possible or by a time certain. The owner does not want to pay more than a reasonable amount for the improvements, nor pay twice for the same work (for obvious reasons). The owner could be forced to pay twice if 1) the owner failed to comply with statutory construction lien procedures, or 2) the owner overpaid a defaulting, un collectible contractor. Looking at the owners' interests, timely completion and paying only once for work done, what is the impact of the contingent payment clause in the subcontract?

1) Timely Completion--Timely completion of the work is a key owner goal. However, when a subcontractor does not get paid the funds it needs to pay for its labor and materials, that subcontractor may do one of the following:

1. Search for creative reasons to stop performing or slow down the performance (and cash outflow) of the work. If the subcontractor searches for and finds a reason (other than nonpayment, the real reason) to stop the work, the result may be the subcontractor making a claim and/or seeking a time extension. The administrative activity addressing possible "creative" claims, along with the slowing or stopping of the work itself, directly and adversely impacts the owner's interest in getting the job timely completed.

2. If the subcontractor is financially able to continue with the work despite lack of payment, and chooses to abide by the law, the contingent payment clause works to the benefit of the owner. However, if the subcontractor cannot or will not perform without payment, despite the legal obligation to continue, the paying party (owner or prime contractor) may be faced with being right, but perhaps "dead right." With a subcontractor who cannot or will not work without funds, the owner or prime contractor is looking at a job completion problem and perhaps a legal claim.

   2) Lien Claim--Where the defense to enforcement of a subcontractor lien claim is alleged to be owner nonpayment and the work for which payment is sought has been performed by the lien claimant, the merit of a position of owner nonpayment to the contractor without a good faith reason rings hollow. (9) When the general contractor shifts the risk of owner nonpayment by a clear contingent payment clause, what purpose is served by the defendant owner claiming that the condition precedent of owner payment to the contractor has not been performed? If the subcontractor does assume the risk of owner nonpayment, what is wrong with the subcontractor pursuing payment directly from the source, the owner, by enforcing a claim of lien against the owner and its property?

   Remember that, in Florida, a construction lien may be recorded for amounts owed for work performed, not just for sums due. (10) The time within which a construction lien may be recorded should not relate to any time or duty of payment under the lienor's contract, but it relates to the last date that work was performed under the authorized contract (or the time that the prime contract was terminated). (11) Thus, nonperformance of the condition precedent of owner payment to the contractor is not a basis upon which to defend the lienor's construction lien remedy. The lien should be enforced for sums unpaid and owed that made the property more valuable (to the extent of the reasonable unpaid value thereof), regardless of the ability of the subcontractor lienor to sue the general contractor for breach of contract. The claim for breach of contract is a separate remedy. (12) The sums that are exposed for recovery by the subcontractor lienor for lien enforcement are the amount of the contract price owed (not due) for the value improved, less proper payments made by the owner. (13) The amount that has been paid to the general contractor for the subcontractor's work is not an issue in the lien enforcement case against the owner, except to the extent of proper payments to the contractor prior to receipt of the lienor's notice to owner; or releases given by the lienor. However, once a subcontractor has served a notice to owner, the owner cannot make a proper payment to the contractor without getting a release from that subcontractor if that subcontractor is owed funds. (14) The value of the work performed, and proper payments are issues to be addressed in the lien enforcement action. Thus, the contingent payment subcontract clause does not benefit the owner as a defense to a lien, just as the proper payment defense under the lien law does not apply to contract or payment bond claims. (15)

   3) Payment Only Once--The owner is generally well advised to...