In the context of a construction contract, a “pay-if-paid” clause provides that payment by the owner to the contractor is an express condition to any payment becoming due to the contractor’s subcontractors or suppliers (i.e., the obligation of the contractor to pay its subcontractor does not arise at all until the contractor has been paid by the owner). Conversely, a “pay-when-paid” clause provides that the contractor is obligated to pay the subcontractor or supplier for work performed, but that payment must occur within a prescribed period of time only after the contractor receives payment from the owner.
The Ohio Court of Appeals recently addressed whether a construction contract clause was a “pay-if-paid” or a “pay-when-paid” provision. (See Transtar Electric, Inc. v. A.E.M Electric Services Corp., 983 N.E.2d 399 (Ohio Ct. App. 2012)). In Transtar, the contractor and subcontractor entered into a subcontract for electrical work. After performing the work, the subcontractor sued the contractor for work that it completed, but did not receive payment. The contractor asserted the subcontract contained a “pay-if-paid” clause and, therefore, the contractor did not have to pay because the owner had not paid the contractor. The subcontractor asserted that the subcontract’s “pay-if-paid” clause was actually a “pay-when-paid” clause because the condition of payment from the owner to contractor was not clear and explicit.
The subcontract provided, in part: “The Contractor shall pay to the Subcontractor the amount due [for work performed] only [after] … the Contractor has received payment from the Owner for the Work performed by Subcontractor. Receipt of payment by Contractor from Owner for work performed by Subcontractor is a condition precedent to payment by Contractor to Subcontractor for that work.”
The Ohio Court of Appeals noted that “pay-if-paid” provisions are generally disfavored, as the risk of insolvency of the owner is usually borne by the contractor, not the subcontractor. The court subsequently found in the subcontractor’s favor and held that the “condition precedent” language in the above clause was not clear enough to sufficiently shift the risk of the owner’s nonpayment to the subcontractor. The court provided that a “pay-if-paid” clause requires a “clear, unambiguous statement that the subcontractor will not be paid if the owner does not pay” and that this clause was not sufficiently clear in this respect, despite the fact the provision contained the phrase “condition precedent.”
The Transtar case decision is in direct opposition to a recent 7th Circuit Court of Appeals case (which covers Indiana), BMD Contractors, Inc. v. Fidelity and Deposit Company of Maryland, 679 F.3d 643 (7th Cir. 2012). In BMD, the 7th Circuit analyzed a contractual provision which provided, “IT IS EXPRESSLY AGREED THAT OWNER’S ACCEPTANCE OF SUBCONTRACTOR’S WORK AND PAYMENT TO THE CONTRACTOR FOR THE SUBCONTRACTOR’S WORK ARE CONDITIONS PRECEDENT TO THE SUBCONTRACTOR’S RIGHT TO PAYMENTS BY THE CONTRACTOR.” The court in BMD found that this language was unambiguous and was sufficient to be enforceable as a “paid-if-paid” clause under Indiana law.
In light of this split of authority in different jurisdictions, contractors and subcontractors in Indiana and other states should pay careful attention to such “pay-if-paid” or “pay-when-paid” clauses in their subcontracts, and take steps to ensure that these clauses are drafted clearly and unambiguously in the event a dispute arises over such provisions.
For more information about construction contract drafting and review, please contact Steve Theising at STheising@KDDK.com or (812) 423-3183; or contact any member of the KDDK Construction Law Practice Team.
About the Author
Steven M. Theising, an Associate at Kahn, Dees, Donovan & Kahn, LLP, in Evansville, Indiana, practices primarily in the areas of business, construction, real estate, tax, and collection and creditors’ rights law. Steve utilizes his accounting and financial background to provide both legal and practical business analysis in negotiating, resolving and closing business, construction and real estate transactions and disputes. He also assists clients with addressing and resolving environmental and estate planning issues.