Are conditional payment clauses enforceable?
By Peter J. Lamont, Esq.
November 16, 2009
Nothing can be more exciting or rewarding for a cabinet company than being hired as a subcontractor on a multi-unit project. Generally, multi-unit projects can generate a substantial amount of revenue for cabinet companies. However, all things considered, being hired as a subcontractor on a multi-unit job is not much different from being hired by a general contractor on a single residential house. As a company, you must assist the decision maker with choosing the appropriate cabinets, then place the order, deliver the cabinets and, more often than not, install the completed cabinets in the units. Most companies believe that the hardest part of being a subcontractor on a multi-unit project is coordinating with the general contractor and the other trades, such as plumbers and electricians. Actually, the hardest part, especially in today's economic situation, is ensuring that your company gets paid for your work.
Why are so many subcontractors not getting paid for their work? The answer is simple: They entered into a contract with the general contractor that contained a conditional payment clause. Although historically general contractors assumed the risk of an owner's non-payment, many subcontracts now include conditional payment clauses that attempt to insulate the general contractor from having to pay its subcontractors if the owner fails to pay him. Look at almost any subcontract and you will find a "paid-when-paid" or "pay-if-paid" clause.
Often when a smaller cabinet subcontractor attempts to get paid and the general contractor refuses to pay, they cite the conditional payment clause in the contract. Believe it or not, many subcontractors then adopt the general contractor's position and fail to obtain legal advice to determine if the clause if actually enforceable. When considering entering into a subcontract, you should understand what type of clause it contains so that you can make an informed decision as to whether or not to sign it. It is always recommended to have your attorney review all prospective contracts before signing. The following is a brief explanation of the differences between the two clauses.
PAYMENT CLAUSES
In general, "paid-when-paid" clauses typically mean that the general contractor has to pay the subcontractor when they receive payment from the owner. These clauses do not insulate a general contractor from their obligation to pay their subcontractor even when they have received no payment from the owner. An example of such a clause is as follows:
"All progress payments of the Subcontract Sum shall be made within 10 days after payment is received by the General Contractor from the Owner."
Pursuant to this clause, the general contractor is required to pay a subcontractor within 10 days after payment is received from the owner. These clauses are generally interpreted as permitting a delay in payment by a general contractor for a reasonable period of time. Generally, "paid-when-paid" clauses leave the risk of the owner's nonpayment with the general contractor, meaning that even if the general contractor does not get paid, he still must pay your company.
Conversely, "pay-IF-paid" clauses can be determined to be conditional clauses that provide absolutes, which shift the risk of nonpayment to the subcontractor. This type of clause seeks to avoid payment altogether. Quite often, general contractors use the two clauses interchangeably and interpret both to be a means of avoiding payment.
However, recent court decisions have shed light on the enforceability of the clauses. In considering the enforceability of "paid-when-paid" clauses, various district courts throughout the country have held that "paid-when-paid" clauses do not allow contractors to avoid payment to subcontractors simply because the owner does not pay them. The general rule is that while a "paid-when-paid" clause allows the contractor to delay payment for a reasonable amount of time, the risk of an insolvent owner is still borne by the general contractor.
"Paid-if-paid" clauses are slightly more complicated. These clauses must be examined beyond the use of the word "if", and interpreted as a whole. In other words, by simply using "if" instead of "when", a contractor is not necessary relieved of his obligations to pay a subcontractor. The following is an example of a "paid-if-paid" clause.
"Subcontractor agrees that it is never entitled to receive payment from Contractor unless and until funds are in hand received by the Contractor in full. This is a condition precedent to any obligation of the Contractor."
STATE DIFFERENCES
Many state courts, including New York, have held that "pay-if-paid" clauses violate both state lien law and public policy. In particular, in order for a subcontractor to be able to file a lien many states require that an amount be "due and owing." Under a "pay-if-paid" clause, the money is not "due and owing" until the general contractor receives payment from the owner. The clause essentially acts as an illegal lien waiver and is thus, unenforceable.
However, in many other states such as New Jersey, courts have held that so long as the "paid-if-paid" clause is explicit in its terms, such as in the example above, it will not violate anti-waiver provisions of liens laws.
The bottom line is that cabinet subcontractors must become familiar with their payment rights under their subcontracts. There are no guarantees when it comes to conditional payment clauses and their enforceability will depend upon the language use in the clause as well as your state's law. As always, it is highly recommended that you have any attorney review all subcontracts before signing on the dotted line.
—Peter J. Lamont, Esq., is a commercial litigation attorney with offices in Hawthorne, NJ, as well as Massapequa, NY. His practice focuses on the representation of small- to large-size companies in the building and design industry, as well as individual designers and architects. To contact him with questions and suggestions on topics for future articles, please email him at plamont@peterlamontesq.com or call him at (973) 949-3770.
