The payment term is the most important provision of any subcontract. Subcontractors are not typically advanced money at the start of their work, requiring them to front the cost of construction based on the contractor’s contractual obligation to pay. But, a subcontractor must insure the contractor’s payment obligation is not illusory. Pay-if-paid and pay-when-paid provisions are frequently misunderstood.
A pay-if-paid provision shifts the risk of nonpayment from the contractor to the subcontractor. If the contractor is not paid by the owner, the subcontractor likewise does not receive payment. To be enforceable, the provision must unequivocally establish that payment from the owner to the contract is an express condition precedent to the contractor’s obligation to make payment to the subcontractor. In contrast, a pay-when-paid provision deals only with timing. The contractor must pay the subcontractor upon receipt of payment from the owner; however, if the owner fails to pay, the contractor must still pay the subcontractor within a reasonable time. If the contractor is not paid by the owner, the contractor is still responsible for payment to the subcontractor.
Recently, the Kentucky Supreme Court clearly joined Tennessee and other states that find a pay-if-paid clause is enforceable if it establishes that payment from the owner to the contractor is an express condition precedent to the contractor’s obligation to pay the subcontractor. See, Superior Steel v. Ascent at Roebling’s Bridge, LLC. For more than 20 years, Tennessee has enforced pay-if-paid clauses, provided the payment condition was explicit. See, Koch v. Construction Technology, Inc. A minority of states, such as North Carolina, expressly reject pay-if-paid clauses and find they are unenforceable. In most instances, these states treat the provision as a pay-when-provision, though some place strict time restrictions on the contractor in which it must pay the subcontractor.
Before entering into any subcontract, determine whether a pay-if-paid or a pay-when-paid is in the subcontract. If present, research how the state in which the project is located treats the provision. The American Subcontractors Association has a number of resources for contractors, including a guide to Contingent Payment Clauses in the 50 States. If the state in which you are working permits pay-if-paid clauses, attempt to negotiate the provision out of your contract. If that is not possible, subcontractors should try to include a provision that allows them to suspend the work until payment is made. Contractors are in the business of making money. Hobbies cost money. By eliminating a pay-if-paid clause, subcontractors can make sure they are not just working for fun.
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