PAY IF PAID, PAY WHEN PAID, PAY WHEN THE GENERAL FEELS LIKE IT?

“Pay if Paid” clauses impose the risk of an Owner’s nonpayment upon the subcontractor, at least with respect to that portion of the work.  For example, if the Owner approves, accepts and pays the general contractor for 70% of the payment application, but withholds 20% due to a claim that the installation of the tile in the rotunda was defective, (and then holds 10% for retainage), every subcontractor that performed work within the 70% that was approved is entitled to prompt payment.  The tile subcontractor is entitled to Notice that its work was not accepted, specific information as to the basis for the rejection, and the prime contractor must follow the notice provisions for rejecting the work as set forth in the parties’ subcontract.

That analysis is not difficult.  But what happens when the Owner does not reject the work, but the subcontractor is advised that the Owner has simply not paid the prime contractor, and accordingly, the prime asserts that it does not owe the subcontractor?  Is the “pay if paid” provision sufficient to deny prompt payment to the subcontractor?  ANSWER:  It depends, but I personally believe that it is very risky for a prime contractor to refuse payment to a subcontractor absent specific evidence that the Owner has reasonably rejected the subcontractor’s work directly related to the payment being withheld.

A “pay if paid” clause must be very specific to be enforceable.  Amelco v. Drake, 20 Wn. App. 899, 583 P.2d 648 (1978)(a “pay when paid” clause means that payment is still due within a reasonable period of time).  Specifically, the phrase “condition precedent” must be used.  However, the issue of whether “pay if paid” contract clauses are valid has not yet reached the Supreme Court of Washington.  In W. States Paving Co. v. Pease & Sons, Inc., 132 Wash. App. 1034 (2006) the issue came up, but the Court of Appeals declined to address it directly.

The cases so far reflect that “pay if paid” clause and “pay when paid” clause are two contract provisions that Washington courts view skeptically, and interpret narrowly.  The evidence of the following questions should be reviewed in determined the course of action each party is entitled to take:

1.  Is the contract payment clause clear, certain and unambiguous?  [If not, then the court can consider the entire context of the parties’ negotiations, and can interpret any uncertainty against the party that drafted the agreement — usually, the prime contractor.  This is known as the Berg rule].   In Washington, several statutes require prompt payment of construction work, including:

a.  RCW 60.04 — mechanic’s lien statutes.  There is a specific statute invalidating any contract clause that would prohibit assertion of mechanic’s lien claims in advance of those claims arising.  Thus, a “pay if paid” clause would appear to be in contravention of that statute for all contracts on private construction.  This assumes that the anticipated work would otherwise be lienable (permanent improvements to real property and structures upon real property).

b.  RCW 39.04.250  is the Washington State Prompt Payment Statute governing public work.  While it doesn’t specifically prohibit any particular contract clause, the public policy to encourage good contractors to continue working upon public projects is only furthered when such contractors can be assured of reasonably prompt payment.  Contract clauses that subvert that purpose should be (and are) viewed very skeptically by the courts.

c.  RCW 4.24.360 prohibits any  “no damages for delay” clause  eliminating claims for delayed performance in advance of that occurrence.  The prime contractor’s performance includes payment to the subcontractor(s).  Therefore, any construction clause that prevents the subcontractor from asserting claims for delayed payment would be void.

d.  Cases governing sureties as insurance companies in Washington have imposed attorney fees upon payment bond sureties that forced claimants to file litigation to obtain the benefits of the bond.  The attorney fees are called, “Olympic Steamship” fees.  Washington law requires prompt investigation of payment bond claims, and a prompt “pay– or deny and explain” approach to claims handling practices.  See, e.g., RCW 48.01.030.  Payment bonds are typically available only on public work projects or very large private projects in Washington state.  They stand in the place of mechanic’s lien rights, available on private work.

2.  Additionally, even if the contract language itself clearly and unambiguously places the risk on the subcontractor, one will want to consider whether the subcontractor agreed to the “pay if paid” clause prior to submitting its bid and having its bid accepted?  IF NOT, did the prime contractor offer any specific new consideration to support this change in the contract terms?  (Usually, contract change orders require the parties to exchange something new for the contractual amendment to be effective).

3.  Do other circumstances indicate a wrongful purpose in the withholding of payment?  If so, any litigation will involve the facts and evidence to support or oppose such claims, making the liklihood that the litigation will be more costly and protracted for the parties.  This takes the profit out of delayed payment for the contractor and gives the payment bond surety or the Owner facing mechanic’s liens reason to believe that it will be paying claims, and seeking recovery from the possibly insolvent prime contractor.  Prompt payment of the legitimate documented claim is usually the wiser course for every party above the claimant on the contracting chain.