|October 24, 2013|
Previously published on October 21, 2013
As a contractor or subcontractor, timely receipt of payment can be the difference between continuing to grow your company and closing its doors. Because of this, contractors and subcontractors will frequently try to shift the risk of nonpayment by the owner onto their subcontractors through the use of what are known as “pay if paid” clauses in their contracts. A typical pay if paid clause states that the contractor only has to make payment to its subcontractor if it receives payment from the owner for the subcontractor’s work. Therefore, if the owner never pays the contractor, the contractor would never have to make payment to the subcontractor.
In New York, these types of clauses have been unenforceable since 1995, when New York’s highest court decided the landmark case of West-Fair Elect. Contr. v. Aetna Cas. & Sur. Co. In that case, the New York Court of Appeals decided that pay if paid clauses violate New York’s public policy that subcontractors cannot waive their mechanic’s lien rights absent a waiver given in connection with actual receipt of payment. The Court reasoned that a pay if paid clause functions to waive a subcontractor’s right to file a mechanic’s lien because a subcontractor’s right to file a mechanic’s lien arises only when payment is due from the contractor. If a pay if paid clause were in effect, then hypothetically, if the owner never makes payment to the contractor, the subcontractor would never have a right to payment and would never have a right to file a mechanic’s lien.
The Court in West-Fair distinguished a pay if paid clause from a “pay when paid” clause. A pay when paid clause fixes a reasonable time for payment instead of creating a situation where a subcontractor never receives payment from a contractor because the owner never pays the contractor. But beware; courts will look beyond the words of the clause to make sure the clause is not really functioning as an unlawful pay if paid provision.
The context in which pay when paid clauses are most commonly seen is when dealing with retainage. If phrased properly, the withholding of retainage can be a valid pay when paid clause, merely fixing the time of payment from the contractor as opposed to making it conditional upon receipt of payment from the owner. However, if you make receipt of retainage from the owner the condition for the release of retainage to the subcontractor, that would be an invalid pay if paid clause. This scenario often arises when payment is conditioned upon acceptance of the work by the owner.
The withholding of retainage in this context is not without its own limitations. Contractors may not withhold retainage indefinitely or where the owner is unreasonably unwilling to approve the work. In fact, one of New York’s intermediate level courts has held that once the owner accepts the work, the contractor cannot withhold retainage from the subcontractor, even where the owner has not yet made payment to the contractor.
To those contractors and subcontractors who also perform work outside of New York’s borders, it is important to know that not all states protect subcontractors from the harsh outcomes associated with pay if paid clauses.