Payment provisions are one of the stickiest areas in construction disputes. Many states have developed laws addressing project payment timeliness, including prompt payment and retainage regulations. However, pay-if-paid clauses condition a subcontractor’s claim to compensation on the general contractor’s obtaining money from the owner.
Pay-if-paid construction contract clauses are losing favor, and the most recent state to outlaw them is Virginia. Contractors and subcontractors should keep up with these modifications. Last year, Virginia voted to prohibit pay-if-paid, requiring all public contracts to include a payment clause that makes the contractor “liable for the entire amount owed to any subcontractor with which it contracts” unless the subcontractor did not comply with the contract.
These contingent payment clauses are typically the focus of ferocious debate in courtrooms and state legislatures around the United States. They are frequently viewed as unfair since they ostensibly transfer the risk of non-payment by the owner to the subcontractor, who often does not have direct contact with the owner. Subcontractors also have limited opportunity to determine or confirm the owner’s financial stability before the start of a project.
In this article, we will discuss how a pay-if-paid clause can affect the payment terms in a construction contract. We will also outline the various steps a subcontractor may take when dealing with a pay-if-paid construction contract clause. Let’s first define what a pay-if-paid clause means.
What is a Pay-If-Paid Clause?
A pay-if-paid clause in a contract specifies that the general contractor’s payment to the subcontractor is subject to the owner’s payment to the general contractor. This implies that the general contractor is only obligated to pay the subcontractor for their services if the owner has paid for them, even though the subcontractor has fulfilled all of their contractual obligations. A pay-if-paid clause transfers to the subcontractor the risk of the owner’s non-payment, affecting the subcontractor’s payment claim.
Courts requires a clear understanding of the contract language used in the provision and clear evidence that all parties involved intended for this type of clause to be included. The basic objective of this contingent payment clause is to transfer financial risk downward. Consequently, several states forbid pay-if-paid clauses. In such states, courts argue that this sort of contractual risk transfer violates the mechanics’ lien rights of the subcontractor.
However, suppose a contractor withholds part or all of the sum invoiced by a subcontractor. In that case, the contractor shall notify the subcontractor in writing of the withholding, including the reason for non-payment and the amount withheld. This amendment shall not prevent withholdings per the subcontract. A general contractor who disregards the new amendment risks receiving interest fines.
How Can a Pay-If-Paid Clauses Affect The Payment Terms of a Construction Contract?
Subcontractors and suppliers are subject to more stringent pay-if-paid requirements. The clause is specifically designed to safeguard the contractor by transferring the risk of non-payment to a company further down the payment chain. It is established so that the contractor is only required to pay the subcontractor after receiving payment. The clause relieves the contractor of seeing that subcontractors are paid, shifting the burden of any non-payment to the subcontractor.
In these circumstances, subcontractors and suppliers may be legally denied compensation for services rendered. The payment terms might change if the clause is removed. In some cases, pay-when-paid clauses are also restricted, so contractors must be paid before paying subcontractors. In such scenarios, more is needed to change the pay-if-paid clause to pay-when-paid. It may be possible to include new payment clauses to protect the contractor from non-payment.
Next Steps for Pay-If-Paid Construction Contract Editing
Subcontractors and suppliers face challenges when pay-if-paid clauses are used instead of pay-when-paid clauses. The party above has more power because there are always parties willing to carry out the work under the terms of the contract as they are. Sub-tier parties cannot typically demand contract language modification. They do not want to lose business because of clauses that, while potentially harmful, are standard practice in many contracts.
Remember that this puzzle is meaningless in jurisdictions where pay-if-paid agreements are illegal. Subcontractors and suppliers should steer clear of pay-if-paid arrangements to prevent the danger they pose.
Avoiding contracts with problematic pay-if-paid clauses is far simpler than going to court and relying on the judge’s interpretation of an ambiguous or unfavorable text. You can always review the contracts before taking the next step. In such cases, AI contract review software may come in handy. The software detects the provision, making contract revision easy and feasible.
At the tendering stage of any project, contractors, subcontractors, and suppliers must all consider the ramifications of contractual clauses affecting payment obligations. Some important practical and contractual steps should be taken to ensure that contractors, subcontractors, and suppliers limit the risks associated with non-payment throughout the contract.
The contract review process is essential for all companies, especially construction companies, since it helps streamline any issues in the document that may affect you negatively in case of unforeseen circumstances. With AI-powered contract review, the process of reviewing and editing contract amendments is automated, allowing builders and other firms to concentrate on projects with a greater financial return.
Use BlackBoiler to review and extract pay-if-paid contracts clauses to easily update your contracts to match your firm’s payment policy. Click here for a demo.