Conditional
Payment Clauses
By James M. Dash, Carlson Dash LLC Conditional payment clauses –
commonly called “pay if paid” or
“pay when paid” clauses depending
on their specific language – are used
in many jurisdictions as a means to protect
upstream (often general) contractors
from the potentially crushing risk of having
to come out of pocket to pay all of its
(trade) subcontractors when the owner has
not yet, and may never, pay the upstream
contractor.
First, some definitions to make sure we
are speaking the same language. When we
refer to a “pay if paid” provision, we mean
that payment to the upstream (again, usually
a general) contractor1 by its customer
(usually the owner) for the work performed
by a subcontractor is an absolute condition
precedent to the upstream contractor’s
obligation to pay the subcontractor
in question. Under such a provision, if it is
enforceable in the applicable jurisdiction,
the upstream contractor has no obligation
to pay its subcontractor unless and until
the upstream contractor is paid by its customer
for the sub’s work. The credit risk is
passed entirely to the subcontractor.
On the other hand, a “pay when paid”
provision generally states that the upstream
contractor’s obligation to pay the subcontractor
is time dependent. The law in some
jurisdictions ( for example, Wisconsin) specifically
provides that it does not prohibit
contract provisions that may delay a payment
to a subcontractor until the prime
contractor receives payment from any person
who does not have a contractual agreement
with the subcontractor, supplier or
service provider. However, most jurisdictions
hold that, in a pay when paid scenario,
the upstream contractor has a “reasonable
period of time” to make payment but may
not defer payment forever. By the time litigation
over the matter has concluded, rest
assured that a “reasonable” period of time,
whatever that is, will have elapsed.
Because prime contractors generally do
not prefer to act as the owner’s bank, there
LEGAL
is a strong incentive for such contractors to
pass the collection risk downstream where
it can. A prime contractor may have a “pay
if paid” clause in its “standard” form subcontract
and may use it even where it is not
likely to be enforceable (absent a downside
to doing so) just to create the impression
on an uneducated subcontractor that the
latter will have to wait for the owner to
pay the prime contractor in order for the
subcontractor to collect its money. The
subcontractor who knows what it is looking
for, on the other hand, is strongly incentivized
to try to eliminate any conditional
payment clause. Where a compromise is
the best course, a subcontractor should at
least try to bargain down to a “pay when
paid” clause.
In this light, it pays for subcontractors
to understand the difference between “pay
if paid” and “pay when paid” clauses and,
to borrow portions of these phrases, if and
when such conditional payment clauses are
enforceable in the applicable jurisdiction.
Subcontractors beware!
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