Never a Sure Thing: Pay-When-Paid Provisions in Construction Contracts
Given the vagaries and uncertainties these days in loan commitments as well as material prices, not to mention the overall state of the construction industry, one can quickly understand why pay-when-paid provisions have become so critical in construction contract negotiations.
What is a pay-when-paid provision?A pay-when-paid provision in a construction contract generally means that a contractor is not liable for payment to its subcontractors until such time as it is first paid by the owner. In the context of litigation, a defense based on a contractual pay-when-paid provision might assert that a plaintiff subcontractor is not entitled to receive payment unless the owner first pays the contractor for subcontractor's fees, or, alternately, that under the relevant contractor-subcontractor agreement a plaintiff subcontractor is not entitled to receive further payment pursuant to its claims until the contractor is paid by the owner for the fees claimed.
In Florida the general rule is that interpretation of contract provisions relating to conditions and time of payment between a contractor and subcontractors (also called risk-shifting provisions) is a question of law that a judge (as opposed to a jury) may decide on his or her own. The Florida Supreme Court has held that risk-shifting provisions are susceptible to only two possible interpretations: (1) if a provision is clear and unambiguous, it is interpreted as setting a condition precedent to the general contractor's obligation to pay; but (2) if a provision is ambiguous, it is interpreted as fixing a reasonable time for the general contractor to pay (whether or not it has been paid by the owner).
If a contract does not clearly express an intention to shift the risk of nonpayment, payment provisions will be interpreted as establishing a reasonable time to pay by the contractor (as opposed to creating a condition precedent to the contractor's obligation to pay the subcontractor). When preparing a contract the burden of clearly expressing an intention to shift risk is on the contractor. This is important because courts will not assume the existence of a pay-when-paid provision in a contractor-subcontractor contract unless it is specifically and clearly expressed in writing by the contractor. The reasoning is that small subcontractors, who need to receive payment for their work in order to remain in business, typically will not assume the risk of the owner's failure to pay the general contractor.
How does a Surety Bond Factor Into Pay-When-Paid Provisions?All of the above rules relating to risk-shifting provisions presuppose the existence of a written contract. If the contract in dispute is verbal it is not possible to successfully argue a pay-when-paid defense. Stated differently, in order for a contractor to validly assert a contractual provision which shifts the risk of payment such a provision must be in writing.
Additionally, a pay-when-paid defense is not available to a surety on a contractor-subcontractor contract for which it has posted a bond. The reason that a surety may not assert a pay-when-paid defense is because the surety bond is a separate, distinguishable contract from the contractor-subcontractor contract and, as such, an inability to proceed against the contractor should not prevent recovery on the bond. Public policy concerns also militate against allowing a surety to assert a pay-when-paid defense, because to do so would undermine the statutory scheme under which a subcontractor can seek recovery under a bond as an alternative to employing the procedural mechanism of applicable lien laws.
To be clear, liability for payment to subcontractors, when a contractor has not been paid by an owner, will hinge on a clearly expressed pay-when-paid provision in a written contract. If a contract contains an ambiguous pay-when-paid provision, Florida law will require a contractor to pay its subcontractors within a reasonable time, irrespective of payment by the owner.