How to Defeat the Dreaded “Pay-if-Paid” Clause

 

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Written By: Kyle M. Winslow

In the context of a subcontractor contract for a construction project, pay-if-paid clauses allow a general contractor to not pay a subcontractor if the owner did not pay the general contractor. While the pay-if-paid clause has not been adopted by the AIA, the typical clause will look something like this:

Subcontractor acknowledges that all payments to Subcontractor are absolutely contingent on Contractor’s receiving payment from Owner. Subcontractor expressly agrees to accept the risk that Subcontractor will not be paid for work performed by Subcontractor if Contractor, for whatever reason, is not paid by Owner for such work.

Pay-if-paid clauses are common and many states permit their enforcement. Other states deem them invalid. With the exception of 2015 unpublished Court of Appeals opinion, Kentucky law offers very little guidance on their enforceability. In Dugan & Meyers Construction Company v. Superior Steel, Inc., et al., 2015 Ky. App. Unpub. LEXIS 3 (Ky. Ct. App. Jan. 9, 2015), the Court of Appeals vacated a trial court judgment and remanded the matter for a new trial due to the trial court’s failure to explicitly instruct the jury with regard to the pay-if-paid clause in a construction contract. While the Court did not provide a detailed analysis, it stated that pay-if-paid clauses are “essentially conditions precedent to performance under the contract.” Thus, the Court of Appeals implicitly recognized the validity of these clauses.

Pay-if-paid clauses are obviously dangerous to subcontractors because they require them to assume all of the risk of owner non-payment. The existence of the clause, however, does not have to end payment discussions. A not well-known law of contracts offers subcontractors a sword in the event that a general contractor invokes the shield of a pay-if-paid clause.

The prevention doctrine is a generally recognized principle of contract law which says that if a party prevents or hinders fulfilment of a condition to his performance, the condition may be waived or excused. Stated another way, the prevention doctrine operates to void pay-if-paid clauses if the subcontractor can show that the general contractor’s actions contributed to the owner’s nonpayment.

For example, in Moore Bros. Co. v. Brown & Root, Inc., 207 F.3d 717 (4th Cir. 2000, the Court found that the general contractor misled lenders regarding the cost of design changes. By misleading the lenders, the general contractor made it less likely that the lenders would arrange additional financing to cover the cost of the design changes. Thus, the general contractor hindered the fulfillment of the condition precedent (payment by owner), and the Court voided the pay-when-paid clause. While the Moore Court considered a pay-when-paid clause, the same analysis could apply to a pay-if-paid clause.

The moral to the story is that a pay-if-paid clause is not the be all and end all of a payment dispute. While Kentucky implicitly approved the clauses, they’re generally disfavored and the prevention doctrine can allow the Court an opportunity to avoid enforcement of the often unfair clauses.

Kyle M. Winslow is a trial attorney with Hemmer DeFrank Wessels PLLC. He represents construction professionals on many aspects of public and private projects, including the preparation and enforcement of mechanic’s liens and bond claims, contract negotiation, arbitration, and the litigation of contract disputes. He is licensed to practice law in Kentucky, Ohio, and Indiana.

Hemmer DeFrank (1)

 

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