They are the bane of all subcontractors and suppliers—those pay-when-paid provisions that say a payment won’t be due from a general contractor until and unless it is first paid by the owner. These attempts to shift the risk of nonpayment from a contractor to its subs and material suppliers have found their way into most construction contracts.
While seemingly straightforward at first glance, many of these clauses are ambiguous. The pay-when-paid language can be interpreted on one hand as establishing a condition precedent where payment must first be received from the owner before it can be paid out to the service provider or, on the other hand, as simply fixing a reasonable time frame for when payment is to be made.
When interpreted as a condition precedent, the provider will get paid only if the party with whom it contracted has been paid by the owner.
However, when seen as fixing a reasonable time frame for payment, the pay-when-paid language is treated as promise by the general contractor to pay the subcontractor with the understanding that the payment may be delayed for some reasonable time while the general contractor obtains payment from the owner.
What if the subcontract with a pay-when-paid clause incorporates the prime contract between the general contractor and the owner? What if that prime contract actually requires the general contractor to pay all bills or debts associated with the work? Reading these provisions in conjunction with the subcontract, which states that payment won’t be due until it is received from the owner, obviously, creates confusion. When this happens and the pay-when-paid language is unclear, then this limiting provision simply sets a reasonable time for payment and is resolved against the general contractor.
The bottom line is that a pay-when-paid clause, if intended to create a precondition to payment as opposed to a reasonable time frame when payment will be made, must be free of any ambiguity and must establish by its express terms that payment by the owner is a condition precedent to any requirement on the part of one party to pay the other.
Too often, more time is spent bidding a project than actually reviewing the agreement that formalizes a party’s selection to perform the work.
Generally, pay-when-paid provisions are not discovered or really understood until the parties are well into a job. By then, it’s normally too late and too costly to do what could have—and should have—been done at contract negotiation.
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