"Pay When Paid," "Pay If Paid": Use with Caution
Contingent payment clauses are popular with general contractors but not so popular with Arizona courts.
This article appeared in the October 2003 issue of "The Construction Advisor"
published by Lang & Klain, P.C.
Free Subscription to the Construction Advisor
Construction Advisor index
Do you have a quick question about this topic? Call
Mike Thal or Kent Lang (480-947-1911) for a no-charge, five-minute phone consultation
One of a contractor's
greatest concerns on a construction project is making sure he is paid for his
work. When the contract has been fully performed, everyone wants to be, and
should be, fully paid.
It is not uncommon for a
general contractor to try to shift to subcontractors the risk of nonpayment by
the owner. Consequently, “pay when paid” and “pay if paid” provisions are
popular with general contractors; however, they are not so popular with the
Public policy, both state
and federal, favors protecting a subcontractor’s or materialman’s right to be
fairly compensated for labor and materials he puts into a construction project.
Mechanics' lien laws protect parties that do work on private projects; payment
bonds protect those who work on federal, state or municipal projects. The amount
due the subcontractor and the time when it becomes due, however, are usually
determined by the terms of the contract.
Typical pay-when-paid clauses go something like this:
“The total price paid to
[subcontractor] shall be [contract price], no part of which shall be paid
until five days after payment is received from owner,” or
“… the Contractor shall pay the
Subcontractor each progress payment and final payment ... within three
working days after he receives payment form the Owner …”
Thos. J. Dyer v. Bishop International Engineering Co., the Sixth Circuit
U.S. Court of Appeals refused to enforce a pay when paid clause. In that case,
Dyer installed plumbing at a race track owned by the Kentucky Jockey Club.
Bishop was the general contractor on the job. Their subcontract read:
“The total price to be paid to
Subcontractor shall be $119,000 lawful money of the United States, no part
of which shall be due until five (5) days after Owner shall have paid
Contractor therefore …”
Unfortunately, the Jockey
Club filed bankruptcy without paying Bishop for Dyer’s work. Bishop argued that
it was obligated to pay Dyer only if it was paid by the Jockey Club. The court
In deciding what the
subcontract language “meant,” the court reasoned that general contractors
ordinarily bear the risk that the owner may become insolvent and thus unable to
pay for the work. It interpreted the pay-when-paid clause to be a “reasonable
provision” designed to postpone payment for a “reasonable period of time,”
during which the general contractor would have an opportunity to collect payment
from the owner. It would be “unreasonable” to require the subcontractor to wait
an indefinite period of time for payment — i.e., until the general contractor
had been paid by the owner — which may never occur.
The Arizona View
Arizona has adopted the Dyer court’s interpretation of pay-when-paid
clauses. Arizona courts look unfavorably upon a “pay when paid” or “pay if paid”
clause, which must be written very carefully to be enforceable. The contract
language must plainly state that the subcontractor agrees to be paid only out of
a specific fund, and, if that fund is insufficient or never created, he will
forfeit payment for some or all of his work.
For example, in L.
Harvey Concrete, Inc. v. Agro Construction & Supply Co., the Arizona Court
of Appeals held that the following clause was plain enough to shift the credit
risk to the subcontractor:
[S]ubcontractor agrees as a
condition precedent to payment … that the owner shall have first paid the
payment … to the contractor, and that payment for either progress payments
or final payment is not due and owing to the subcontractor as provided for
herein until the owner has made such payment to the contractor.
The court held that this
language states plainly that payments from the owner to the general contractor
were the sole source of funding for the subcontract, and, until the owner paid
the general, no payment to the subcontractor became due.
understand that, as a practical matter, a pay-when-paid or pay-if-paid clause
always creates confusion about when and if payment becomes due. You can bet that
the general contractor thinks the clause is binding, and time and money will be
required to prove otherwise.
should understand that, at the present time, a pay-when-paid or pay-if-paid
provision can be valid in Arizona, provided it is properly written and plainly
shifts the risk of nonpayment to subcontractors. However, courts do not like
these provisions and will try very hard to find a reason to invalidate them.
"Pay if Paid"
do contractors satisfy the Dyer ruling in shifting the burden of owner
nonpayment by the owner? Say it clearly in a contract provision, for example:
“… the subcontractor is paid only if
the general contractor is paid, (or the subcontractor will not be paid
unless the general contractor receives payment from the owner) …”; or
“… the subcontractor assumes the
risk of nonpayment by the owner due to insolvency or other inability to pay
Such contract language
has been held by many courts to sufficiently shift the burden of nonpayment to
Even with that apparently safe language, though, a pay-if-paid clause can
encounter rough sledding if judges are of the opinion that “risk shifting”
violates public policy.
The California Supreme
Court ruled, in Wm. R. Clarke Corp. v. Safeco Ins. Co. of Amer., that
pay-if-paid clauses are unenforceable as a violation of California’s public
policy. The court noted that a “pay if paid” clause is an indirect forfeiture of
a subcontractor’s constitutionally protected lien rights. The New York high
court has likewise concluded that “pay if paid” clauses are void as against