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The "Pay-if-Paid" Clause - A Suspect Subcontract Provision

Fall 2007Cole Schotz DocketAttorney: Adam J. Sklar

General contractors sometimes include in their subcontracts clauses which condition payment from the general contractor to the subcontractor on payment from the owner to the general contractor.  These clauses, depending on their language, are commonly known as “pay-if-paid” or “pay-when-paid” clauses.  A pay-if-paid clause requires payment to the subcontractor only if the general contractor is paid by the project owner.  A pay-when-paid clause requires payment to the subcontractor when the general contractor gets paid. 

New Jersey has no statute specifically governing the enforceability of these clauses.  The only published court decision to interpret either of these clauses under New Jersey law was Seal Tite Corp. v. Ehret, Inc., a 1984 federal trial court decision, which dealt with a subcontract containing a pay-when-paid clause.  The court held that the issue was one of contract construction, and not of public policy, and agreed with the subcontractor that the pay-when-paid clause did not reflect the intention of the parties to shift the risk of the owner’s insolvency from the general contractor to the subcontractor.  The court interpreted this standard pay-when-paid clause, not as creating an absolute condition precedent to payment to the subcontractor, but rather as affording the general contractor a postponement of payment for a reasonable period of time in order to allow the general contractor an opportunity to collect funds due from the owner.  The court also suggested that the parties to a subcontract could shift the risk of the owner’s insolvency to the subcontractor, and make payment to the general contractor an absolute condition precedent to payment to the subcontractor, provided that the subcontract clearly and unequivocally so provides. 

There have been no reported decisions relating to the enforceability of either of these clauses, however, since the enactment of the New Jersey Construction Lien Law (“CLL”), which became effective in early 1994.  Unlike New Jersey’s prior Mechanics’ Lien Law, which was in effect at the time of the Seal Tite case, the CLL states that “[w]aivers of construction lien rights are against public policy, unlawful, and void,” except to the extent of payments actually made to the subcontractor.  New York and California, which also prohibit lien waivers, have invalidated pay-if-paid clauses in subcontracts,  holding that a pay-if-paid clause, by shifting the risk of the owner’s non-payment to the subcontractor, is essentially an illegal lien waiver because a lien claim may not be enforced until payment is actually due and owing, which may never occur under such a clause. 

It is likely that, when and if the issue comes before an appellate court in New Jersey, pay-if-paid clauses may be deemed unenforceable as against public policy.  Pay-when-paid clauses, however, will likely remain enforceable.  Unlike a pay-if-paid clause, where the obligation to pay the subcontractor may never ripen, a pay-when-paid clause arguably only acts to delay payment to the subcontractor. 

As a result, general contractors may want to consider abandoning pay-if-paid clauses in favor of pay-when-paid clauses, which will likely continue to allow the general contractor a reasonable time to secure payment from the owner.  The alternative may be an obligation to make immediate payment to the subcontractor if the pay-if-paid clause is deemed unenforceable. 

A subcontractor, on the other hand, who has not gotten paid due to a pay-if-paid clause, may want to take legal action to challenge the enforceability of the clause and seek immediate payment from the general contractor. 

Please note that this article is limited to subcontracts on private construction jobs.  Public jobs, state and federal, are beyond the scope of this article.

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