May 2003
By ALEXANDER A. MIUCCIO, CIC Legal Counsel
A pay-when-paid clause in a subcontract generally provides that payment to a subcontractor does not become due until the general contractor or construction manager has received payment from the owner of the project. The courts have interpreted such a clause as setting a time for payment, rather than a condition for payment to the subcontractor. In other words, the courts have held that such a pay-when-paid clause permits a reasonable time for the general contractor to receive payment from the owner before having to pay their subcontractors, but payment becomes due to the subcontractor after a reasonable time, whether the general contractor has been paid or not.
By contrast, a pay-if-paid clause provides that payment by the owner is a condition precedent to the obligation to pay the subcontractor. That is, unless and until the owner pays the general contractor or construction manager, the obligation to pay the subcontractor does not arise. Such a pay-if-paid clause was held unenforceableÑmeaning, as being against public policyÑby the landmark case of West-Fair Elec. Contrs. v. Aetna Cas. & Sur. Co. decided by the New York Court of Appeals in 1995.
Notwithstanding that decision, such clauses continue to give rise to litigation, as illustrated by the recent case of Bonavist v. Inner City Carpentry, Inc.
Background
As the owner, Avalon Properties, Inc., entered into an agreement with York Hunter Construction, Inc., as construction manager, to build residential housing in Mamaroneck, NY, known as the Avalon Willow project. The construction manager entered into subcontracts, or trade contracts, with various subcontractors, including Inner City Carpentry, Inc. The subcontract provided that "to the extent permitted by applicable law" receipt by the construction manager of funds from the owner designated for payment to the subcontractor was "a condition precedent" to payment by the construction manager to the subcontractor. The clause also stated that the subcontractor was relying solely on the credit of the owner, and not the credit of the construction manager, for its payment.
The subcontractor employed union carpenters for the project. The construction manager was party to a project labor agreement with the carpenters union and the subcontractor was party to a collective bargaining agreement with the union.
The construction manager, as required by its contract with the owner, furnished a labor and material payment bond, issued by National Union Fire Insurance Company of Pittsburgh, Pa., as surety, covering the claims of subcontractors, sub-subcontractors, suppliers and laborers. The bond stated that its coverage was to the extent that the contractor had been paid for the labor, services, or materials provided by the claimant. The bond also stated that nothing in the bond precluded the claimant from serving a notice to the owner or filing a lien on the project.
The trustees of certain benefit funds of the Suburban New York Regional Council of Carpenters commenced an action in federal court against the subcontractor, the construction manager and the surety on the payment bond, seeking recovery of unpaid wages and fringe benefit contributions owed to the funds and individual carpenters represented by the union. The claim against the surety was based solely upon the payment bond for unpaid wages and fringe benefits. The surety moved for summary judgment dismissing the claim against the bond based upon the pay-if-paid provisions of the subcontract and bond.
Arguments
The surety argued that the explicit terms of the payment bond provided that the surety's payment obligation arose only if the construction manager was paid by the owner for the subcontractor's work. The surety claimed that the construction manager had paid the subcontractor all of the money it received from the owner on behalf of the subcontractor.
The union, relying on the West-Fair decision, argued that the "pay-if-paid" provisions of the payment bond were unenforceable and void as against public policy.
Decision
The court agreed with the union and denied the surety's motion for summary judgment. The court followed the decision in the West-Fair case. According to the court, because a pay-if- paid provision (incorrectly referred to as a pay-when-paid by the court) may indefinitely postpone a subcontractor's right to receive payment, the subcontractor has effectively waived its right to enforce a mechanic's lien, which may not be enforced until the debt is due and payable. Waiver of the right to enforce a mechanic's lien is against public policy, and, therefore, the pay-if-paid provision is void and unenforceable.
The court held that the provision of the payment bond, which attempted to make the surety liable only to the extent that the construction manager received payment from the owner, and the provisions of the subcontract, which attempted to limit the construction manager's obligation to pay the subcontractor until after receipt of payment from the owner, were unenforceable as against public policy.
Comment
Subsequent to the West-Fair decision, general contractors, construction managers and their sureties have been trying to circumvent the holding by trying to find language which will limit their liability to instances where the owner has paid, without violating the public policy against waiving the right to file and enforce mechanic's liens. So far, they have not been successful. As long as the pay-if-paid provision makes payment by the owner a condition precedent, the courts will refuse to enforce it.
Pay-when-paid provisions, however, which merely set a time for payment, not a condition for payment, will be enforced to the extent of permitting a reasonable time for the payment from the owner to the general contractor or construction manager before payment becomes due to the subcontractor.
About the author: Mr. Miuccio is a partner in the New York City- based law firm Altieri, Kushner & Miuccio, P.C. and legal counsel to the Construction Industry Council of Westchester and Hudson Valley, Inc. Robert Mark Wasko, senior associate with the firm, assisted in the preparation of this article.