September 2004
By ALEXANDER A. MIUCCIO, CIC Legal Counsel
A "pay-when-paid" clause in a subcontract typically provides that payment to the subcontractor or supplier does not become due until the general contractor has received payment from the owner of the project. Such a provision effectively shifts the risk of non-payment by the owner downward to the subcontractor. As a result, such clauses are disfavored under New York Law and, under the landmark case of West-Fair Electrical Contractors v. The Aetna Casualty & Surety Co., New York's highest court held that such a contingent payment is unenforceable because it violates public policy.
Notwithstanding that decision, litigation continues to arise over the nature and limits of a "pay-when-paid" clause. The most recent of these is American Building Supply Corp. v. Avalon Properties, Inc.
Background
Avalon Properties, Inc., as owner, entered into an agreement with York Hunter Construction, Inc., as general contractor, to construct residential housing units in Mamaroneck, NY. National Union Fire Insurance Co. issued a labor and material payment bond naming York Hunter as the principal and Avalon as the obligee. The bond contained a "pay-when-paid" clause, stating that the surety would only pay claims for labor, services or materials supplied with respect to the project for which York Hunter had been paid by Avalon. Four of York Hunter's subcontractors or suppliers commenced actions under the payment bond, claiming that they had not been paid for the labor or materials they furnished to the project. The surety moved to dismiss the actions based on the pay-when-paid provision contained in the payment bond, which limited its liability to amounts actually paid to the general contractor by the owner. The lower court denied the surety's motion, causing the surety to appeal the decision.
Decision
The appellate court affirmed the decision of the lower court, relying on the rationale of the Court of Appeals in West-Fair, that a "pay-when-paid" clause in a subcontract violates the policy of New York. There, the highest court held that a "provision, which forces the subcontractor to assume the risk that the owner will fail to pay the general contractor, is void and unenforceable as contrary to public policy."
The appellate court reasoned that the liability of the surety in issuing a payment bond is measured by the terms of the liability of the general contractor, its principal under the bond. Since the challenged "pay-when-paid" provision in the bond would be void and unenforceable if it were contained in a subcontract, the court held that the clause is similarly void as a condition precedent to recovery under the payment bond.
Comment
The effect of this case is to extend the reasoning of the West-Fair decision to the surety level and reaffirm that a surety's obligation is co-extensive with its principal. While it has long been clear that the general contractor may no longer shift the risk of non-payment by the owner down to its subcontractors and suppliers, some sureties continue to assert receipt by the general contractor of payment from the owner as a condition precedent to their payment bond obligations. They will not be successful. As long as the contingent payment provision makes payment by the owner a condition precedent to recovery, the courts will refuse to enforce it.
About the author: Mr. Miuccio is a partner in the law firm of Goldberg
& Connolly and General Counsel to the Construction Industry Council of
Westchester and Hudson Valley, Inc.