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General contractors face a lot of potential risks on construction projects. Those risks range from the possibility of weather events delaying or destroying work to the possibility that the owner will refuse to pay for completed work. To ensure profitability and reduce the cost of disputes, contractors will try to shift as much risk as possible onto other parties including subcontractors.
One of the popular ways in which general contractors attempt to shift the risk of non-payment by the owner is through “pay if paid” or “pay when paid” clauses in their subcontracts. Such clauses typically state that the contractor will pay the subcontractor for work completed within a specified number of days after receiving payment from the owner. Sometimes the language will more explicitly indicate that the subcontractor is not entitled to payment until the owner has first paid the general contractor. The contract may specifically indicate that the owner’s payment (often full payment) is a condition precedent to the subcontractor’s right to be paid.
The Texas legislature attempted to protect innocent subcontractors from being denied payment for their work through pay if paid provisions by legislating around it. Under Texas law, an unpaid subcontractor can reject such contractual provisions from being enforced when the reason the owner did not pay is wholly unrelated to the work of the subcontractor. In other words, such contingency payment provisions are only enforceable against a sub when the sub’s work is the reason the owner is withholding payment.
Unfortunately for subcontractors, “pay when paid” clauses are still enforceable if the payment is to be made within a reasonable period of time. What constitutes a “reasonable” period of time, however, is up to the judgment of the contracting parties. Consequently, general contractors will want to use language that defines reasonable time as the full amount of time it would take the general contractor to exhaust all legal claims and remedies against the owner for non-payment. And that time period could easily last 5 years or more, leaving subcontractors in effectively the same problematic situation as before.
From a subcontractor’s perspective, it is therefore important to review how a pay when paid contract defines a reasonable period of time and insist on a definition that fixes the time period as a number of days from when the subcontractor completes work and submits a request for payment. Structuring the payment obligation in this way will ensure that the subcontractor can control whether the right to be paid arises (by completing work as agreed and submitting a payment request).
From a practical perspective, it is more equitable for the general contractor to bear the risk of non-payment by the owner. The general contractor, not the subs, meets, evaluates, and works directly with the owner. This closeness and direct privity of contract puts the general contractor in a superior position to evaluate the owner’s credit risk and ability to pay. Such information is outside the subcontractor’s purview and control, thus the associated risk should be as well.