Pair of Cases Concerning Pay-if-Paid Provisions

Within the last month, two decisions with two outcomes were issued concerning "pay-if-paid" provisions. Observe that a "pay-if-paid" provision is a true condition precedent in that a general contractor is not required to pay its subcontractor unless and until it receives payment from the owner.  A different result flows from a "pay-when-paid" provision which only allows the general contractor a reasonable time to pay the subcontractor after receiving payment from the owner, but the risk of non-payment from the owner is not shifted to the subcontractor.

In Midlantic Fire, LLC v. Ernest Bock & Sons, Inc., No. DC–8529–14, 2016 WL 3093075, at *1 (N.J.Super. Ct. June 3, 2016), the pay-if-paid clause stated:

Payment by Owner to the General Contractor for the work/materials invoiced by the Subcontractor/Supplier shall be a condition precedent to General Contractor's obligation to pay Subcontractor/Supplier. Accordingly Subcontractor/Supplier agrees and understands that it shall bear the risk of non-payment by the Owner and shall be entitled to no compensation from the General Contractor in the event of non-payment by the Owner for its work/materials.

The plaintiff subcontractor installed a fire protection system in accordance with drawings and plans supplied by the defendant general contractor.  Subsequent to installation, the general contractor learned that the sprinklers interfered with structural supports that needed to be installed.  The subcontractor issued a change order, which was approved by the general contractor.  The subcontractor performed the changed work.  When the general contractor submitted the invoice for payment, the owner declined to pay because there was a "lack of communication [and] coordination" between the general contractor and subcontractor. The general contractor, citing the pay-if-paid provision, then refused to pay the subcontractor.   The plaintiff subcontractor prevailed at trial, and the defendant general contractor appealed the application of the pay-if-pay by law.

Applying Pennsylvania law, per the contract, the court affirmed in favor of the subcontractor because "courts are reluctant to enforce a conditional payment provision against an unpaid subcontractor that is not responsible for the condition giving rise to the payment defense" and because "parties to a contract have an implied duty not to frustrate conditions precedent to their performance" (citing Quinn Constr., Inc. v. Skanska USA Bldg., Inc., 730 F.Supp.2d 401, 420 (E.D.Pa.2010)).  Because the subcontractor had relied on the plans and drawings submitted by the general contractor and therefore because all coordination among subcontractors was the general contractor's responsibility, the subcontractor was not responsible for the non-payment. Rather the defendant general contractor's own error spurred the need for the change order and the owners refusal to pay the change order. As such, the pay-if-paid provision was inapplicable and the general was required to pay the subcontractor.

In A. Zahner Company v. McGowan Builders, Inc., No. WD 78063, 2016 WL 2994022, (Mo.App. Ct May 24, 2016), the pay-if-paid stated:

[Subcontractor] agrees that [the general contractor] will not be responsible to make any payment, progress or final, to [subcontractor] for any and all of the goods identified in this Purchase Order unless and until [general contractor] receives payment for such goods from the Owner of the project . . . . If Subcontractor is not paid within 45 days of when a pay application is submitted, Subcontractor may stop the Work of this Subcontract until payment is received . . . .

The trial court had concluded that the above provision was ambiguous because the "unless and until" language was a condition precedent to payment shifting the risk of non-payment to the subcontractor whereas the "stop the Work" sentences "eased the burden" of risk to the subcontractor.  The appellate court disagreed and instead held that the entire provision could be read harmoniously. That court held that altogether the provision simply "distributes financial risk between the parties and provides both [with] a measure of financial protection."  In sum, the general contractor did not need to pay if owner did not pay.  As its recourse, the subcontractor did not need to continue work if it was not paid.  As such, the appellate court concluded that the pay-if-paid provision was applicable and remanded the case for fact-finding -- whether the owner indeed did not pay the general contractor.

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The author, Katharine Kohm, is a committee member for The Dispute Resolver. Katharine practices construction law and commercial litigation in Rhode Island and Massachusetts.  She is an associate at Pierce Atwood, LLP in Providence, Rhode Island.  She may be contacted at 401-490-3407 or kkohm@PierceAtwood.com.

Ohio Supreme Court Reinstates Assessment of Liquidated Damages Equal to 40% of Original Contract Value in Public Works Project

In Boone Coleman Construction, Inc. v. TheVillage of Piketon (2016 Ohio 628), the Ohio Supreme Court reviewed its liquidated damages precedents within the context of a public works project for the first time.  The matter stems from the award of a $638,000 public works contract for the installation of a new traffic light and associated roadway improvements with a substantial completion duration of 120 days.  Contained within the contract was a liquidated damages provision in the amount of $700 per day for each day after the substantial completion date.  The project’s date of commencement was set for July 30, 2007 putting substantial completion on November 27, 2007.  Boone Coleman was granted an initial extension to May 30, 2008, but its second request for an extension was denied and Piketon put Boone Coleman on notice that liquidated damages would be sought for every day after May 30, 2008.  The project eventually reached substantial completion on July 2, 2009, 397 days after the schedule extension date of May 30, 2008.

Boone Coleman brought suit against Piketon for not paying $144,477 of construction costs and Piketon countered in the amount of $277,900 for liquidated damages.  The trial court granted Piketon’s motion for summary judgment and awarded liquidated damages.   The appeals court reversed that decision and found the liquidated damages to be “unreasonable and disproportionate.”  Piketon appealed to the Ohio Supreme Court.

The Court stated it would review the case for two propositions of law: 1) courts must review the validity of liquidated damages prospectively, not retrospectively, and 2) liquidated damages are not deemed to be a penalty simply because the construction is new and actual damages cannot be presented. It began by defining liquidated damages and pointed to Ohio’s three part test for determining whether a contract term is a liquidated damage or a penalty.  A term is a liquidated damage if:

(1)   [Damages are] uncertain as to amount and difficult of proof.

(2) The contract as a whole is not so manifestly unconscionable, unreasonable, and disproportionate in amount as to justify the conclusion that it does not express the true intention of the parties.

(3) The contract is consistent with the conclusion that it was the intention of the parties that damages in the amount stated should follow the breach thereof.

The Court next discussed the inclusion of liquidated damage provisions in public works contracts.  The Court stated that, “The Supreme Court and many state and federal appellate courts also recognize that liquidated-damages provision in public contracts are particularly valuable given the unique difficulty in calculating the damages associated with a public contractor’s breach of its promise to timely complete a public improvement project.”  The Court then pointed to the statutory requirement passed by the Ohio legislature requiring public-improvement-construction contracts contain a liquidate damages provision.

The appeals court determined that the first and third parts of the above three part test were satisfied in the contract and the Court concurred, but it also found that the appeals court erred in determining the second part was not fulfilled.  The Court identified the fact that the appeals court incorrectly focused its analysis on the total amount of liquidated damages and not the per diem amount when it concluded that the provision was an unenforceable penalty. The Court stated, “[h]ere the appellate court improperly engaged in retrospective analysis, i.e., it looked, with hindsight, to the aggregate application of the per diem liquidated damages to conclude that the provision was unconscionable.  But it did not determine that the per diem amount was unconscionable at the time the parties entered into the contract.”

The Court further mused that with the appellate court’s reasoning, had the delay been only a few days and the liquidated damages did not accumulate to the level in the present matter, then the provision might have been enforceable. The court found this to be unacceptable so as to “relieve a breaching party of the consequences it agreed to by refusing to enforce a per diem liquidated-damages provision solely because the breach was an egregious one.” 

The Court vacated the judgment of the appellate court and remanded.

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The author, Brendan Carter, is a contributor to The Dispute Resolver and a former Student Division Liaison to the Forum on Construction Law.  He is an attorney and a Senior Consultant with Navigant’s Global Construction Practice based out of Boston, MA.  He may be contacted at 617.748.8311 or brendan.carter@navigant.com.

Division 1 Steering Committee Meeting Minutes - May 16, 2016

Moving forward we will be posting the Division 1 Steering Committee Meeting Minutes to the Blog.  Here is a link to the Minutes from our May 16, 2016 Meeting. 

United States Court of Appeals for the Federal Circuit Provides Guidance on Accrual of Pass-Through Subcontractor Claims

In Kellogg Brown & Root Services, Inc. v. Murphy, the timeliness of prime contractor Kellogg Brown & Root Services, Inc.’s (“KBR”) May 2, 2012, claim to the Army was sole issue on appeal - particularly, whether KBR’s claim had accrued on or before May 2, 2006, for purposes of the Contract Disputes Act’s (“CDA”) 6-year statute of limitations.   The court held that the 6-year statute of limitations had not run.

The project at issue involved KBR’s contract with the Army to construct dining facilities and provide meal and related services for troops in Iraq.  KBR subcontracted with a joint venture between The Kuwait Company for Process Plant Construction & Contracting K.S.C. and Morris Corporation (AUST) PTY Ltd. (“KCPC/Morris”) to implement certain work release orders for the project.  On July 31, 2003, KBR terminated KCPC/Morris for alleged default.  KCPC/Morris disputed the termination but continued performance until transition to a new subcontractor on September 12, 2003.

In 2004, KCPC/Morris filed suit against KBR in the United States District Court for the Eastern District of Virginia based on the termination.  In the suit, KBR claimed that KBR and KCPC/Morris had reached an oral settlement and sought to enforce it.  On January 24, 2005, KBR and KCPC/Morris reached an agreement dividing KCPC/Morris’ alleged costs into two categories and converting the default termination to a termination for convenience.

As part of the agreement, KBR and KCPC/Morris agreed to cooperate to prepare invoices to the Army for KCPC/Morris’ termination costs.  On August 26, 2006, KCPC/Morris submitted to KBR a certified claim.  On November 3, 2006, KBR forwarded KCPC/Morris’ claim to the Army, but KBR did not certify the claim. 

The Army responded on May 30, 2007, that KBR was responsible for negotiating and discussing claims with its subcontractors and that the Army does not comment in advance whether a claim or costs are appropriate.  The Army also refused to meet with or correspond directly with KCPC/Morris.  The Army directed KBR to settle with KCPC/Morris, and then submit a claim to the Army.

On October 10, 2007, KBR “sponsored” KCPC/Morris’ claim and certified the claim on January 10, 2008.  However, on September 8, 2010, KBR withdrew the claim, stating it was a business dispute between KBR and KCPC/Morris.

On August 4, 2011, KCPC/Morris filed suit against KBR in the United States District Court for the Eastern District of Virginia regarding KBR’s handling and submission of KCPC/Morris’ claim to the Army.  KBR and KCPC/Morris ultimately settled the suit, and then on May 2, 2012, KBR submitted a certified claim with the Army for the settlement amount.  The contracting officer did not act on the claim, thereby placing it in the “deemed denied” status.  KBR appealed to the Board.

The CDA requires that a claim “shall be submitted within 6 years after the accrual of the claim”.  41 U.S.C. § 7103(a)(4)(A).  The Army claimed that the 6-year CDA statute of limitations had run and moved to dismiss.  The Board granted the Army’s motion, finding alternative dates for the accrual of the claim - the first on September 12, 2003, when KCPC/Morris ended its work, and the second on January 24, 2005, when KPB and KCPC/Morris agreed to submit KCPC/Morris’ alleged termination costs to the Army.  Both dates preceded the critical limitations date of May 2, 2006.

The court noted that the FAR defines “accrual” of a claim as:

the date when all events, that fix the alleged liability of either the Government or the contractor and permit assertion of the claim, were known or should have been known.  For liability to be fixed, some injury must have occurred.  However, monetary damages need not have been incurred.

48 C.F.R. § 33.201.  The court also noted that the FAR, the conditions of the contract, and the facts of a particular case determine when a CDA claim accrues.

KBR argued that until KBR determined the amount of payment KBR would request from the Army, the claim did not yet exist and could not accrue.  KBR argued that until KCPC/Morris provided its costs on August 26, 2006, which KBR ultimately included in KBR’s certified claim to the Army, the claim had not accrued.

The Army presented a theory, which the Board adopted, that the payment of the remaining subcontractor costs following the termination was a “non-routine” request for payment, which accrued as of the date the subcontractor ended its work, in this case, on September 12, 2003.  The Army based its theory on jurisprudence that allows a contractor to immediately seek payment of damages flowing from some unexpected or unforeseen action of the government.  However, the court noted that termination of a subcontractor is not an unforeseen government action.

The court further noted that the limitations period does not begin to run if a claim cannot be filed because of mandatory pre-claim procedures, and here, the Army required KBR to resolve the disputed costs with KCPC/Morris, then submit the claim to the Army.

The court also rejected the Army’s various alternative theories of claim accrual and ultimately reversed the Board’s dismissal and remanded the case to the Board to determine the claim merits.  The court did not identify the date that KBR’s claim did accrue, only that the claim had not accrued before the critical May 2, 2006, date.

For your reference, linked here is a copy of the May 18, 2016, decision.