"Pay-When-Paid": Is there a "Reasonable Time" for Subcontractors to Wait for Payment Once Contractor-Owner Litigation Ensues?

Obviously, subcontractors prefer to be paid within a reasonable time, but the issue of what constitutes a “reasonable time” has been a conundrum many states have tackled over the years. From “pay-if-paid” to “pay-when-paid” provisions, states have either adopted one, both, or neither of these commonly controversial, heavily negotiated provisions. Recently, the California Court of Appeals has ruled on a “pay-when-paid” provision that might set the groundwork for subcontractors in other states arguing that “paid-when-paid” provisions should be against public policy.

Distinguishing Between Provisions

Both “pay-if-paid” to “pay-when-paid” provisions ultimately determine who will bear the financial risk of a construction contract. A “pay-if-paid” provision makes “payment by the owner to the general contractor a condition precedent to the general contractor’s obligation to pay the subcontractor for the work the subcontractor has performed.”¹ Under a “pay-if-paid” provision, the risk of non-payment falls on the subcontractor if the owner refuses to pay the general contractor. Many states, including California, have concluded that “pay-if-paid” provisions are unenforceable because they indirectly waive or forfeit the subcontractor’s mechanic’s lien rights in the event of nonpayment by the owner.²

Under a “pay-when-paid” provision, the general contractor agrees to pay the subcontractor within a period of time after the general contractor is paid by the owner.³ Thus, under a “pay-when-paid” provision, the risk of non-payment falls on the general contractor. While a “pay-when-paid” provision is not a condition precedent, there is an implied understanding that the subcontractor has an unconditional right to payment within a reasonable time. While many states depart as to whether “pay-when-paid” provisions are enforceable, the underlining issue for a “pay-when-paid” provision is what constitutes a “reasonable time.”

Crosno Construction, Inc. v. Travelers Casualty & Surety Co. of America

On April 17, 2020, the California Fourth Appellate District Court of Appeals ruled against enforcing a “pay-when-paid” provision that would postpone the plaintiff’s right to recover under a payment bond for an indefinite time period. The underlining issue was whether a surety may defend a public works payment bond action by invoking an expansive “pay-when-paid” provision in a construction subcontract that defers payment for an indefinite period of time.⁴

North Edwards Water District (District) selected Clark Bros., Inc. (Clark) as its general contractor on a public works project to build an arsenic removal water treatment plant. Clark hired subcontractor Crosno Construction (Crosno) to build and coat two steel reservoir tanks.⁵ The subcontract contained a “pay-when-paid” provision that stated:

“If Owner or other responsible party delays in making any payment to Contractor from which payment to Subcontractor is to be made, Contractor and its sureties shall have a reasonable time to make payment to Subcontractor. ‘Reasonable time’ shall be determined according to the relevant circumstances, but in no event shall be less than the time Contractor and Subcontractor require to pursue to conclusion their legal remedies against Owner or other responsible party to obtain payment, including (but not limited to) mechanics’ lien remedies.”⁶

A dispute arose between Clark and District halting the project. Crosno sought to recover payment owned under the public works payment bond that Clark had obtained for the project.

The Court focused on whether postponing Crosno’s right to recover under the payment bond until Clark’s litigation against the District concluded would result in an unreasonable impairment of Crosno’s statutory payment bond remedy. Crosno never executed a waiver and release required to validly “waive, affect, or impair” its payment bond rights. Applying precedent, the court reiterated that postponing payments:

“. . . earned by a subcontractor, itself without fault, until a dispute between the contractor and the owner is resolved, perhaps months or even years later … gives no reasonable assurance that such a dispute would ever be resolved. If the contractor lost the dispute, the contractor would be required to pay his subcontractor creditor from other funds. If the contractor won the dispute, the contractor would be required to apply all or a substantial part of the money he receives toward his subcontract obligations. . . the contractor’s interest would seem more likely to benefit from avoidance of any settlement with the owner.”⁷

A “reasonable time,” in this case, would include an indefinite timeframe. In fact, the litigation between Clark and District had already reached the two-year mark prior to this ruling. For many subcontractors, managing business in the wake of the COVID-19 crisis is difficult enough. If subcontractors were to be forced to wait until contractor-owner litigation were resolved prior to receiving payment, most subcontractors would fail to survive.

Conclusion

Crosno reminds lawyers representing subcontractors that the purpose behind a public works payment bond is to provide subcontractors a sufficient means of payment. This distinct remedy to public works subcontractors is in addition to the protection payment bonds provide in the event of a defaulting contractor. Moreover, Crosno provides a subtle reminder of the importance of drafting specific waiver and releases. Generally, a waiver and release of payment bond rights can be enforceable to the detriment of the subcontractor. While many states differ on their enforcement of “pay-if-paid” and “pay-when-paid” provisions, arguing the element of reasonableness to protect otherwise disadvantaged subcontractors caught in-between contractor-owner litigation might be your best option.

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1 Wm. R. Clarke Corp. v. Safeco Ins. Co., 15 Cal. 4th 882, 885 (1997).^↩
2 Id. at 886.^↩
3 Chapman Excavating Co. v. Fortney & Weygandt, Inc., 2004-Ohio-3867, ¶ 22 (Ct. App.).^↩
4 Crosno Constr., Inc. v. Travelers Cas. & Sur. Co. of Am., Nos. D075561, D075562, 2020 Cal. App.at *8-9 (Ct. App. Apr. 17, 2020).^↩
5 Id. at 1-2.^↩
6 Id. at 4-5.^↩
7 Id. at 17-18 (citing Yamanishi v. Bleily & Collishaw, Inc., 29 Cal. App. 3d 457, 463 (1972).^↩

Author Christopher M. Wise is an attorney and the Managing Member of Wise Law, LLC in Louisville, Kentucky. He focuses on contractor-subcontractor litigation and property law.

What the 1918 Flu Can Teach Us About COVID-19

The COVID-19 pandemic shows no signs of sparing the construction industry. Nearly every jurisdiction has implemented some level of restriction on business activity, i.e. “essential” versus “non-essential,” and as a whole construction has been caught in the grey zone. Some jurisdictions have found that construction is “essential,” thereby allowing work to proceed. Others, including New York, Pennsylvania, New Jersey, and Vermont, have halted nearly all construction projects not serving an emergency or essential purpose.

State Restrictions on Construction Activity Vary

Some states have enacted significant limitations on construction projects. One of the most stringent is Pennsylvania, which on March 19, 2020, issued an executive order forcing the closure of any business not deemed “life-sustaining,” including a state-wide prohibition on construction activity. Days later, the executive order was amended to deem the construction of medical facilities and emergency repairs as “life sustaining.” On March 27, 2020, except for the construction of medical facilities and emergency repair, nearly all construction work state-wide was closed. On a case-by-case basis, the Pennsylvania Department of Community and Economic Development has granted some waivers/exemptions.

While Pennsylvania closed nearly all construction projects, both New York and New Jersey initially considered construction an “essential” business. However, as the fight against COVID-19 intensified, these states restricted their definitions of essential to be project-specific, e.g. medical facilities, infrastructure, and affordable housing. Now, New York is threatening fines of up to $10,000 against teams found working on non-essential or non-emergency construction projects. While New York has a robust and responsive waiver process, New Jersey has not instituted a formal waiver process. In some jurisdictions, municipalities responding to the COVID-19 with their own rules. Presently, there are several major metropolitan areas with significant restrictions on construction activities, including Boston and San Francisco.

On the other hand, many states including Texas and Florida have relied on federal guidance from the U.S Department of Homeland Security’s Cybersecurity and Infrastructure Security Agency (CISA). CISA deems nearly all construction projects as essential, e.g. residential construction is essential “to combat the nation’s existing housing supply shortage.” California has also permitted most construction projects to continue.

In either case, COVID-19 has likely impacted the workforce and supply of readily available labor to work on any given construction project.

Lessons from the 1918 Flu

As clients continue to struggle with the full implications of the ongoing emergency, some experts suggest analyzing a similar pandemic from 100 years ago. As soldiers returned home from the battlefields of World War One, a global pandemic of influenza cast a pale over victory celebrations. The so-called “Spanish Flu” took over 50 million lives, about twice as many as the Great War itself. In the United States, it is estimated a staggering 29 million people contracted the 1918 Flu. Approximately 675,000 Americans lost their lives.

The 1918 Flu pandemic shares some parallels with COVID-19, but there are also a few important differences. Whereas COVID-19 seems particularly dangerous for older demographics, the 1918 Flu seems to have attacked younger people between the ages of 20 and 40.¹ As a result, historians believe a greater proportion of construction workers likely fell ill. In fact, one study from Toronto indicated construction workers had one of the highest mortality rates.²

The government response to the 1918 Flu was also less consistent. While some state and local governments acted aggressively to help fight the spread of the virus, there seems to have been less of a response at the federal level. Many of the local government responses were similar to today, such as mandating the use of masks in public, banning public gatherings, and encouraging social distancing. Many local businesses were ordered to close. On the other hand, mandatory shelter in place orders were uncommon 1918. Although some of the data is anecdotal, there is general agreement the 1918 pandemic caused a sharp, but short economic contraction.³ Labor shortages caused delays, shortages, and rising wages.⁴ Unlike the COVID-19 pandemic, which to date has included significant and ongoing economic stimulus, the 1918 pandemic did not result in any significant government stimulus. Thus, even before accounting for “work from home” or “remote work” capabilities, a direct economic comparison may prove difficult.

Available case law indicates courts reached inconsistent conclusions regarding delays and interruptions arising from the 1918 Flu. Courts seem to have generally upheld the power of local governments to enact quarantines. Soap Co. v. Peet Bros. Mfg. Co., 50 Cal. App. 246, 194 P. 715 (Cal. Ct. App. 1920). Additionally, the “contingency or delay in performance” provision in a contract was triggered by an enforcement of a local quarantine order and excused the supplier’s delayed performance. Id.

Other courts facing contract issues arising from the 1918 Flu pandemic reached the opposite conclusion. Napier v. Trace Fork Mining Co., 193 Ky. 291, 235 S.W. 766 (1921). The plaintiff entered into an agreement to complete grading as part of a railroad sidetrack construction project. Due to the 1918 Flu pandemic, the plaintiff was unable to find enough labor needed to qualify for an early completion bonus. The court refused to apply an unforeseen circumstances analysis because, “defendant accepted the work as soon as it was completed and offered to pay plaintiff therefor in exact accordance with the plain and unambiguous terms of the contract.” Id. at 767. The court found plaintiff merely showed timely completion was more difficult and expensive, not that it was impossible.

The lesson from history is that these cases are fact-sensitive even during times of pandemic. In that regard, best practices include well-tailored requests for time or additional money, supporting documents and materials to demonstrate entitlement at the claim level, and prompt notice. Much like the contractor in Napier, parties cannot risk overplaying or overstating the impact of COVID-19 on contractual performance. It appears the divergence of judicial analysis resulting from the 1918 Flu may be on the verge of repetition 100 years later.

Conclusion

The current patchwork of government restrictions on construction activity has generated a plethora of legal issues. Some of these include force majeure clauses, excusable delay, change orders, cash flow problems, employment and supply chain issues, and business interruption coverage. Although the 1918 Flu may be an imperfect comparison, it suggests COVID-19 will likely have a significant, although hopefully transitory, economic impact on the construction industry.

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1 “1918 Pandemic (H1N1 Virus),” Centers for Disease Control and Prevention, https://www.cdc.gov/flu/pandemic-resources/1918-pandemic-h1n1.html (last visited April 22, 2020).^↩
2 Peter Kenter, ‘”Unsung Heroes”: Toronto Construction Workers and The Spanish Flu Epidemic,” Daily Commercial News, https://canada.constructconnect.com/dcn/news/labour/2020/03/unsung-heroes-toronto-construction-workers-and-the-spanish-flu-epidemic (last visited April 22, 2020).^↩
3 Thomas A. Garrett, “Economic Effects of the 1918 Influenza Pandemic: Implications for a Modern-day Pandemic,” at 9, (Federal Reserve Band of St. Louis) https://www.stlouisfed.org/~/media/files/pdfs/community-development/research-reports/pandemic_flu_report.pdf (last visited April 22, 2020).^↩
4 Id. at 21.^↩

Co-authors Gaetano Piccirilli, partner and Patrick McKnight, associate, are members of the Litigation Department at Klehr Harrison Harvey Branzburg LLP in Philadelphia, Pennsylvania and serve on the Klehr Harrison Coronavirus Task Force.

INSIGHT: Best Practices for Conducting Remote Arbitration Hearings

Two King & Spalding attorneys were one week into a two-week arbitration hearing when New York City shut down due to the coronavirus pandemic. They learned valuable lessons from continuing the hearing via video and share their experience and some tips.

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Most businesses must now connect virtually, due to the coronavirus pandemic, and arbitration hearings are no exception. We were one week into a two-week arbitration hearing when New York City shut down, forcing the hearing to conclude via video. Video hearings may be the future of arbitration—at least in the short term.

Attorneys need to think about important considerations and best practices for conducting a hearing via video. This article also addresses applicable arbitral institution rules (or lack thereof) and discusses why this area is ripe for consideration by these institutions.

Technology Considerations

• Zoom vs. Alternatives: Zoom, a highly-popular video conference platform, is an inexpensive and effective means of conducting virtual hearings. It allows many individuals to participate, and the arbitral tribunal and speakers are visible to all participants. Screen sharing can be used to display exhibits, demonstratives, and PowerPoint presentations. Note, however, that the party initiating the meeting must have an upgraded Zoom account to utilize many features, included organizing extended meetings and virtual break-out rooms. Moreover, there have been security and privacy concerns about Zoom that are currently being investigated. Many court reporting services offer alternative platforms that provide similar features, but are generally more expensive than Zoom subscriptions.

• Transcription Services: Most court reporting services can provide transcription services via an online platform, including access to live transcription during the hearing for a daily fee.

• Translation Issues: One potentially complicating factor when conducting remote hearings is the need for translation. While many translators can provide services remotely, such translation would likely need to be sequential rather than simultaneous and would require speakers to be particularly careful not to speak over each other.

• Test the Technology: To ensure a smooth first day of the hearing, the parties, witnesses, tribunal, and court reporter should test the technology in advance. Witnesses will need to ensure they have cameras on their computers. Most importantly, everyone will need strong and reliable internet connections—particularly the tribunal, witnesses, court reporter, attorneys, and client representatives directly involved in the proceedings.

Agreed-Upon Protocol

• Implement a Written Protocol: Parties can minimize potential disputes by reaching an agreement on a detailed written protocol, including details about the schedule, exchange of exhibits, pre- and post-hearing deadlines, and other logistical matters.

• Exchange of Exhibits: The parties should outline how and when they will exchange documents and demonstratives in the written protocol, including the means for providing exhibits to be used during cross-examination to witnesses, opposing counsel, the tribunal, and the court reporter. It may be easier to exchange documents electronically, particularly during the coronavirus pandemic when many firms and document vendors have reduced onsite staffing.

• Reliability of Testimony: Possible safeguards to ensure the reliability of testimony include requiring witnesses to be alone when they testify and to affirm that they will not look at email or smartphones during the examination. If hard copy documents are sent to witnesses before they testify, the documents can be sealed in a box wrapped in colored tape that the witness must open on camera in the presence of opposing counsel and the tribunal immediately before testifying. Additional safeguards can be put in place by not providing cross examination bundles to opposing counsel until about 30 minutes before an examination is set to begin.

Presentation Considerations

• Displaying Documents: It is important to make sure the online platform chosen to host the video hearing includes a mechanism to display documents on the screen so all participants can see them. Most online video platforms, including Zoom, have this feature. It is helpful to pinpoint specific pages or sections of documents so that the process is as seamless as possible.

• Effective Cross Exam: The obvious difference when conducting a cross-examination via video is the loss of in-person, face-to-face contact with the witness, the tribunal, and opposing counsel. The witness should be positioned close enough to the camera to gauge facial expressions and other silent cues.

Arbitral Institution Rules

Most of the various arbitral institutions do not have rules in place specifically addressing videoconference hearings, or more generally, addressing what to do in times of local, national, or global crises.

For example, both the American Arbitration Association’s construction and commercial rules provide that an arbitrator may “allow for the presentation of evidence by alternative means including video conferencing.”

Similarly, pursuant to the JAMS arbitration rules, “[t]he Hearing, or any portion thereof, may be conducted telephonically or videographically with the agreement of the Parties or at the discretion of the Arbitrator.”

The International Institute for Conflict Prevention & Resolution is silent about videoconference hearings, providing only that unless the parties agree on the place for the arbitration, the tribunal shall decide “based upon the contentions of the parties and the circumstances of the arbitration.”

Rules promulgated by the International Chamber of Commerce , the London Court of International Arbitration, and the Singapore International Arbitration Centre provide for videoconferencing for emergency procedures. But none of these institutions appear to contemplate full merits hearings by video, much less provide specific rules for how such video hearings should proceed.

Although arbitral rules are aimed at providing individual arbitrators and parties significant control over hearing procedures, it would be helpful to have specific, consistent guidance from these institutions on how virtual hearings should be conducted.

More generally, parties would benefit from institutional guidance about how matters should proceed in the face of natural disasters or catastrophes. The Covid-19 pandemic hit the U.S. hard and fast. With many hearings already in progress, arbitrators, lawyers, and clients alike were faced with difficult decisions about whether to continue in-progress hearings in person or whether to adjourn hearings without any idea about when a live hearing could resume and no existing rules or protocols in place for continuing by video.

Although arbitrators generally have discretion to conduct a merits hearing as they see fit, explicit guidance about adjourning hearings during a global health crisis, national disaster, or other widespread catastrophe would be valuable for parties and arbitrators alike.

*This article previously appeared in Bloomberg Law.

Author Information

Jessica Sabbath is a senior attorney in King & Spalding LLP’s Trial and Global Disputes practice in Atlanta. She focuses on construction-related disputes, particularly those arising from large energy projects. She also has extensive commercial litigation experience in state and federal courts at the trial and appellate levels, as well as domestic and international arbitration experience.

Brianna E. Kostecka is a senior associate in King & Spalding’s International Arbitration practice in New York. She focuses on domestic and international litigation and arbitration of construction disputes involving large-scale projects primarily in the energy, oil and gas, and manufacturing industries. She has also represented clients in complex matters involving commercial agreements.