Pay-if-Paid Enforced Opening Door to Subcontractor Claim Against Owner

 

https://libeskind.com/work/the-ascent-at-roeblings-bridge/

In Superior Steel, Inc. v. Ascent at Roebling's Bridge, LLC, No. 2015-SC-000204-DG, 2017 WL 6380218 (Ky. Dec. 14, 2017), a subcontractor and a sub-subcontractor sued the general contractor and owner for the failure to pay for extra work. The general contractor and owner cross-claimed against the other for, inter alia, indemnification.  At the jury trial, the subcontractors recovered under theories of implied contract and unjust enrichment.  All parties appealed, in particular, as to the pay-if-paid jury instruction. The Court of Appeals vacated the judgment and remanded.  In turn, all parties petitioned to the Supreme Court of Kentucky.

 

The key questions in the petition were whether the pay-if-paid provision was enforceable as between the general contractor and subcontractors and, if so, whether the subcontractors could pursue the owner directly for payment notwithstanding the lack of privity between owner and subcontractors.

 

The Supreme Court concluded that, as a result of the pay-if-paid clause, the general contractor had not breached subcontract for the failure to pay for the subcontractor's extra work.  The relevant subcontract provisions stated:

• "no compensation . . . for any claim arising out of the performance of this Subcontract, unless the Contractor has collected corresponding additional compensation from the owner, or other party involved"
• And more directly - "payment [to] the Contractor from the Owner for the Subcontractor Work is a condition precedent to payment by the Contractor to Subcontractor. The Subcontractor hereby acknowledges that it relied on the credit of the Owner, not the Contractor for payment of the Subcontract Work."

Reading these together, the Supreme Court agreed that the general contractor's receipt of payment from owner was a condition precedent to its obligation to pay the subcontractors.  Because the general contractor did not receive payment from the owner, there could be no breach. The Court did note that "pay-if-paid clauses have fallen out of favor in some states, [but] the prohibition against their use has come from the legislature rather than the courts." In Kentucky, no such statutory prohibition existed.

 

However, because the subcontractors were left with no useful contract remedy against general contractor, the Court held that the subcontractors were not barred from bringing unjust enrichment claims against the owner.  The Court acknowledged that typically “unjust enrichment is unavailable when the terms of an express contract control.”  But noted that, here, the "adequacy" of a "legal remedy" (or the "actual realization of that contractual remedy") was absent due to the "contractual gridlock" caused by the owner.  Indeed, if the contract was the only avenue for the subcontractors to obtain relief, that result would allow the owner to take advantage of its own failure to pay after receiving "a substantial benefit" from the subcontractors' work.

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The author, Katharine Kohm, Esq. is a committee member for The Dispute Resolver.  She practices construction law at Pierce Atwood, LLP in Providence, Rhode Island. 

 

Risky (shifting) Business: Pay-if-Paid Provision Enforced to Subcontractor's Detriment

In Baker Concrete Const., Inc. v. A. Pappajohn Co., No. FSTCV166028187S, 2017 WL 4106383, at *1 (Conn. Super. Ct. 2017), at issue was the age-old dispute of non-payment for work performed.

The Baker Court first recounted the direct avenues for collecting on a construction project when payment is not made in the regular course: "[A] mechanic's lien may be available, and in connection with public works projects, a payment bond is statutorily required given the unavailability of a mechanic's lien in such projects."   That said, "[d]epending upon the equity in the property . . . a mechanic's lien may be insufficient (especially if a project has been financed with a mortgage placed on the property as a first lien)." Even with these direct avenues along with filing suit, insolvency of the parties in the project chain can thwart any collection efforts of the lower tier contractors.  In addition, contractual language, for example a pay-if-paid provision, too can arrest an unpaid party's effort to be paid. The Baker Court considered the requirements for applying such provisions. In Baker, the general contractor-subcontractor contract stated, in pertinent part, that:

Progress payments to the Subcontractor for satisfactory performance of the Subcontractor's Work shall be made only to the extent of and no later than ten (10) working days after the receipt by the Contractor of payment from the Owner for the Subcontractor's Work. The Subcontractor agrees that the Contractor shall be under no obligation to pay the Subcontractor for any Work until the Contractor has been paid by the Owner . . . The Subcontractor expressly acknowledges and agrees that payments to it are contingent upon the Contractor receiving payments from the Owner.

By its plain language, this pay-if-paid provision appeared to foist all risk of the owner's potential insolvency onto the subcontractor.  For its part, the subcontractor argued that "the provision is a timing issue (or should be interpreted and applied as such) rather than a risk-shifting provision." In other words, notwithstanding that the general contractor was not paid by the owner in a reasonable period of time after the work was performed by the subcontractor, the subcontractor was still entitled to be paid.  The court disagreed.

After disposing of a burden of proof argument raised by the subcontractor, the Baker Court resolved the contract interpretation question. It examined the caselaw and observed that where the provision does not explicitly "creat[e] a condition precedent to payment" the courts will construe the provision as "setting the time of payment" rather than establishing a defense to payment. However here, the contingency was explicit and moreover the contract provision also put the risk of insolvency explicitly onto the subcontractor: "The Subcontractor expressly accepts the risk that it will not be paid for the Work performed by it if the Contractor, for whatever reason, is not paid by the owner for such Work. The Subcontractor states that it relies primarily for payment for Work performed on the credit and ability to pay off the Owner and not of the Contractor[.]"

In light of the foregoing the Baker Court held that there was no ambiguity in the terms and therefore the contract's pay-if-paid provision would be enforced as written.  The court summed up the reality of working in the construction industry (and frankly any industry): "It is clear that the defendant [contractor] took advantage of its superior bargaining position in this contract; the plaintiff [subcontractor], however, seemingly made a conscious decision to [get the job by] sign[ing] a contract containing this risk-assumption provision which, in these unfortunate circumstances, has come into play."

As an aside, observe that Connecticut's statutory prompt payment provisions do not preclude contractual pay-if-paid clauses. See Conn. Stat. 42-158i et seq.

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The author, Katharine Kohm, Esq. is a committee member for The Dispute Resolver.  She is an associate at Pierce Atwood, LLP in Providence, Rhode Island. 

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.