“Everything was going along fine and then I stopped getting paid. Because I had a prior relationship with the prime contractor I just kept working. Then I found out the project was shut down and the owner was out of cash. What do I do now?”
This is a common scenario for many subcontractors. In many instance it can turn into a subcontractor’s worst nightmare – no payment, unexpected legal costs and yet a continuing obligation to make payroll or pay lower tier vendors and suppliers. The first step in the legal assessment is to review the contract documents between the subcontractor and the prime contractor. Specifically the payment provisions are usually the focus of that initial assessment. Is it a “pay when paid” or a “pay if paid” provision? Does the payment provision merely fix a time for payment or does it actually shift the risk of the owner’s insolvency to the subcontractor?
Examples of typical “pay when paid” and “pay if paid” provisions commonly used by prime contractors in their standard form subcontracts are presented below:
Paid when Paid: Subcontractor shall submit to Prime invoices for services rendered either monthly or at completion of the services. Prime shall review each invoice and shall promptly notify Subcontractor if it objects to any portion of the invoice. Prime shall invoice Owner/Client monthly on account of approved Subcontractor’s amount and shall pay Subcontractor within fifteen (15) days of receipt of payment from Owner/Client. It is intended that payments to Subcontractor will be made as Prime is paid by Owner/Client and that Prime shall exert reasonable and diligent efforts to collect prompt payment from Owner/Client.
Paid if Paid: Prime shall pay the Subcontractor in accordance with the unit costs specified in Exhibit C – Commercial Basis. Payment will be made based on monthly billings invoiced to Prime no later than fifteen (15) days after the end of each month. Prime will review such invoices and, upon approval, process for payment. Prime shall not be required to pay Subcontractor any portion of the unit costs, and/or any adjustments thereto, including those requested by Subcontractor under change orders, unless and until Prime receives the applicable payment from the Owner/Client. Receipt of such payment from the Owner/Client by the Prime is considered a condition precedent to any obligation of Prime to make payments to Subcontractor under this Agreement.
These provisions can vary greatly from contract to contract. In addition the interpretation and enforcement is usually guided by state case law. For this reason drafting these provisions requires careful understanding of the applicable law, the roles of the parties and the goals of the prime and/or the subcontractor in any particular contract. In most instances the summary points below provide a basic contract guide:
A pay when paid provision merely fixes the time for payment and does not shift the risk of the Owner/Client’s insolvency to the subcontractor.
Properly drafted a pay if paid provision shifts the risk of the Owner/Client’s insolvency to the subcontractor.
Typically, use of the words “condition precedent” is required to craft an enforceable paid if paid provision.
Pursuant to a paid when paid provision, courts will generally require a Prime to make payment to a subcontractor after a reasonable waiting or time period, even if the Prime has not been paid by the Owner/Client.
Note: The sample provisions above are for illustration purposes only and are not intended for use without appropriate review in your jurisdiction.