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Pay if paid clause vital to contractors

Jim Porter

Contractors and subcontractors, listen up. The California Supreme Court just issued an opinion that will affect a subcontractor’s right to get paid by the general contractor when the owner doesn’t pay the general. Boring stuff for the rest of you.

Facts

Keller Construction had a $16 million contract to build a commercial building in Los Angeles.

Keller contracted with several subcontractors to do most of the work. Each subcontract contained a “pay if paid” clause which makes payment by the owner to the general contractor necessary before the general is required to pay the sub for the work the sub performs.

The owner ran out of money and didn’t pay Keller, who didn’t pay the sub; the sub sued Keller.

The “pay if paid” paragraph, which is the most important clause in a subcontract, read as follows:

“Receipt of funds by Contractor from Owner is a condition precedent to the contractor’s obligation to pay Subcontractor under this Agreement, regardless of the reason for Owner’s non-payment, whether attributable to the fault of the Owner, Contractor, Subcontractor or due to any other cause. Contractor shall have no obligation, legal, equitable, or otherwise, to pay Subcontractor for Work performed by Subcontractor unless and until Contractor is paid by the Owner for the work performed by the Subcontractor. Furthermore, in the event Contractor is never paid by Owner for Subcontractor’s work, then Subcontractor shall forever be barred from making, and hereby waives, in perpetuity, any claim against Contractor (and its bonding company, if any) therefore.

Nothing in this Contract shall be interpreted as limiting Subcontractor’s right to enforce its statutory mechanic’s lien rights or remedies, if any, against Project property and Subcontractor expressly agrees that such mechanic’s lien rights, if any, shall be its sole remedy and means for payment (regardless of whether the value of project property is sufficient or insufficient, for any reason, to satisfy Subcontractor’s claim) on account to work performed by Subcontractor for which Contractor has not been paid by Owner.”

Discussion

If you are still with me, here’s what happened in this important case. The sub who had done the work for contractor Keller was not paid, based upon the above subcontract language.

The general argues that the contract was very clear; pay the sub only if paid. The sub argued that the pay if paid language merely fixes the usual time for payment to the sub, with the implied understanding that the sub is to be paid within a reasonable time even if the owner never pays the general.

Decision

The Supreme Court in a 4-3 decision came down in favor of the subcontractor concluding that “pay if paid” clauses in subcontracts are against public policy as unduly burdensome on subcontractors and a violation of the law, because such contracts waive the constitutionally protected mechanic’s lien rights of subcontractors. Is anyone following this?

The three dissenting justices, with whom I agree, would have ruled in favor of the general: Upholding pay if paid clauses, imposing no obligation on the general to pay the sub unless the owner pays the general, but at the same time allowing subs to record mechanic’s liens against the owner’s property. A perfect solution.

My Advice

My suggestion is that generals include language like that quoted above in their subcontracts, add my language in brackets, and hope the sub’s attorney hasn’t read this case, or argue that my bracketed language makes pay if paid clauses enforceable. My advice to subcontractors is to fight like hell to delete pay if paid clauses or make them applicable only if the owner does not pay the contractor because of the sub’s work.

Jim Porter is an attorney with Porter Simon, with offices in Truckee and Reno. He is also a mediator.


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