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The purpose of a pay-if-paid clause is to shift financial risk down the chain. Pay-If-Paid provisions state that a general contractor does not have to pay her subcontractor unless he is paid by the owner. In Louisiana, Pay-if-Paid clauses are typically enforceable so long as the contract is specific and explicit.
Most contractors are familiar with the two clauses but the implication of both can be massive. The Louisiana Fourth Circuit Court of Appeal recently provided a fairly thorough analysis distinguishing the two.
Clear and Unequivocal Language
Tymeless Flooring, Inc vs. Rotolo Consultants, Inc, involved a lawsuit filed by a sub-subcontractor against a superior subcontractor for breach of contract seeking payment for work performed on a YMCA project located in New Orleans. In response to the suit, the subcontractor asserted that it had not received payment from the general contractor and that its contract with the sub-subcontractor contained a “pay-if-paid” clause. On that basis, the subcontractor argued that the sub-subcontractor could not proceed against it with the lawsuit. The trial court agreed and dismissed the claim. The Court of Appeal reversed the ruling finding rather that the contract contained a “pay-when-paid” provision.
The Fourth Circuit explained that “[t]he narrow issue presented is whether the payment provision in the construction contract between the parties is a ‘pay-when-paid’ clause—a term of payment—or a ‘pay-if-paid’ clause—a suspensive condition.” To explain the significant distinction between the types of clauses, the Court cited a commentator’s clarification as follows:
A “pay-when-paid” clause governs the timing within which a general contractor must remit payment to its subcontractor, linking the general contractor’s receipt of payment from the owner to the general contractor’s payment to the subcontractor. Under this type of provision is included in the contract, the general contractor must make payment to the subcontractor within a reasonable time, even if the general contractor does not receive payment from the owner.
The more restrictive “pay-if-paid” clause, however, does not govern the timing of a general contractor’s payment obligation, but rather dictates whether such payment obligations exist at all. Where there is a valid “pay-if-paid” provision in the contract, the general contractor is only required to pay the subcontractor if and to the extent that it receives payment from the owner for the subcontractor’s work. Thus, under a “pay-if-paid” provision, there is a transfer of risk of the owner’s nonpayment from the general contractor to the subcontractor.
The Court then explained that the determinative factor is the language in the contract and that to enforce a “pay-if-paid” clause, the clause must contain “clear and unequivocal language set forth unambiguously on the face of the contract.” The Court provided the following examples of language which other courts have upheld as valid “pay-if-paid” clauses: “(1) payment to the contractor is a condition precedent to payment to the subcontractor; (2) the subcontractor is to bear the risk of the owner’s nonpayment; or (3) the subcontractor is to be paid exclusively out of a fund the sole source of which is the owner’s payment to the subcontractor.” On the other hand, the following is an example of a contractual provision which the Louisiana Supreme Court held constituted a “pay-when-paid” clause: “Contractor shall pay to Subcontractor, upon receipt of payment from the Owner, an amount equal to the value of Subcontractor’s completed work, to the extent allowed and paid by Owner on account of Subcontractor’s Work.”
While the variation between the language in the above examples may seem insignificant, their effects certainly are not. For example, in the 2011 case of Coastal Dev. Grp., L.L.C. v. Int’l Equip. Distributors, Inc., 2010-1202 (La. App. 1 Cir. 2/11/11), a subcontractor filed suit against the general contractor and the Parish of Livingston after performing debris removal work following Hurricane Gustav. It was undisputed that over $400,000.00 remained unpaid to the subcontractor. However, finding that the subcontract contained a “pay-if-paid” clause and that the work had not been approved and paid for by FEMA, the Court held that the subcontractor’s lawsuit was premature and dismissed the case. The Court explained that “[w]hile this court is sympathetic to the plight of [the subcontractor] because they performed the work and should be paid for it, according to the unambiguous language of the subcontract, until the work is deemed eligible by FEMA and actual receipt of payment from the Parish to [the general contractor], the right of the subcontractor to demand payment is premature.”
Pay-if-Paid and Surety Bonds
A recent case helped make it clear that pay if paid clauses won’t stop Louisiana bond claims. The project was private, but the GC provided a payment bond. When a dispute arose between the GC and the Sub, payments stopped making their way down to the Supplier.
As a result, the Supplier filed a mechanics lien against the project under the Louisiana Private Works Act. The Supplier also eventually filed an action against the GC’s payment bond.
At the trial court level, the Surety argued that they were not liable for the Supplier’s claim due to a pay if paid contract that existed between the GC and the Subcontractor. According to the Surety – payment was not actually owed from the GC to the Sub, so then payment was also not owed to the Supplier. Since payment wasn’t owed, according to the Surety, the Supplier’s claim was invalid.
The court found that, because the payment bond was obtained under provisions of the Private Works Act (read: Louisiana mechanics lien statute), the provisions of the Act were applicable. Specifically, § 4812(d) of the Act states that the bond “shall be deemed to conform to the requirements of this part notwithstanding any provision of the bond to the contrary…” This means that bond language that contradicts what’s required by the statute will be ignored. Thus, the pay if paid provision was irrelevant.
Should you have any questions or you would like to discuss this issue in further detail, please do not hesitate to contact us to schedule a free consultation.