Controversial Contract Provisions – Pay if paid

11/15/2010

Following up an earlier theme about contracts, it occurred to me that there are various controversial contract provisions regularly used that warranted discussion. I will not say they are good or bad because, like opinions about art, such opinions are in the eye of the beholder; or in this case the party with control over what terms go into a contract.

As I’ve noted before, contracting is about allocating risk. One common way the risk of non-payment is allocated is a “pay if paid” clause. While variously worded, the key concept from the verbiage is that one party acknowledges pre-payment to the other as a condition precedent to payment to that other party. The most common example is in a subcontract, wherein the general contractor includes a provision that payment to a subcontractor is not due unless and until the general contractor is paid by the owner.

Some states, like North Carolina, have legislatively voided such provisions as being against state public policy; however, Virginia has not, and the Virginia Supreme Court, who has considered that question, has expressly upheld such provisions as being valid and enforceable if clearly and unambiguously written. There are certainly justifiable reasons for arguing both sides of enforcability and voidability.

For example, general contractors will argue they are not banks and so if they have not been paid upstream they should not have to pay downstream, whereas conversely subcontractors will argue they are not banks and in the business of doing work for free and as between they and the general contractor the general contractor has better means of controlling payment. The most common way this comes to a head is, as is more frequently occurring of late, an owner becomes insolvent or bankrupt and has no ability to pay for work in place.

Pay if paid clauses push that risk down to the lower level; a result welcome to the general contractor but untenable to its subcontractors. Again, fair or unfair depends upon your point of view, but prudence regardless dictates that if you are involved in the contract process you consider the pay if paid application; one way or the other.

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