“Pay when paid” clauses are clauses found in many construction contracts that state that the contractor will pay his subcontractor only if and/or when the contractor receives payment from the owner. Are these clauses enforceable? The answer depends on (1) what state you are in and (2) what choice of law provision is contained in your construction contract.
A limited number of states do honor “pay when paid” clauses under the theory that the parties are usually sophisticated parties who negotiated the contract terms and as such they are duty bound to honor those terms. When such a clause is enforced, it can prove fatal in a case where the owner files bankruptcy or otherwise defaults on its payments to the general contractor.
In North Carolina, such clauses are unenforceable as against public policy.
Performance by a subcontractor in accordance with the provisions of its contract shall entitle it to payment from the party with whom it contracts. Payment by the owner to a contractor is not a condition precedent for payment to a subcontractor and payment by a contractor to a subcontractor is not a condition precedent for payment to any other subcontractor, and an agreement to the contrary is unenforceable.
Does that mean that, if you are a subcontractor, you don’t need to worry about such “pay when paid” clauses in North Carolina? Not necessarily. It depends on what law is the law that will be applied by the court. If your contract states that the law of another state will apply, you need to know if that state is one in which “pay when paid” clauses are enforceable. In some states, such as Virginia, the contract is king and whatever the contract says will be enforced. Such clauses are also generally enforceable in a few other states such as Connecticut and Michigan.
Other states take a more cautious view, and hold that such clauses are only enforceable if unambiguously written, including Arizona, Ohio, and Massachusetts.
States which concur with North Carolina’s view that such clauses are unenforceable include New York, California, and South Carolina.
Therefore, it is important to know not only what your contract says, but what state’s law will apply to your contract.
Because case law and statutes change the law regularly, consult a licensed attorney in the jurisdiction you are concerned about to learn the latest status of contingent payment clauses in that jurisdiction.
I have a question regarding the applicability of this clause to architects and other design professionals. Can an architect, or other design professional, withhold payment to a consultant until paid by owner? In the definitions, 22C-1.2, I interpret the last sentence of the definition to mean that architects are in essence contractors in the application of this law. Therefore, they legally cannot tell a consultant that they will “pay when paid.” Am I interpreting this definition correctly?
Will:
Good question. Architects are treated similarly to contractors in many respects– i.e., in the multi-prime context, for lien purposes, etc. So, I would concur with your interpretation that stating you will be “paid when paid” would not work for consultants any more than subcontractors. Not to say it isn’t done, but I would not want to be on the side having to defend such a term in a court of law! This makes sense from a public policy standpoint too. I’m having my house painted right now. Somehow I don’t think telling my painters that they’ll get paid when I get paid from a certain client will fly!
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I disagree with a subtle part of this interpretation of NC General Statute 22C-2 as referenced in this article. The statute states that owner payment can not be condition precedent for payment to subcontractor. Therefore pay if paid is not enforceable, but pay when paid provides legal justification for withholding payment from subcontractor for an extended period of time as long as payment is made at some point.
Jay, thanks for the interesting comment. The NC Courts, however, seem to read “pay if paid” and “pay when paid” as the same. In a Court of Appeals opinion, the Court, referencing N.C. Gen. Stat. 22C-2, has held: “We therefore conclude that the “pay when paid” clause of the contract is indeed unenforceable.” American Nat. Elec. Corp. v. Poythress Commercial Contractors, Inc. 167 N.C.App. 97, 101, 604 S.E.2d 315, 317 (2004).
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Melissa, this is a great post. In N.C., isn’t pay-when-pay ok in the residential setting, but not the commercial, or vice versa? I seem to recall dealing with this distinction many moons ago.
Thanks for the comment, John-Paul! After reading your comment, I went back the statute and don’t see where they make any distinction for residential vs. commercial. I know there are some distinctions with other areas (i.e., implied warranty of habitability, which is part of tomorrow’s (6/17/10) post). If you find something that shows otherwise, I’d be very interested in seeing it. Take care!
John-Paul: You are correct! Mea culpa. Updated post coming on 1/6/2011 !
Thanks Chris!
Thanks for the link Melissa. I enjoy your blog and look forward to keeping up with it in the future.