It is critical for subcontractors to scrutinize their subcontracts – specifically the payment clause. Some clauses require payment by the owner to the general contractor before the general contractor is legally required to pay the subcontractor. These are commonly referred to as “Pay-If-Paid” or “Pay-When-Paid” clauses. However, knowing what type of clause is in your subcontract is not always easy and could lead to unexpected payment delays. This article will generally discuss “Pay-If-Paid” and “Pay-When-Paid” clauses and why parties must understand the difference.
What is a “Pay-If-Paid” clause?
A “Pay-If-Paid” clause makes payment by the owner to the general contractor a requirement before the general contractor has any legal obligation to pay the subcontractor. If the owner never pays the general contractor, then the general contractor has no legal payment obligation to the subcontractor.
What is a “Pay-When-Paid” clause?
A “Pay-When-Paid” clause also makes payment by the owner to the general contractor a requirement before the general contractor has any legal obligation to pay the subcontractor. However, if the owner does not pay the general contractor in a “reasonable” amount of time, the general contractor is still legally obligated to pay the subcontractor, even though payment from the owner has not yet been received.
Are “Pay-If-Paid” Clauses Enforceable in California?
No. In California, and many other jurisdictions, a “Pay-If-Paid” clause is void and unenforceable. In Wm. R. Clarke Corp. v. Safeco Ins. Co. (1997) 15 Cal. 4th 882, the court ruled that “Pay-If-Paid” clauses represent an impermissible infringement on mechanics lien rights and therefore violate Civil Code section 8122. In Capitol Steel Fabricators, Inc. v. Mega Const. Co. (1997) 58 Cal. App. 4th 1049, the court further considered whether a “Pay-If-Paid” clause used in a contract for a public works project was enforceable. The court refused to enforce the “Pay-If-Paid” clause because of its tendency to interfere with stop payment notice and payment bond claim rights of subcontractors and suppliers.
Are “Pay-When-Paid” Clauses Enforceable in California?
Yes, subject to limitations. While “Pay-When-Paid” clauses are generally enforceable, a general contractor can only wait a “reasonable” amount of time to receive the owner’s payment before it is legally obligated to pay the subcontractor. A general contractor cannot force a subcontractor to wait for payment until the owner and general contractor have finished litigating their claims. (Crosno Construction, Inc. v. Travelers Casualty and Surety Company of America (2020) 47 Cal.App.5th 940.) “Pay-When-Paid” clauses are also prohibited by California Civil Code section 8122 if the payment delay is so long that it creates a waiver of the subcontractor’s mechanics lien, stop payment notice, or payment bond claims.