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Pay When Paid Clauses: Are they enforceable?

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The "pay-if-paid" or "pay-when-paid" clause is frequently included in subcontracts. These clauses state that the general contractor is not required to pay the subcontractor unless and until the project owner pays the general contractor. Such provisions can be problematic to subcontractors when collection action is necessary. If the subcontractor demands payment, the general contractor may rely upon the pay-when-paid clause and defend on the basis that it has not yet been paid by the owner.

Courts are split on whether the pay-when-paid clause is enforceable. The following states have ruled that these clauses (or certain variations of them) are valid, and that they shift the risk of owner nonpayment to the subcontractor: Arizona, Colorado, Georgia, Florida, Illinois, Michigan and Maryland.

In contrast, California and New York have totally abolished the pay-when-paid clause. In other states, the enforceability of these provisions remains unclear, but the courts have tended to invalidate them. The following states do not appear to have a steadfast rule on the issue, but tend to disfavor them and have previously invalidated pay-when-paid clauses on technical or other grounds: Alabama, Connecticut, Louisiana, Massachusetts, Missouri, Pennsylvania, Tennessee and Washington, D.C. The Federal First and Fourth Circuit Courts of Appeals have also invalidated these types of provisions for various reasons.

This issue was addressed in Minnesota in 1990 in the case of Mrozik Construction, Inc. v. Lovering Associates, Inc. In that case, the clause in question stated that the subcontractor would be paid "to the extent that the [general] contractor has been paid on the subcontractor's account." In keeping with the trend in other states, the Minnesota Court of Appeals ruled that this alleged pay-when-paid clause would not be enforced. However, this ruling did not clearly invalidate such clauses across the board. Instead the Court stated that the language of the clause did not unequivocally shift risk of the owner's insolvency to the subcontractor, and therefore would not be enforced against the subcontractor to prevent payment. The Court stated that such a clause would not be enforceable in Minnesota "absent unequivocal, unambiguous language" conditioning payment to the subcontractor on payment from the owner.

At the time Mrozik was decided, the Minnesota legislature had already taken steps to invalidate certain other standard contract provisions, but the pay-when-paid clause had not been addressed. In 1984, Minnesota Statutes Chapter 337 (sometimes called the "Subcontractor Bill of Rights") was enacted and invalidated the following types of contract provisions: 1) general indemnification clauses; 2) jurisdictional clauses requiring litigation in another state or application of another state's laws; and 3) lien waiver clauses that purport to waive lien rights before the project starts.

The Subcontractor Bill of Rights also requires "prompt payment to subcontractors." Unfortunately, this clause could be construed to actually support a "pay-when-paid" clause in the subcontract. Specifically, the law states that the general contractor must pay a subcontractor or material supplier within ten days after the general contractor receives payment for undisputed services that the subcontractor or material supplier provided. Since this law is conditioned on the general contractor receiving money from the owner, it implies that a "pay-when-paid" clause could be enforceable in Minnesota, especially if it is "unequivocal" as stated by Mrozik court. Therefore, the Mrozik case and the Subcontractor Bill of Rights read together do not result in a clear answer on pay-when-paid clauses in Minnesota.

Caution should be used in pursuing payment from a General Contractor under an AIA or AGC subcontract. These contracts usually contain numerous vague and burdensome provisions. Seeking the advice of an experienced construction attorney when faced with a pay-when-paid clause is recommended before taking any collection action.