In a typical construction scenario an owner contracts with a general contractor and the general contractor then contracts with various subcontractors and so on down the chain to lower tiers. In the absence of any contract language or statutory provisions to the contrary, the general contractor bears the risk of non-payment from the owner. So, for example, if the owner fails to pay through no fault of the subcontractor, the general contractor may still remain liable to its subcontractor to pay for the work performed.
Contingent payment clauses like “pay-when-paid” and “pay-if-paid” typically provide that the contractor is not required to make payments to the subcontractor unless or until the contractor has received payment from the owner. Such clauses are utilized in subcontracts to change the traditional allocation of the risk of non-payment by the owner from the general contractor down to the subcontractors and/or lower tiers. Numerous jurisdictions have addressed such clauses as to their enforceability between the contracting parties with varying results. Some uphold such clauses, other reject them, still others have enacted laws addressing such clauses.
A pay-when-paid clause governs the timing of a contractor’s payment obligation to the subcontractor, usually by indicating that the subcontractor will be paid within some fixed time period after the contractor itself is paid by the owner. Thus, generally, if a contingent payment provision simply requires the contractor to pay the subcontractor “upon receipt of payment from the owner” (or similar language), the clause will be considered to be a “pay-when-paid” clause that merely acts as a timing mechanism. “Pay-when-paid” provisions have been construed by the courts on numerous occasions to simply provide the contractor with a “reasonable” time within which to obtain payment from the owner and to make payment to the subcontractor. The question invariably becomes what is a “reasonable” time in which to make payment. The measure of a reasonable time for a contractor to withhold payment to its subcontractor while it is seeking payment from the owner will vary from case to case. Because pay-when-paid clauses do not entirely preclude payment from the general contractor to the subcontractor, such clauses are generally held to be enforceable as between the general contractor and the subcontractor.
In contrast, a pay-if-paid clause, as the name suggests, provides that a subcontractor will be paid only if the contractor is paid. The intent of this type of clause is to shift the risk of the owner’s non-payment to the subcontractors. A typical clause of this type might read: “Contractor’s receipt of payment from the owner is a condition precedent to contractor’s obligation to make payment to the subcontractor; the subcontractor expressly assumes the risk of the owner’s nonpayment and the subcontract price includes the risk.” Thus, the key distinction between “pay-when-paid” and “pay-if-paid” provisions is the use of unequivocal language showing that payment from the owner is a “condition precedent” to the general contractor’s obligation to pay the subcontractor and that the risk of the owner’s non-payment has been shifted down from the general contractor to the subcontractor.
The question whether a stipulation in a contract constitutes a condition precedent is one of interpretation dependent on the intent of the parties to be gathered from the words they have employed. Although no particular form of words is necessary in order to create an express condition precedent, such words and phrases as “if,” “provided that,” “when,” “after,” “as soon as,” or “subject to,” have been held to commonly indicate that performance has expressly been made conditional. However, the general rule is that if there is any ambiguity, a contingent payment clause will be construed as a timing provision rather than a condition precedent to payment.
While the Maryland courts have upheld pay-when-paid and pay-if-paid clauses, the Maryland legislature has barred the enforceability of pay-if-paid clauses in certain circumstances. See Md. Code Ann., Real Prop. § 9-113(b) & (c). Section 9-113 (b) provides that a provision in an executory contract between a contractor and a subcontractor that is related to construction, alteration, or repair of a building, structure, or improvement and that conditions payment to the subcontractor on receipt by the contractor of payment from the owner or any other third party may not abrogate or waive the right of the subcontractor to: (1) Claim a mechanics’ lien; or (2) Sue on a contractor’s bond. Any provision made in violation of this statute is void as against the public policy of the State. See also Md. Code Ann., State Fin. & Proc. § 17-108(d)(2) & (3).
Even if the contingent payment clause is enforceable as a general matter, there still may be factual defenses to its application. Courts have recognized that the “credit risk” that an owner will be unable to pay is different from the risk of nonpayment arising because of defenses to payment that the owner may possess, such as untimely performance or poor workmanship. The general contractor is responsible for coordinating the work of its subcontractors and the overall performance of the project. Accordingly, many states recognize that if the general contractor or another contractor for whom the general contractor is responsible is the reason that the owner is refusing to pay, and the claiming subcontractor is without fault, the contingent payment clause may not be enforceable.
Fighting for the MBE
Government contractors are all too familiar with the contractual requirements for subcontracting a portion of the work to minority owned businesses (MBE’s). On a federal and local scale, numerous requirements mandate that the prime contractor maintain those minority contractors and their level of work through the end of the job. For those subcontractors who find that they are mistreated as the project progresses, a recent decision by the federal court for the Southern District of New York provides a valuable example of a legal weapon available to a wrongfully terminated minority business enterprise (MBE) subcontractor and a caution for prime contractors seeking to terminate a MBE subcontractor.
In Annuity Funds Operating Engineers Local 15 v. Tightseal, (S.D.N.Y. August 14, 2018), the general contractor on the Queens Midtown Tunnel Rehabilitation Project, Jadlau, terminated one of its MBE subcontractors, Tightseal Construction. Tightseal sued Jadlau under 42 U.S.C. § 1981 claiming Jadlau had terminated it in “bad faith” and because of racial animus. Tightseal’s allegations that Jadlau’s superintendents had displayed racial harassment by using racist names and slurs were sufficient allegations to allow the case to proceed forward. Jadlau moved to dismiss the complaint but the district court found that Tightseal’s claims could continue since it alleged sufficient facts displaying a hostile racial situation and was a “disadvantaged African-American Company” and that Jadlau had “subjected it to race discrimination.”
Not only must prime contractors seeking to terminate MBE subcontractors ensure that they are acting within the confines of the contract, due diligence also means that the prime contractor ensure that termination or performance reasons will not be challenged because of unanticipated reasons outside of the contract. Employers have long been subjected to liability for the harassment which is endured by their employees by their customers and this case demonstrates that contractors on public jobs must ensure that the same protections are provided to MBE’s working on the jobsite. This means that the prime contractor not only must educate its employees on proper working etiquette but also that it must appropriately investigate and address any claims from MBE regarding mistreatment outside of the contract.
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