For my introductory article, I would like to bring focus on two recent court decisions that highlight the disparity in attitudes across the country concerning whether a prime contractor can condition its duty to pay a subcontractor upon its actual receipt of payment from the owner.
Typically, conditional payment language in a subcontract is referred to as either a “Pay If Paid” or “Pay When Paid” provision. However, the more precise term is “Pay If Paid.” A “Pay When Paid” provision merely prescribes the time period within which the subcontractor will be paid after the prime receives the owner’s payment—it does not address what happens if the owner never pays. Whether a particular clause is a “Pay If Paid” or a “Pay When Paid” is the subject of hundreds of reported court cases across the country.
Typically, a prime will argue that if the owner never pays, the prime has no duty to pay the subcontractor.
Only a small minority of courts side with the prime contractor’s argument. An effective “Pay If Paid” provision must contain specific language stating that the owner’s payment to the prime is a “condition precedent” to the prime’s duty to pay the subcontractor.
The state of the law surrounding “Pay If Paid” provisions was fairly certain across the country because most courts have had the opportunity to rule on their enforceability. However, two recent cases have reintroduced some confusion.
In Wellington Power Corp. v. CNA Surety Corp., 614 S.E.2d 680 (W. Va. 2005), two subcontractors filed a lawsuit against a prime contractor’s payment bond surety on a public project to collect amounts they claim the prime owed under their respective subcontracts. The surety denied both claims because both subcontracts contained identical “Pay If Paid” provisions and the sums sought by the subcontractors had not been paid by the public entity owner. The court ruled the “Pay If Paid” provisions were clear and unambiguous and, acknowledging the longstanding rule that a surety “stands in the shoes” of the bonded contractor and may raise all defenses the bonded contractor may assert, dismissed both claims.
In Moore Bros. Co. v. Brown & Root Inc., 207 F.3d 717 (4th Cir. 2000), the U.S. Circuit Court of Appeals for the Fourth Circuit was faced with nearly identical facts as Wellington, but reached the opposite conclusion. Like the court in Wellington, the Fourth Circuit acknowledged the validity of “Pay If Paid” provisions in Virginia, found that the subcontract provision contained no ambiguity and acknowledged the general rule allowing sureties to “stand in the shoes” of the bonded contractor. However, it refused to allow the surety to rely on the “Pay If Paid” provision of the subcontract because (1) the provision was not expressly incorporated into the bond and (2) enforcing the “Pay If Paid” provision in favor of the surety would defeat the very purpose of the payment bond (i.e., to provide payment protection to those performing work to the project).
The Moore Bros. decision delivers a substantial setback to prime contractors, who typically agree to indemnify their sureties as a condition of receiving bonding on a project. The decision thus reverses previous decisions upholding the validity of “Pay If Paid” provisions because it allows subcontractors to avoid the harsh effects of the provision by simply bringing a claim under the payment bond for which the prime will ultimately be responsible.