When public policy preempts agreed-upon contract terms, does certainty suffer?

This column published as "The Better Forum" in May/June 2021 issue

Jon Straw / May 05, 2021 / 3 minute read
Jon Straw

Consider the intersection of a payment bond claim and a pay-if-paid provision.

In defending against a payment bond claim, the principal and surety generally share the same defenses. For example, there is a one-year deadline to file a payment bond claim under the Federal Miller Act. Similarly, both surety and principal have common law rights of setoff (payment reduction) for work that was improperly or untimely performed by a claimant. Even contract provisions setting a reasonable time for payment are still enforceable (i.e., pay-when-paid clauses).

Unlike a pay-when-paid provision that simply sets a reasonable time for payment, a pay-if-paid clause typically conditions payment on the owner first having paid the prime before the prime must pay the sub. Enforceable pay-if-paid clauses must be express and unambiguous because they shift the risk of non-payment to a party that cannot directly trigger the condition. The sub cannot directly control whether the owner pays the prime. Unless, however, the owner does not pay the prime because the sub, with control over its own scope of work, fails to timely or properly perform. Hypothetically, the sub indirectly controlled payment by the owner to the prime, because the sub directly controlled performance of its own work.

Although both federal and state courts are skeptical of pay-if-paid clauses, results vary. Federal courts tend to strike down pay-if-paid clauses when a payment bond claim is made under the Miller Act. If a pay-if-paid clause were Superman, the Miller Act would be its kryptonite. Without the Miller Act, a federal court should apply the substantive law of the same state where the federal court is located. State courts interpreting pay-if-paid clauses under respective Little Miller Act statutes (so-called because they are state-level statutes usually modeled after the Federal Miller Act) tend to balance enforcement of contractual payment clauses and public policy for payment. Ostensibly, the public policy is that persons timely and properly performing work should be promptly paid regardless of any knowing agreement to waive, release, or limit payment.

State courts without applicable payment statutes have only the contractual provisions to apply, which is the best chance for enforcement of pay-if-paid provisions. A few state courts, however, have struck down otherwise enforceable pay-if-paid clauses simply because they held a party to a contract could not agree to an uncontrollable condition. Such few courts reasoned that the public policy for payment outweighed the freedom to contract.

For example, in the 2008 case of Lehrer McGovern Bovis Inc. v. Bullock Insulation Inc., the Nevada Supreme Court held that pay-if-paid provisions are generally unenforceable because they violate public policy. From 2008 to 2020, several claimants in Nevada federal and state courts argued broadly that pay-if-paid provisions are always unenforceable. In an October 2020 opinion in the case of APCO Construction Inc. v. Zitting Brothers Construction Inc., the Nevada Supreme Court “clarified” its own prior decision that pay-if-paid provisions are not always unenforceable. Rather, enforceability is determined in a case-by-case analysis.

Such analysis, however, can be costly and uncertain. One of the fundamental goals of any contract is to promote certainty, to couch their agreement in writing by which the parties’ intent is objectively unambiguous and readily ascertainable in the near or distant future. Yet, one of the very contract provisions agreed to address payment if the owner does not first pay (e.g., the pay-if-paid clause) can catalyze a dispute that, absent subsequent agreement/settlement, can only be resolved in a case-by-case analysis. This can be frustrating to all sides in a dispute.

What should a claimant or other contractor do? Continue striving for certainty. Considering the courts’ tendencies discussed above, claimants on public projects will tend to fare better in federal courts. Claimants on private projects should use prompt payment statutes or liens. Either way, claimants with a choice of state or federal courts should pick the better forum.

Defendants should do likewise and chart a plan for the best results. Before contract formation, consider if the law of the state where the project is located is the best for your likely position. If the law of another state is available, would it be more favorable to your position? If you cannot change the law, will another venue (different court or arbitration) be a better forum? There is no one-size-fits-all. But, plans improve likelihood, which may be the closest to certainty.

About the Author

Straw is a partner with Kraftson Caudle, PLC, a law firm in McLean, Va., specializing in heavy-highway and transportation construction. Straw can be contacted via e-mail at [email protected]

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