June 1, 2020

By: Brent Laman, Associate, Smith, Currie & Hancock LLP.

In an early Rolling Stones classic, Mick Jagger sang, “Ti-i-i-ime is on my side. ”The refrain to that hit melody “yes it is” appears to hold true if you are a subcontractor in New York looking to get paid for completed work even while the owner and general contractor duke it out in protracted litigation over amounts you are owed.

A recent New York state decision underscores the unenforceability in that state of the payment risk shifting term commonly known as a “pay-if-paid” clause and adds nuance to the interpretation of payment timing mechanisms referred to as “pay-when-paid” provisions. The project was the construction of four apartment buildings at a total cost of just more than $5,000,000.00. Not quite a year in to the project, a payment dispute arose between the owner and general contractor, Plank, LLC. In response, Plank demobilized the site. At that time, Plank owed the electrical subcontractor, A.E. Rosen Electrical Co., Inc., $161,805.49. The owner later paid Rosen $44,527.00, and Rosen pursued its lawsuit against Plank for the remainder.

The subcontract between Rosen and Plank required Plank to make progress payments to Rosen within 15 days of receiving corresponding payments from the owner. Plank also agreed to make a final payment to Rosen within thirty days of receiving the final payment from the owner. The contract contained the specific stipulation that “[t]he parties acknowledge that this is a ‘pay when paid’ timing mechanism and not a ‘pay if paid’ provision,” likely because New York courts had decided 25 years’ prior that “pay-if-paid” provisions were void for public policy reasons (more on this below).

Plank raised this contract provision as defense in the lawsuit, arguing simply that it could not be liable for payment to Rosen because it had not yet been paid by the owner. It is worth noting here that by the time the court was asked to consider this defense, more than two years had passed from the date Rosen had completed the work for which payment was demanded. If that argument sounds no different than what would have been argued had the provision been a “pay-if-paid” provision, it is. The result was a ruling from the court highlighting the Empire State’s limitations of the time-based “pay-when-paid” provisions versus the absolute conditional nature of “pay-if-paid” provisions. The court concluded that Plank could not use the contract provision to effectively shift all risk of owner non-payment to Rosen, thereby converting a contractual timing-of-payment mechanism into a conditional “pay-if-paid” provision shifting risk of owner non-payment to the subcontract. Therefore, the provision could only be enforced to the extent the delay in payment was for a reasonable amount of time after the work was complete. To hold otherwise would be to obliterate any difference between the two types of provisions.

If you are building in New York, the question begged by this court’s holding is: what is a reasonable amount of time for a general to withhold payment under a “pay-when-paid” provision when the general has not been paid by the owner? The New York court first looked to a federal case that considered three years to be an unreasonable amount of time, then, without much in the way of explanation, held that the “well over two years” Rosen had waited for payment was an unreasonable amount of time. Of course, there is a lot of ground between what a subcontractor may consider a timely payment, say 30 to 60 days after submission of a payment request, and the “well over two years” at issue in the case. What if it had only been one year or even six months? The court gave no indication as to whether a shorter period of time would have been reasonable.
Perhaps a more useful question to ask is, “What happens when a savvy contract lawyer decides to “draft around” the A.E. Rosen ruling?” For instance, what if the provision said something like “General Contractor (GC) agrees to make payment to Subcontractor (SC) within 15 days of receiving a corresponding payment from Owner. The Parties agree that: (i) in the event of a lawsuit or arbitration between the GC and Owner or (ii) the Owner’s bankruptcy or insolvency, and where the GC has not been paid by the Owner, it is reasonable for GC to wait five years after SC’s work is complete for GC to make payment for that work. The Parties agree that five years is reasonable because neither party is banking on this job to stay solvent or feed their families.” This example may lean toward being silly, but the point is made. Will the New York courts come in and protect the subcontractor from itself by rewriting these provisions, replacing five years with their own ideas of “reasonable” or will they uphold the sacred freedom to enter into potentially perilous contracts? The importance of being able to draft an enforceable “pay-when-paid” provision is underpinned by the increasing number of states that have passed statutes outright prohibiting or severely limiting “pay-if-paid” provisions.

New York long ago decided that “pay-if-paid” provisions were unenforceable and void as against public policy. The stated legal reason for these decisions was based on close examination of New York’s lien laws with the courts finding that “pay-if-paid” provisions amounted to an impermissible waiver of lien rights. The same is true of California and other states. Of course, courts can often succumb to tortured legal reasoning to arrive at the result they intended from the outset; often knowing where they will land before they figure out how to jump there. A more practical concern, and a reason actually noted in the A.E. Rosen court’s decision, is that suppliers and small contractors on large construction projects need reasonably prompt payment for their work and materials in order for them to remain solvent and stay in business. Of course, the same could be said for many small businesses. On the other hand, the multi-tier, multi-contract nature of a large construction project is unique and has spawned some unique risk-shifting provisions.

Regardless of why, more states have hopped on the bandwagon of prohibiting “pay-if-paid” provisions, primarily through enactment of prompt payment statutes. The following states have statutes that if they do not outright ban “pay-if-paid” provisions, limit (or appear that they may limit) their application: North Carolina, South Carolina, Massachusetts, Illinois, Maryland, Missouri, and Wisconsin. Several states have no reported cases dealing with conditional payment provisions and some specifically allow them; however, the takeaway is always to know your state’s law on conditional payment provisions, and, if possible, draft around them in your favor. If your contract is enforced in a state that has banned “pay-if-paid” provisions, careful contract drafting might provide a general contractor with a lengthy period of time to hold onto its money while it tries to negotiate a resolution with the owner as to subcontract funds owed. On the other hand, if you are a subcontractor contracting in one of these states and your subcontract contains a “pay-if-paid” clause, you might consider letting it lay; before taking that course, however, you should consult with counsel on the effect of leaving in such a provision and resulting costs you might incur in attempting to litigate over the enforceability of this risk shifting mechanism. In either event, a thorough vetting and review of the contract before signing it, even if that includes retaining counsel on the front end to review the terms, may be the best way to ensure that enough time is on your side to protect and ensure your payment rights and obligations. That may, after all, be the best way for you to get the satisfaction you desire.

The  views expressed in this article are not necessarily those of ConsensusDocs. Readers should not take or refrain from taking any action based on any information without first seeking legal advice.