Where a pay when paid clause in a construction subcontract unambiguously states that the subcontractor will only be paid for its work after the prime contractor has been paid by the project owner, the clause was ambiguous due to incorporation of the AIA form prime contract which provided the owner would reimburse contractor for payments made by the contractor to the subcontractor in accordance with the subcontract requirements. Since the subcontract requirements were themselves quite plain that payment would only be made after receipt of the owner payments, the prime contract provision was deemed by the court to relate only to the amount of money to be reimbursed to the prime contractor for its subcontractor payments rather than to the timing of payment. Applying Virginia law, the 4th Circuit Court of Appelas in the case of Universal Concrete Products v. Turner Construction Company, 595 F.3d 527 (4th Cir. 2010), held that the subcontractor was not entitled to be paid for its services since the prime contractor had not been paid by the Owner.
Case
Payment of $885,507 was the amount at issue in this case. There was no issue over the performance of the work or the quality of the work. Instead, as the court noted, “Like countless other construction ventures since collapse of the real estate market, the [ ] project ultimately fell through [ ] when the owner could not longer finance it.” Turner Construction had not paid the subcontractor for any of the work performed, because Turner had not yet been paid by the owner. When the subcontractor sought payment for the work it had performed, Turner refused, citing the pay when paid provision of the subcontract.
The subcontractor argued that the subcontract, when read in light of Turner’s (AIA A121) prime contract with the owner is “patently ambiguous” as to when Turner was required to pay the sub. The subcontractor cited two court decisions from other states that ruled in favor of subcontractors on almost identical contract language. The court declined, however, to follow those decisions, finding instead that under Virginia law the courts would find in favor of Turner on the basis of the clear subcontract language which provided as follows:
“The obligation of Turner to make a payment under this Agreement, whether a progress or final payment, or for extras or change orders or delays to the Work, is subject to the express condition precedent of payment therefor by the Owner.”
The court also pointed out that another section of the subcontract stated that the agreement was intended to supplement the agreement between Turner and its sub, and that “any conflict between the two agreements will be read to impose the greater obligation on the subcontractor.”
Pay when Paid Contract
In arguing ambiguity between the prime and subcontracts, the subcontractor cited A121 section 6.1.3, which states that the costs for which the owner will reimburse Turner include “[p]ayments made by the Construction Manager to Subcontractors in accordance with the requirements of the subcontracts.” The subcontractor emphasized the term “payments made” which it claimed demonstrated that Turner and the owner contemplated Turner’s paying the sub before invoicing the owner. The balance of that same clause, however, states that the “payments made” are those payments made “in accordance with the requirements of the subcontracts.” In view of that, the court found that the clause relates only to the reimbursement amount, and not to the question of when the amounts would be paid. Other clauses in the applicable A201 contract, including sections 9.6.2 and 9.3.1, contemplate the likelihood that the general contractor and subcontractor would enter into a paid-when-paid contract.
For these reasons, the court affirmed the trial court decision, holding that the pay-when-paid clause was clear on its face and must be enforced in favor of Turner Construction against the subcontractor. It should be noted that the Court included a footnote in its opinion stating that Turner was pursuing a claim against the project owner seeking payment of over $13 million, which includes the amount owed to the subcontractor.
Comment
In the current economically troubled times, the pay when paid clause has proven to be an important tool to protect a prime contractor against having to pay its subcontractor for work that the project owner itself has not paid to the general contractor. On the other hand, it can create a terrible situation for the subcontractor that has properly performed its work and has no recourse to get paid. If this clause is included in the contract, the subcontractor needs to pay special attention to including language in the contract to permit it to suspend or terminate work in the event that it is not being paid when its invoices are due. It is also important to preserve the right to file liens on the property and to exercise that right. The pay-when-paid clause is also becoming a problem for design professional subconsultants in manner similar to construction subcontractors. When commenting on the pay-when-paid clause in design professional subconsultant’s contracts one suggestion I offer is to set an ultimate time limit on how long payment can be withheld. For example, a sentence could be added to the effect that “In no event shall payment of uncontested amounts on invoices be paid later than 120 days from submittal of the invoice.” Since that shifts the risk of payment back to the prime consultant, however, it may be difficult to obtain.
About the newsletter and author: J. Kent Holland is a construction lawyer located in Tysons Corner, Virginia, with a national practice (formerly with Wickwire Gavin, P.C. and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners. He is also founder and president of ConstructionRisk, LLC, a consulting firm providing consulting services to owners, design professionals, contractors and attorneys on construction projects. He is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932. This article is published in ConstructionRisk.com Report (2010) at www.ConstructionRisk.com. This article is published in ConstructionRisk.com Report, Vol. 13, No. 4 (April 2011).
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