Pay if paid clauses are controversial at best, and are treated differently by each state. With a valid pay if paid clause in a subcontract, the subcontractor is bearing all the risk of nonpayment by the owner. Arizona laws do allow for the enforceability of these types of provisions. However, since the effects of such a provision are so serious, the courts have heavily regulated them.
Pay-if-paid provisions
A pay if paid clause, is a type of contingent payment clause designed to shift the risk of non-payment from the general contractor to their subs or suppliers. Basically, if the subcontract included an enforceable pay if paid provisions, the GC is not obligated to make payments to the subs until they have received payment from the owner. Unlike, pay-when-paid clauses, these can result in subcontractors assuming the entire risk of the owner’s nonpayment.
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Arizona pay-if-paid clauses are enforceable
Although enforceable per se in Arizona, the courts tend to frown upon their validity. The provision must be clearly drafted and unambiguously state that payment is contingent on the owner paying the general contractor. There is no bright-line rule to establish validity, but rather the contract language will be assessed on a case by case basis.
Requirements in order to be enforceable
These types of clauses are enforceable on both public and private language. The only real hurdle to overcome it if the language “plainly and unambiguously” indicates payment is contingent on the Gc receiving payment from the owner. The specific requirements were the topic of the case L. Harvey Concrete, Inc. v. Agro Const. & Supply Co. Here, the pay if paid clause was considered enforceable. The provision in question was drafted as follows:
Subcontractor agrees as a condition precedent to payment… that the owner shall have first paid the payment to the contract, and that payment for progress or final payment is not due and owing to the subcontractor as provided herein until the owner has made such payments to the contractor.
Using this clause as an example of a clear and unambiguous contingent payment provision, the court established three general requirements for enforceability. The clause should expressly state:
- The receipt of payment from the owner is a condition precedent to payment;
- The payment is not due and owing until the owner has made payments to the contractor; &
- Identify the source of funding for the subcontract is the payments made by the owner to the contractor.
Unenforceable clauses
Failure to meet these requirements could lead to the pay if paid clause being unenforceable. However, in some cases, the provision may constitute a pay-when-paid clause, which doesn’t absolutely shift the risk from the GC to the sub. This was the case in Watson Const. Co. v. Reppel.
The clause in question stated that the sub was to be paid “promptly upon receipt from the owner the amount received by the contractor on account of the subcontractor’s work to the extent of the subcontractor’s interest therein.”
This was deemed to be unclear and did not expressly establish a condition precedent. Instead, it provides that the payments to the subs and suppliers are to be passed on within a reasonable time following the receipt of funds.
Conflict with the Arizona Prompt Payment statute
The Harvey case occurred shortly after the passage of the Arizona Prompt Payment Act. Although there has yet to be any litigation on the matter, it appears that contingent payment clauses run directly counter to the statute’s requirements. The effect of the prompt pay statute on these clauses remains up in the air.
Some could argue that the prompt pay statute’s language constitutes a prohibition on such clauses. The flip side of that is the fact that there is no specific mention of these clauses in the statutory language. It only refers to contracts clauses that go specifically against public policy. But since these clauses have been enforced, they clearly aren’t against public policy.
We keep our ears pretty close to the ground when it comes to construction payment law. Stay tuned for any future developments or litigation regarding this debate.
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