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Navigating the perils of ‘pay when paid’

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by Journal Of Commerce last update:Nov 24, 2009

A pay when paid provision in a subcontract makes the general contractor’s duty to pay the subcontractor conditional on the general contractor’s receipt of payment from the owner. 
Navigating the perils of ‘pay when paid’

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A pay when paid provision in a subcontract makes the general contractor’s duty to pay the subcontractor conditional on the general contractor’s receipt of payment from the owner. 

Such provisions are intended to relieve a general contractor from becoming the ham in the sandwich by having to pay amounts to subcontractors which it cannot prevail on the owner to pay to it.

While a general contractor’s desire to avoid being caught short as the result of a payment dispute with the owner is understandable, pay when paid runs afoul of the philosophy of the contractual relationships on a construction project, by holding subcontractors hostage to the state of the owner-general contractor relationship.

In addition to the concerns, which apply to the use of such a provision at any time, pay when paid gives rise to special problems in times of recession.

The law does not like pay when paid provisions.

Case authority has identified the extraordinary nature of such terms and confirmed that they will only be enforced when the wording of the subcontract unambiguously creates such a defence to payment by the general contractor.

The most problematical aspect of the operation of a pay when paid provision is its absolute effect, potentially absolving the general contractor from having to pay the subcontractor at all if payment is not forthcoming from the owner, despite the subcontractor’s full performance of the subcontract work.

The risk to subcontractors entailed in such an arrangement is magnified in the common situation in which there is no companion provision imposing a positive duty on the general contractor to take legal steps to pursue the owner to recover payment on account of the subcontractor.

The troublesome nature of pay when paid provisions is never more obvious than in the present depressed construction environment.

In recent months, the credit crunch, failures of lending institutions and falling property values have significantly increased the incidence of owners who are encountering difficulty in making payments under general contracts.

The problem for subcontractors is most seriously reflected in the suspension of various large scale projects, some of whose developers have entered Companies Creditors Arrangement Act (CCAA) reorganization or full receivership or bankruptcy.

Those circumstances often bode poorly for substantial payment recovery by general contractors under either a corporate reorganization proposal or a bankruptcy liquidation of assets. In either of those scenarios, an effective pay when paid provision in a general contractor’s subcontracts will restrict the contractor’s liability to subcontractors to that limited recovery.

That situation contrasts with a subcontract’s entitlement in a bankruptcy protection or bankruptcy scenario when there is no pay when paid provision. In that case, limited recovery from the owner will affect the subcontractor’s holdback entitlement under the Builders Lien Act, but will not restrain the subcontractor from pursuing the general contractor for its contractual entitlement to payment of the balance of its claim.

Further, the stay of proceedings, which generally limits the ability to pursue judgment during CCAA or bankruptcy proceedings will not apply to delay or obstruct the subcontractor’s prosecution of its claim against the general contractor. Pay when paid provisions are commonly imposed by some general contractors and are frequently accepted by subcontractors hungry for work and incapable of negotiating their deletion from subcontracts.

A subcontractor should never accept them if they can be avoided. A common compromise is the inclusion in subcontracts of a provision delaying the subcontractor’s ultimate entitlement to payment. The inadvisability of a subcontractor’s agreement to a pay when paid provision applies more than ever in the present economy.

J. Marc MacEwing is associate counsel with Shapiro Hankinson & Knutson Law Corporation in Vancouver, whose practice focuses on all aspects of construction law. Direct questions or comments to editor@journalofcommerce.com

last update:Nov 24, 2009

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