Construction projects come with inherent risks for all parties involved. To manage some of this financial risk, general contractors often include pay when paid clauses in their subcontractor agreements. These clauses make subcontractor payments conditional on the general contractor receiving payment from the client first.
While pay when paid clauses can help general contractors maintain cash flow and keep projects running smoothly, they can create significant cash flow problems for smaller subcontractors, who may have to wait for payments they cannot control.
Here, we’ll discuss the definitions of pay when paid clauses, how they fit in with prompt payment legislation rules, and how to handle finances when one of these clauses is in place.
Construction contracts – a primer
Construction contracts lay down the rules for every interaction throughout the project. They seek to demystify as much of the process as possible – even accounting for what-if and what-about scenarios construction stakeholders may never have encountered before.
The contract should lay out the project details and describe in detail the rights and responsibilities of everyone involved, especially laying out the scope of work to be completed and the process for handling change orders.
There are some common construction contract templates and forms out there that can help construction firms draft their contracts and help make industry contracts a little more standardized.
It is absolutely vital for every party involved in the project to read and understand the entire contract before starting work. It’s a big ask, because legal jargon is generally hard to read, but construction businesses will be held to the terms of the contracts they sign – including those that may delay payment.
Clauses to watch for in construction contracts
There are all kinds of clauses in construction contracts, including those that outline the responsibility for sourcing materials, the warranty on the work, and who’s in charge of getting permits. Some, however, may require a second look, as they may put too much of the balance or risk on one party.
No lien clauses seek to prevent a contractor or subcontractor from putting a mechanic’s lien on the property. It’s like signing a lien-waiver before ever starting the work, and takes away one of the contractor’s main levers for getting paid.
No damages for delay clauses mean if the subcontractor can’t start or continue work as planned because of project delays they didn’t cause, the sub can’t seek to be compensated for time lost.
Escalation clauses seek to manage the risk of risking materials costs by setting out procurement rules that help ensure the costs remain similar to those quoted in the bid. Subs should ensure the stipulations are fair and balanced.
Definition of pay when paid
A pay when paid clause is a section in a construction contract that stipulates the GC is responsible for paying the subcontractor within a certain period of time after having received payment from the property owner or project developer.
If all goes well, pay when paid may not impact the subcontractors much at all – if the GC has worked out cashflow plan and sets a schedule to pay the trades contractors when an influx of money comes in, it may all run smoothly.
Pay when paid contract clauses can become contentious when GCs don’t get paid as scheduled – either because they miss application or work deadlines or there are project owner cashflow issues, for example. When this happens, subcontractors may be held off on payment indefinitely. Despite not being paid, subcontractors will still have to pay for the materials and labor hours incurred in completing the work.
Payment solutions like Truss can help avoid missed payment applications and streamline payment processes, helping avoid cash flow crunches. Truss even allows flexibility for progress payments so that construction firms can track amounts paid and owed without repeated manual data entry.
Pay when paid vs pay if paid
Contractors should be aware of the differences between pay when paid clauses and pay if paid clauses. Known as contingent payment clauses, both pay when paid and pay if paid indicate that the prime contractor’s own remuneration may impact payments. However, pay when paid never negates the GC’s responsibility to eventually pay the subcontractor, while pay if paid could mean that if the GC never gets paid, it may never pay the sub progress payment or final payment.
Both pay when paid and pay if paid clauses are subject to different interpretations from one state to another. Many states actually prohibit pay if paid clauses from appearing in construction contracts.
Legal implications of pay when paid
Contingent payment clauses present a quandary for both construction and legal professionals. Nonpayment can make it pretty tough for GCs to pay their subs, but it’s not really up to subs to take on all the risk of owner nonpayment, either. And how are material suppliers and laborers impacted when subs’ payments are delayed?
Courts in many states, including Alabama, California, Florida, and New York, agree that pay when paid clauses are timing mechanisms, suggesting that payment timing may be impacted by the clause but the GC retains responsibility for subcontractors to get paid.
As recently as 2022,Virginia passed Senate Bill 550 on prompt payment, which invalidates contingent payment clauses in most cases and requires construction contracts to instead include clauses obligating contractors to pay their subcontractors in full.
That same year, Connecticut upheld a pay if paid clause in a contract in Electrical Contractors Inc. v. 50 Morgan Hospitality Group LLC, saying the contract was clear enough that the subcontractor knew the rules when going in.
Before signing any contract with a contingent payment clause, subcontractors should understand its implications and applicability in that state. Using Truss Payments can mitigate the risks associated with payment, by automating payments to avoid delays and keeping accurate records of exchanged funds so that contractors can protect their interests in case of dispute.
Best practices for dealing with contingent payment clauses
Although courts may protect subcontractors from nonpayment resulting from pay when paid clauses, contractors should understand that when they sign any contract that contains these clauses they are effectively agreeing to them.
Instead of hoping for the best, contractors should exercise their rights to negotiate payment terms, especially if they impact the contractor’s lien rights on the property or go against the state’s prompt payment legislation.
To protect themselves in case of payment disputes, contractors should be sure to keep track of all paperwork, sending complete and proper invoices by the predetermined deadlines. In many construction industry dispute cases, the victor winds up to be the party who can prove the case the best, through adequate documentation.
Payment solutions like Truss can help track payments, including progress payments, and automate invoicing and payments to ensure subcontractors’ compliance to all the rules so that if a dispute arises, they have the best chance of coming out on top.
How to manage risks and best practices for pay when paid clauses
While pay when paid clauses serve as a financial management tool for GCs, they pass along considerable financial risk to lower-tier contractors. It’s crucial for all contractors who sign construction agreements to understand the clauses and how they may be interpreted by local courts.
Ultimately, proactive communication, clear contractual agreements, and effective payment management through Truss Payments can help mitigate the challenges associated with contingent payment clauses and ensure smoother project execution for all stakeholders.
