Ask an Attorney: Between a Rock and a Hard Place - Subcontractors Caught in the Middle of Payment Disputes

by: Jeffrey C. Bright, Esquire at Harmon & Davies, P.C.

Pay-if-paid clauses are a common and frequently discussed contract clause. The clauses are typical in contracts between general contractors and subcontractors. These clauses state that the general contractor only has to pay the subcontractor if, and only if, the general contractor has first been paid by the owner. Under these clauses, if the owner fails to pay the general contractor, then the general contractor need not pay the subcontractor.

Lawyers are constantly advising general contractors and subcontractors on these clauses, but one item that is often overlooked is the importance for a first-tier subcontractor to include pay-if-paid clauses in its sub-subcontracts down-the-line. A pay-if-paid clause in a sub-subcontract has the same effect as previously discussed; merely, it applies to the second-tier subcontractor. Thus, the first-tier subcontractor only has to pay the second-tier subcontractor if, and only if, the first-tier subcontractor has been paid by the general contractor.  If the general contractor fails to pay the first-tier subcontractor, then, the first-tier subcontractor need not pay the second-tier subcontractor.

By including pay-if-paid clauses in sub-subcontracts, it allows a subcontractor to fend-off claims from laborers and suppliers down-the-line while a payment dispute is pending. For example, if a dispute arises between the general contractor and the owner, and this causes a withholding of payments, then, the general contractor will fail to make payment to the subcontractor. When this occurs, the second-tier materialmen and laborers, who contracted with the subcontractor, will begin clamoring for payment. This puts the subcontractor between a rock and a hard place: on the top-end, payment is not flowing to the subcontractor; on the bottom, second-tier subcontractors are threatening claims for lack of payment.

A pay-if-paid clause in the subcontractor’s down-the-line contracts is one of the best methods for pushing back on potential lawsuits. The clause allows the subcontractor to present a strong defense to any threatened claims by sub-subcontractors, and, depending on the circumstances, the subcontractor may be able to demand the second-tier subcontractor to continue to perform the work while the dispute is pending. The general hope is that the first-tier subcontractor can fend-off the second-tier subcontractor claims for enough time to allow the general contractor to resolve the payment dispute.

Even if a subcontractor is unable to negotiate a revised clause in its contract with the general contractor, an option of equal importance is to negotiate the inclusion of a pay-if-paid clause in the sub-subcontracts down-the-line.  To a certain degree, pay-if-paid clauses in the sub-subcontracts also help the general contractor, because it may delay litigation filed by the
second-tier subs.

When entering or litigating construction contracts, it is best to seek legal advice and professional assistance.  The author, Jeffrey Bright, is a Pennsylvania and Maryland licensed attorney practicing at Harmon & Davies, P.C., a Lancaster based law firm that has been a member of ABC Keystone for more than 35 years.  The content of this article is not legal advice.