One of the risks that most construction projects have involves getting paid. It’s a fact of life that we all want to get paid for the work we perform. But what happens when someone doesn’t pay? The resulting situation causes a domino effect of sorts. The owner can’t or won’t pay, which means the general contractor then can’t pay their sub-contractors.
The bad boy mentioned in the headline is the pay-if-paid clause that is often written into construction contracts. What this clause does is shift the risk from the general contractor to the subcontractor. For example, if the owner of the project lost their construction financing and the contractor wasn’t paid, they could legally refuse to pay the sub-contractors for their work.
This contingent payment clause allows the contractor to permanently withhold payment based on the owner not paying the contractor in the first place. Tennessee law has held that the pay-if-paid clause is enforceable when written as, “payment from the owner is a condition precedent to any and all payment obligations provided by the contract.” Not all states enforce this clause and some have passed legislation that voids these provisions.
This clause is all about when the subcontractor gets paid—as opposed to if. The clause links the timing of the subcontractor's payment to the time when payment is made by the owner. From the subcontractor’s point of view, this is the much better clause. Tennessee law has said that the clause setting the time for payment of a subcontractor (after the contractor has received payment) does not create a condition precedent to payment. It merely establishes a reasonable time for payment from the contractor to the subcontractor. Koch v. Construction Tech., 924 S.W.2d 68 (Tenn. 1996).
It is recommended that legal counsel familiar with construction law should be used with these clauses as well as all construction contracts.