“Pay-When-Paid” vs. “Pay-If-Paid”

While there are numerous types of clauses common to construction contracts that affect when subcontractors are entitled to payment, two of the more common clauses are “pay-when-paid” and “pay-if-paid.” The purpose of this article is to highlight the important distinctions between these two clauses that every subcontractor should be aware of before entering into a subcontract agreement.

Much like it sounds, a pay-when-paid clause governs when a general contractor is obligated to pay a subcontractor for work performed under a subcontract. Under a pay-when-paid clause, a general contractor is obligated to pay a subcontractor once the general contractor receives payment from a project owner. These clauses are typically joined by some additional language that sets out a reasonable amount of time for the general contractor to issue payment to the subcontractor once he is paid by the owner.

Subcontractors should note that pay-when-paid clauses are often asserted as a complete defense to a subcontractor’s claim for payment. When a general contractor asserts that he has no obligation to pay under a pay-when-paid clause, the subcontractor should carefully analyze the language of the subcontract.  Absent express language in the subcontract stating otherwise, most jurisdictions do not recognize pay-when-paid clauses to set any conditions precedent before the general contractor is obligated to pay the subcontractor. In other words, the subcontractor may still be entitled to payment from the general contractor. Colorado courts typically interpret pay-when-paid clauses to require payment within a reasonable amount of time even if the general contractor has not yet received payment from the owner.

A pay-if-paid clause, on the other hand, sets out a condition, otherwise known as a “condition precedent,” that must first be met before the general contractor is obligated to pay the subcontractor: the general contractor must be paid by the project owner for the work before the general contractor must pay the subcontractor. This clause shifts the general contractor’s risk of the project owner’s nonpayment to the subcontractor, who, now, under the terms of the agreement is not entitled to payment unless and until the general contractor is paid for that work by the project owner. Colorado courts enforce pay-if-paid clauses if the clause expressly states (1) that the subcontractor will be paid only if the general contractor is first paid by the owner and (2) that the subcontractor bears the risk of the owner’s nonpayment. Otherwise, Colorado courts will interpret the language as a pay-when-paid clause.

General contractors often use pay-if-paid clauses in their subcontracts to avoid funding projects for owners who may not have the credit history to receive adequate financing for their projects. Many general contractors understand that subcontractors are typically not able to assess a project owner’s credit standing, nor do many subcontractors appreciate the risk they accept by agreeing to pay-if-paid clauses.

Therefore, if a payment dispute arises, the first question a subcontractor should consider is whether he entered a written subcontract with the other party and, second, whether he is entitled to payment under the terms expressed in that agreement. By keeping these two questions in mind, subcontractors reduce the risk of finding themselves in a situation where they face nonpayment.

Knowing how to assess the potential risks of entering subcontracts is one of the most important tools a subcontractor has in his tool-belt. If you are a subcontractor seeking guidance on how to better equip your company with the tools it needs to manage risk, please contact an attorney at Galvanize Law Group. We are happy to answer any questions about your subcontract agreements to help you improve your likelihood of promptly being paid.