Contingent-Payment Provision Puzzle—Safeguarding against an Unintended Outcome

Abstract

The success of a construction project requires the timely flow of money from the owner to the contractor down to the subcontractors, sub-subcontractors, suppliers, and vendors. The owner is supposed to be the financier for the project. However, when the owner defaults or withholds payments from the contractor, the contractor can end up unwittingly financing the project because, without a contractual provision to the contrary, the owner’s failure to pay the contractor does not relieve the contractor from its obligation to pay its subcontractors. Therefore, the contractor must be concerned about meeting its obligation to pay its subcontractors before receiving payment from the owner. Likewise, the subcontractors, who want to pay their sub-subcontractors and suppliers only after they have received prompt payment from the contractor, are placed in the same predicament. General contractors take issue with having to pay subcontractors until they are paid by the owner and believe that any loss should be shared equally. Subcontractors argue they are not allowed the same access to the owner’s financial information as the contractor and therefore are not able to form an opinion about the owner’s financial position. In fact most form contracts, including American Institute of Architect 201, 1997, allow the general contractor the right to request financial information from the owner; however, this does not normally happen. Subcontractors believe that they are not equals with the general contractor in deciding to do business with a particular owner on the basis of the contractor’s financial track record Fisher et al. 2005 . Contractors often attempt to shift the risk of the owner’s nonpayment to subcontractors by including contingent payment provisions—such as pay-when-paid or pay-if-paid clauses—in the subcontract. This article focuses on the contractual relationship between contractors and subcontractors; however, most of the discussion in this article is also directly applicable to subcontractor/ subcontractor/supplier contractual relationships. A generically drafted contingent-payment provision may not effectively shift the risk to the extent intended by the contractor. Courts across the country vary greatly on their willingness to enforce contingent payment provisions, and such enforcement often depends on the precise wording of the clause. For example, Georgia and Maryland are among the few jurisdictions that strictly enforce such provisions as conditions precedent to payment Architectural Systems, Inc., v. Gilbane Bldg. Co.; D. I.