Recently, the Virginia governor signed into law “SB550,” which explicitly makes “pay-if-paid” clauses unenforceable by statute, joining six other states with similar laws. Texas also has a statute governing pay-if-paid or contingent payment clauses, though does not outrightly void them.  What are contingent payment clauses and what are the statutory restrictions in Texas on their enforceability?  This article provides a primer.

What are contingent payment clauses?
Contingent payment clauses are just that, clauses that provide that when X happens, Y occurs (i.e., X is a condition precedent to Y). Interpretation of these exact clauses vary by state, but, generally, a “pay-when-paid” clause relates to the timing of when a general contractor has to pay a subcontractor whereas a “pay-if-paid” clause makes owner payment to a general contractor a condition precedent to the general contractor paying the subcontractor. With a pay-when-paid clause, the general contractor’s obligation to pay its subcontractor is never gone (extinguished, in legal terms) but rather delayed. With a pay-if-paid clause, the subcontractors do not get paid if the owner does not pay the general contractor.

Contingent payment clauses in practice.
While these clauses seem fairly intuitive, it helps to understand some of the complexities of these provisions in practices. For example, the AIA A401-2017 Standard Form of Agreement Between Contractor and Subcontractor contains a payment clause that reads, “The Contractor shall pay the Subcontractor each progress payment no later than seven working days after the Contractor receives payment from the Owner.” Is this a paid-when-paid or a paid-if-paid clause?

Reading the plain language of the provision, one could read the after the Contractor receives payment from the Owner to mean that if the contractor is never paid then the contractor is never required to pay the subcontractor (a pay-if-paid clause). However, Texas Courts interpreting this clause have interpreted it as the contractor’s obligation to make payment is suspended for a reasonable amount of time, not that the obligation is extinguished (or extended indefinitely).

Why? Upon closer examination, the language does not make receipt of payment from owner a “condition precedent” of payment to the subcontractor, it merely references the owner’s payment as part of when payment is to be made. A pay-if-paid clause might read, “Contractor receipt of payment from Owner is a condition precedent to Contractor’s obligation to make a payment to the Subcontractor, and Subcontractor expressly agrees to assumes the risks of nonpayment by the Owner.” It is noteworthy that most “standard form” contracts (e.g., the AIA suit of documents) do not contain pay-if-paid provisions.

Why do some states prohibit pay-if-paid clauses?
The primary arguments in favor of an outright prohibition of pay-if-paid clauses is protection of the lower-tier contractors by avoiding the somewhat onerous and draconian lien laws and keeping the burden of ensuring payments on the prime contractors, who have the direct relationship with the owner and are in the best position to manage (or influence) the financial health of a particular Project. The argument against such a prohibition, beyond freedom to contract, is that subcontractors and suppliers are already afforded remedies for non-payment by virtue of state lien laws.

What about Texas?
Texas allows pay-if-paid clauses, but are enforceable only if certain statutory requirements are fulfilled. The Texas Business and Commerce Code, Chapter 56 statutorily defines and regulates contingent payment clauses.

To be enforceable, a contingent payment provision must be clear and unambiguous that a condition precedent exists for payment. Even if unambiguous, there are certain situations where the clause may still be unenforceable:

• • • If nonpayment is due to the general contractor’s performance (or nonperformance);
    • If the subcontractor (against whom the provision is being enforced against) objects in writing to the general contractor;
    • If there is an existence of a sham relationship (as defined in the property code) between the owner and general contractor; or
    • If the clause is deemed unconscionable as part of the contract.

Reading and interpreting Texas’s contingent payment statute is not for the feint of heart.  It is complex and technical, and demands special attention when drafting contracts or interpreting existing ones for purposes of determining whether payment is due.

Our attorneys in Dallas and Austin are available to assist in interpreting your payment obligations and negotiating contracts that protect your interests.  Please contact us at info@gstexlaw.com with any questions you may have.

Legal Disclaimers

This blog is made available by Gerstle Snelson, LLP for educational purposes and to provide general information about the law, only.  Neither this document nor the information contained in it is intended to constitute legal advice on any specific matter or of a general nature.  Use of the blog does not create an attorney-client relationship with Gerstle Snelson, LLP where one does not already exist with the firm.  This blog should not be used a substitute for competent legal advice from a licensed attorney.

©Gerstle Snelson, LLP 2022.  All rights reserved.  Any unauthorized reprint or use of this material is prohibited.  No part of this blog may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage or retrieval system without the express written permission of Gerstle Snelson, LLP.