What is the distinction between pay-if-paid and paid-when-paid clauses in construction contracts?  From both a payment and legal perspective, much larger than you might think.

Often included in the payment provisions in construction contracts is a clause requiring payment only “if” the general contractor is paid or “when” the general contractor is paid.  The enforceability of pay-if-paid clauses, also called contingent payment clauses, in Florida was the subject of one of our recent blogs.

If and when

Contingent payment clauses in their simplest form are “if-then” commands.  If the owner pays the general contractor, then the general contractor is obligated to pay the subcontractor.  If the owner fails to pay the general contractor, then the general contractor is not obligated to pay the subcontractor.  This is the essence of a contingency payment clause. The “if” is a “condition precedent”, a legally nice way of saying, it must occur before payment is due.  Because the subcontractors do not have a seat at the table when the owner and general contractor negotiate the prime contract, many states, including Texas, impose restrictions on pay-if-paid clauses.  In Texas, such restrictions include financial disclosures and specific instances when contingent payment clauses are unenforceable.

With a pay-when-paid clause, the if-then command is slightly different.  The general contractor’s obligation to pay its subcontractor is never extinguished, but rather delayed.  When, rather than if, the general contractor is paid, then it is obligated to pay the subcontractor.

Typical pay-when-paid clause

The AIA A401-2017 Standard Form of Agreement Between Contractor and Subcontractor contains common pay-when-paid language, which reads: “The Contractor shall pay the Subcontractor each progress payment no later than seven working days after the Contractor receives payment from the Owner.”  The clause is fairly straightforward in that it means after the owner pays the general contractor, the general contractor must pay the subcontractor within seven working days. However, there are a few challenges for subcontractors to be aware.

After

Although one could interpret “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), Texas Courts have drawn a distinction.  The “after” clauses are not interpreted to create contingent payment clauses, but instead to suspend the contractor’s obligation to make payment for a reasonable amount of time.  Unlike a contingent payment clause, the pay-when-paid clause does not legally extinguish the payment obligation if the owner failed to pay.

When

From both a subcontractor’s perspective, there are two statutes that may help define “when” and will certainly allow a subcontractor to be more assertive in seeking payment. The first is the Prompt Pay Act and the second is the mechanic’s lien statute.  Each state has some version of each, though some states like Texas have cumbersome and user-unfriendly lien statutes.

The Texas Prompt Pay Act helps define “when” by providing statutory deadlines for payments on a construction project. Under the Act, an owner must pay the general contractor (subject to certain statutory allowed or required offsets or withholdings) not later than the 35th day after the date the owner receives the general contractor’s request for payment. The general contractor must pay its subcontractors (and then the subcontractor must pay its subcontractors) not later than the 7th day after the date the general contractor receives the owner’s payment.

Texas’ lien laws allow subcontractors to be more assertive in securing payment for goods and services. The statutes provides that subcontractors and suppliers send notices, file lien affidavits and file suit to foreclose on filed liens within prescribed time periods. Whether liens are allowed, the timing of the notices and who must receive them, and timing to file suit to foreclose on a lien are dependent on the type of project (e.g., commercial, homesteaded residential, public), the tier of contractor (e.g., original or prime contractor, first-tier subcontractor, second-tier subcontractor), and a several other factors.  If the project qualifies for liens and the notices, affidavit, and suit is filed timely and properly, the lien statute can assist a subcontractor laboring under a pay-when-paid clause to have some enforcement rights against the owner if payment is not made within a reasonable period of time.

The attorneys in our Austin and Dallas offices are available to answer any questions you may have about payment provisions, the Prompt Pay Act or lien statutes.  Please contact us at info@gstexlaw.com.

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