Everything You Need to Know About the “Pay-if-Paid” Clause

When it comes to legal disputes, it is not uncommon for a construction litigation attorney to deal with contracts with a pay-if-paid clause. This clause includes payment provisions often used between two or more parties, usually in the construction sector. A pay-if-paid clause determines which party will bear the financial risk of the project.

These Clauses are Risk-Shifting Systems

Pay-if-paid clauses are specifically designed to shift financial risk down the chain. A pay-if-paid clause allows a general contractor the freedom to pay subcontractors only after receiving payment from the property owner. This excuses the obligation of payment from the primary contractor and shifts the burden of non-payment to the subcontractors. 

State Legislation Against Pay-if-Paid Clauses

Over the past two decades, pay-if-paid clauses have become more sophisticated, especially after the housing fiasco and recession hit in 2008. Property developers and general contractors have used this clause to shift the financial risk of a project down the contracting chain, and abused it in order to withhold payments.

As a result, this has initiated many disputes that required the aid of a professional litigation attorney to resolve. Many contractors and subcontractors have strongly vocalized their disdain for the pay-if-paid clause, which prompted some states to legislate against it. 

The legislatures of these states have completely banned pay-if-paid clauses directly in statutory language. Several states have followed suit and adopted some version of a “prompt payment” statute – a mandatory payment to a subcontractor by the party with whom he contracted, provided the work was performed.  This approach seems to be gaining favor and currently, the pay-if-paid clause is already outlawed in the following states: California, Kansas, Illinois, Indiana, Nevada, Montana, Ohio, North Carolina, New York, South Carolina, Utah, and Wisconsin.

Despite the movement toward removing pay-if-paid clauses, there are some situations in which one may still be valid. It is important for contractors and suppliers, to be cautious when a contract includes this provision. It is crucial to include specific contractual language to state that both parties understand that the risk should be shifted. These contracts are best reviewed by a construction litigation attorney. Contact Warren S. Dank for more information about how you can protect yourself and your business.

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