Today’s guest post is by one of my favorite construction lawyers and friends, Burr partner Ned Nicholson in our Columbia, SC office.  Ned regularly represents clients in construction defect and compensation claims, manufacturer/dealer disputes, and insurance coverage lawsuits. He is also a South Carolina certified mediator. Ned can be reached at nnicholson@burr.com or (803) 799-9800.

If you are a homebuilder, residential housing developer, construction industry insurer, or any one of the many participants in the industry providing affordable and decent housing for the citizens of South Carolina, you are already aware that South Carolina courts have for decades prioritized the promotion of consumer (i.e., home buyer) rights, usually at the expense of the providers of housing.  There is nothing inherently wrong with that; the goal is laudable.  But as in so many things, the implementation has been extremely costly for the residential construction industry as a savvy plaintiff’s bar has taken advantage of grey areas that are inevitably created in our judicial system.

For example, years ago a South Carolina Supreme Court Justice proudly stated that “South Carolina, through both its courts and legislature, has previously been in the vanguard of protecting consumers, particularly in the area of home construction.”  Reynolds v. Ryland Group, Inc., 531 S.E.2d 917, 921 (S.C. 2000).  It is also no secret to builders and insurers that South Carolina’s joint and several liability rules mean that if a builder is only 1% negligent in the cause of construction defects, the builder can still get stuck with 100% of the damages, with the courts leaving it up to the builder to try and collect from other negligent parties.

It is therefore no surprise that in South Carolina, and nationally for that matter, homebuilders have attempted to bring some economic fairness to the table by inserting arbitration clauses in their construction and sales contracts.  Arbitration is a private dispute resolution method where parties to a contract agree that instead of going to court in a public lawsuit, any dispute will be handled by a neutral third party, usually an attorney, in a more informal and less expensive manner than the court system.  Usually the homebuilders attempt to ensure that arbitrators knowledgeable in the construction world will decide such disputes, so that experts truly decide the disputes.

Not surprisingly, plaintiff’s lawyers do not generally like arbitration, as they tend to believe their client homeowners would be more fairly treated by a jury or judge who are not construction experts and perhaps would be more sympathetic to a consumer in a close case.  Because of that, there are constant attacks on arbitration clauses in the courts as owners try to find creative ways to bypass binding arbitration.

Beware!  The South Carolina Supreme Court on September 14, 2022 embraced one of those creative bypasses in Damico v. Lennar Carolinas, LLC, et al, Op. No. 28114.  In Damico, the homebuilder had masterfully integrated special warranty clauses, arbitration clauses, and other contract documents to provide a clear, reliable outline and process for both the home buyer and the homebuilder to follow for dispute resolution by arbitration.  Or so the homebuilder thought.

To the surprise of the builder, the Court held that the arbitration clauses were “unconscionable,” and thus not enforceable.  The only way the Court could reach that conclusion was that the arbitration clause in this case did not say that issues of enforceability of the arbitration clause were for the arbitrator, not the courts, to decide.  (If a clause says that, the court must stop and defer to the arbitrator on that issue.)  Unfortunately for the homebuilder in this case, the elaborate arbitration clause missed that one checkpoint, which opened the door for the Court to attack the clause itself.

And attack it did.  With the adroitness of a prize fighter, the Court bobbed and weaved through various legal barriers that ordinarily may have ended its decision making process and made its way to the unconscionability holding.  The Court seized on the arbitration clause’s joinder provision that provided that the homebuilder at its sole option could join any subcontractors or other potentially liable parties in the arbitration.  The Court held that this seemingly minor procedural issue made the clause unconscionable and unenforceable because normally the plaintiff (home buyer) decides who to sue and this provision took that right away.  The Court believed it also could lead to inconsistent results in other forums and force the homeowner to litigate the same issues in court.

Of course, in the real world, there is almost always a chance of there being many forums.  The homeowner can always sue at fault subcontractors in court under other theories; that happens all the time.  The reasoning of the Court if taken to its extreme could undermine almost any arbitration clause since the home buyer does not have contracts with subcontractors and thus no arbitration clauses.

So how does a homebuilder avoid the trap created by the Court in Damico Perhaps a work-around could be if homebuilder includes in every subcontract an arbitration provision that allows a home buyer to demand arbitration against a subcontractor as well as joinder in an arbitration with the homebuilder.   Another way may be the well-known legal maxim of KISS (Keep It Simple Stupid.)  Drafters of arbitration clauses may want to keep the clause very vanilla—for example, beyond the basic language needed to ensure arbitration is applicable to a dispute, let the rules of a national arbitration association govern and do not insert any procedural hurdles that a court could in any way interpret to be unfair in some way to the consumer.  And of course, make sure that the arbitrator, not a court, will determine if a clause if unconscionable or not.

There are other lessons to be learned from Damico, and the homebuilders will certainly face a new round of attacks on their contracts as lawyers and courts start applying the opinion in not just the homebuilder industry, but consumer transactions in general.

This weekend was all about The Rise of Gru.  I love Gru so much that when my children ask for money, my best Gru-like voice belts back: “Now, I know there have been some rumors going around that the bank is no longer funding us….In terms of money, we have no money.”  And that’s precisely what many lenders say on distressed projects when the owner fails to make final payment and the contractor looks to the bank for funding: “We have no money for you contractor!”

In BCD Associates., LLC v. Crown Bank, CA No. N15c-11-062 (Super. Ct. Del, May 2, 2022), the trial court found that when a bank pays a contractor directly, it can create a legally binding relationship subject to the terms of the construction loan agreements with the owner.

The project involved a $13m construction loan between the lender and the owner to renovate a hotel.  The owner and contractor entered into an AIA Contract for the construction management services.  During construction the contractor would submit payment applications to the lender, who would review and approve the invoices for payment.  The lender then would pay 90% of the approved payment application and hold back the remaining 10% as retainage.  The contractor was supposed to be paid the final retainage upon completion, which it did not receive in accordance with the terms of the AIA Contract.

While the contractor asserted numerous claims against the lender—including breach of contract, unjust enrichment, promissory estoppel, and misrepresentation—ultimately the court found that the lender breached contractual obligations owed to the contractor.  Applying New Jersey law, the court held:

The controlling documents are the Loan Commitment and the Loan Agreement. The Court recognizes that [contractor] is not a named party in those agreements. Moreover, the Court acknowledges that the Loan Agreement specifically provides that there are no third-party beneficiaries to the Loan Agreement. But, contractually, factually and practically, [contractor] is the intended third-party beneficiary to the Loan Commitment and the Loan Agreement. Moreover, [owner] and [lender] treated [contractor] as a third-party beneficiary to the applicable agreements.

The court found it important that the lender chose to “cut out the middle man” by paying the contractor directly at all times.  Finally, the court also found sufficient basis to find in favor of the contractor on its unjust enrichment and promissory estoppel claims, but was not able to recover for misrepresentation.

Lessons learned. For contractors, the decision in BCD Associates is a good reminder to look beyond the owner for sources of funding.  Even if the lender on the project says there is no more funding, the bank may nonetheless be on the hook if it has made direct payments to the contractor during the project.  For owners and lenders, be aware that your actions may create third-party beneficiaries despite clear language in the loan documents to the contrary.

Excuse the eye patch, as I just had retina surgery yesterday.  I am surprised at how different the world looks with only one eye to focus—from the depth of the stairway, to the water flowing from the sink, to the words flying out from the computer screen.  In other words, there is more than meets the eye, a problem that many employers and employees face when a dispute arises.

In Mankin Media Systems, Inv. v. Timothy Crowder, No. 19CV-48300W (Jun. 30, 2022), the Court of Appeals of Tennessee reversed the confirmation of an arbitration award because the so-called arbitration clause appeared in the employee handbook and was not a stand-alone agreement.  Because the handbook did not constitute an enforceable employment contract, the appellate court concluded that the trial court erred in ordering the parties to arbitrate in the first instance and later in affirming the arbitrator’s award.

The employer in Mankin hired the employee as a salesperson, a position that gave the employee access to certain confidential and proprietary information. At the time of hire, the employee signed an acknowledgement of receipt of the employee handbook, which contained an arbitration clause.  The handbook expressly negated any contract of employment:

  • “. . . the Employee Handbook is not an employment contract, and nothing in this Employee Handbook gives an employee any right, express or implied, to continue employment.”
  • “[A]ll terms, conditions, policies, and procedures as stated in this document are subject to change, and nothing stated herein is guaranteed to remain a fixed term or condition of your employment.”
  • Nothing in this employee Handbook creates a binding employment contract between Company and its employees or provides a guaranty of continued employment for any amount of time.”

When the employee left, he allegedly downloaded from his computer and took certain confidential information. The employer filed suit against the former employee in state court, and the employee filed a motion to dismiss based upon the arbitration clause in the employee handbook.  The trial court denied the motion to dismiss, but stayed the lawsuit and ordered the parties to arbitrate.

Following an arbitration hearing, the arbitrator denied the employer’s request for damages and entered a final award in favor of the employee.  The employer filed a motion to vacate the award, arguing that the arbitrator exceeded its authority.  The trial court granted the employee’s motion to confirm the award.

The court of appeals reversed the trial court, holding that the employee handbook was not a valid and enforceable contract:

As set out above, the Handbook clearly states that it is not intended to be a contract, and further states that the provisions therein are subject to unilateral change without the employee’s consent. Therefore, under the foregoing authority, we conclude that the Handbook does not constitute a valid, enforceable contract between the parties.

Although the trial court ultimately concluded that the Handbook was not a valid employment contract, it nonetheless enforced the arbitration provision of the Handbook. This was error. In the absence of a valid contract requiring arbitration, there was no basis for the trial court to order the parties to arbitrate. Rather, the lawsuit was subject to adjudication by the trial court and should not have been decided by arbitration.

Lessons learned.  There are a couple of lessons from the Mankin decision.  First, there is always more than meets the eye.  In what would appear to be a clear and express indication by the parties to arbitrate their dispute, the writing may not be enforceable if not part of an enforceable contract.  Second, and you have seen these words before on this blog, words matter.  Parties to a construction contract need to make sure that there are no conflicting provisions and they pay special attention to the arbitration provisions if they intend to arbitrate disputes.  In this case, the employer seemed to want to arbitrate employment disputes by including such a provision in its employee handbook, but later wanted to litigate disputes.

Sometimes you “do” bad things.  Sometimes you “look like” you do bad things.  Just look at the difference between Bad-boy Jack and my youngest daughter, who just “looks like” she’s up to no good.  In the world of construction contracting, both can get in you in trouble, including a termination for default of performance.

nogood

Appeals of  Industrial Consultants, Inc. d/b/a W. Fortune & Company, ASBCA No. 59622 (2017) involved a construction contract to upgrade an HVAC system at a facility in New Hampshire. The Board held that the contractor was properly terminated for default where: (1) it repeatedly insisted on changing the design of the project; (2) it furnished the submittals consistently late and at times did not submit them; (3) it did not respond to certain communications regarding design changes and rejections; and (4) it never submitted a safety plan.

The Facts.  Following award of the contract to the successful bidder, immediate concerns arose regarding the design. The contractor’s president believed there was a defect in the design and he began to offer suggestions on redesign. The contractor submitted numerous RFI’s, to which the government responded. During the process, the contractor delayed in providing submittals and often times never provided submittals. The contracting officer sent a notice to the contractor demanding the contractor to cure its deficiencies.  Numerous communications are back and forth between the parties, all of which demonstrated that the contractor was accusatory and combative.  In the end, the contracting officer has sent three cure notices and ultimately issued a termination for default.

The Decision. The Board found that the contractor failed to proceed with the work in violation of FAR 52.233-1 (Disputes) (June 2008), which requires that the “contractor shall proceed diligently with performance of this contract, pending final resolution of any request for relief, claim, appeal, or action arising under the contract, and comply with any decision of the contracting officer.” As to the merits, the Board found:

The government bears the burden of demonstrating that [the contractor] did not perform in a timely manner and that it failed to gain approval of its submittals. Failure to proceed with the work during a dispute is a ground for termination for default. In this appeal, it is undisputed that [the contractor] failed to complete the work on time, failed to proceed with the work after the Corps rejected its proposed changes to the project, and failed to furnish some submittals and failed to gain approval of other submittals. The government has made a prima facie case for default termination; [the contractor]must, therefore, prove that its nonperformance was excusable.

The Board then found that the contractor’s default was not excusable—as it had a basic misunderstanding as to its role as a contractor on the project.

Lesson Learned.  Ultimately, the Board concluded that “government contractors must perform the contracts they execute and cannot require the government to rewrite the contract so that they can build some other project they like better.”  In this case, the contractor questioned the design of the HVAC system and notified the government of those concerns.  But in the end, the government  chose to proceed with the design. At that point, the contractor had one choice: continue to build the project as it had contracted to do.  It did not have the option to act bad by “dragging its feet” and refuse to perform, which ultimately led to the termination for default.

In life, rejection is often hard to swallow.  In construction, that rejection can sometimes amount to millions of dollars.  A Massachusetts court recently held that an owner’s rejection of the contractor’s payment applications was not properly certified and, thus, violated the state’s Prompt  Pay Act.

In Tocci Building Corp. v. IRIV Partners, LLC, (App. Ct. Mass. June 7, 2022), the court was asked to construe for the first time the provisions of Massachusetts’s Prompt Payment Act, which applies to certain private construction contracts in excess of $3,000,000. The Act requires that progress payments shall not exceed: 30 days for submission; 15 days after submission for approval or rejection; and 45 days after approval for payment.  Notably, if the owner does not provide an approval or rejection within 15 days of a proper payment application, then the payment application will “be deemed to be approved”.

What is a proper rejection under the Act?  The statute specifies that “[a] rejection of an application for a periodic progress payment, whether in whole or in part, shall be made in writing and shall include an explanation of the factual and contractual basis for the rejection and shall be certified as made in good faith.” A rejection notice under the statute can be subject to the parties’ dispute resolution clause, but any contract provision that causes delay to commencement of the dispute resolution period longer than 60 days is void and unenforceable.

In Tocci, disputes arose between the owner and contractor over seven interim payment applications that were, in whole or part, not paid by the date required in the parties’ contract. The owner alleged the contractor performed defective work and failed to perform warranty work when required.  The court reviewed each of the payment applications and determined whether the owner’s emails and other communications constituted valid “rejections” under the Act.  Ultimately, the court concluded that each disputed payment applications was “deemed approved” because the rejections: (1) came after the date payment was due; (2) did not contain a contractual or factual explanation; and/or (3) did not contain a certification that it was made in good faith.

Much of the court’s decision focused on whether the owner’s communications were properly certified within the meaning of the statute:

The Legislature required this certification if a rejection is to be effective, and we are not free to ignore that requirement by deeming it merely ministerial—to do so would be to read the requirement out of the statute. In any event, the certification requirement is an essential component of the scheme set up by the statute. As this case reflects, on a complicated construction project, there may be an enormous amount of communication back and forth between the owner and the contractor. Much of it may touch on issues involving compliance with the contract, and much of it may touch on payment. The certification requirement ensures not only that the owner be deliberate about rejecting applications for periodic progress payments, and that it takes care to reject them only in good faith, its presence on a communication also provides a clear indication to the contractor that an application has been rejected, so that the contractor can know both that some response is needed and that time periods have been triggered for invoking what remedies are available.

The court made clear that the owner’s claims of defective work and other breaches of contract were not waived by the failure to include these items in a proper rejection under the statute.

So what? If your project is subject to Massachusetts law, the decision in Tocci provides an excellent summary of the Prompt Pay Act.  However, the decision also provides a good lesson to parties involved payment disputes on a construction: follow the letter of the law  In other words, while you may have factual or contractual reasons supporting your position, the law may impose certain requirements to preserve and/or prevail on your claims. Make sure your contracts are up to date with the most recent laws of your state, and that you have checklists in place when disputes arise.

My commute home last night took longer than usual. It was not excessive traffic, an accident, or a stalled car.  Rather, the cause of my delayed commute was a turtle: one single turtle crossing the road, holding up about 30 cars for what seemed like an eternity. (Never mind the fact that no one got out of their car to help the little guy!)

When we think of delays on a construction project, the first inquiry is to identify the turtle—the one party holding up progress or causing the delay. Many times, the parties’ contract will dictate whether the contractor can recover delay damages or will be limited to a time extension for delays beyond the contractor’s reasonable control.

In Sarasota County, Fla. v. Southern Underground Industries, Inc., 333 So. 3d 285 (Fla. 2d DCA 2022), the court recently held that a “no damages for delay” clause did not preclude an award of damages to the contractor following the County’s suspension of work.  In that case, the County issued a stop work order to the contractor installing a sanitary pipe and water line when an adjacent homeowner complained that vibration from the drilling caused damage to his home. The contractor secured an engineer’s report that concluded the damage was cosmetic only and that the vibration did not exceed the acceptable threshhold.  The adjacent homeowner rejected the contractor’s offer to fix the damages. Ultimately, the County continued the suspension of work for an additional two months while attempting to address the adjacent homeowner’s concerns.

The contractor sought additional compensation for the two extra months of suspension. The County rejected the claim, arguing that the “no damages for delay” clause in the parties’ contract precluded the award of delay damages. The court found in favor of the contractor, relying on an exception to the general rule:

Although “no damages for delay” clauses are recognized in the law, they will not be enforced in the face of governmental “fraud, bad faith, or active interference” with performance under the contract. The record supports the trial court’s finding that the County impeded work on the project, at [the contractor’s] expense, long after it was determined that it was safe to proceed with minimal damage to the adjacent homes.

What is “active interference”? While not explicitly defined in the Sarasota County case, it requires the showing of an affirmative willful act of the owner that unreasonably interferes with the contractor’s work.  Here are a few more lessons when dealing with a delay on a project:

  1. As a contractor, you need to first review your contracts for a “no damages for delay” clause. If one is present, then you will want to negotiate an “active interference” clause that defines what constitutes an active interference.
  2. An “active interference” could mean that the owner knows about the delay and still proceeds; or it could mean that the owner conceals or actively interferes by affirmative conduct.
  3. During performance, you should document the impact of the owner’s actions, including whether the owner failed in coordinating other trade contractors for which it alone is responsible.
  4. Even if your contract does not have an “active interference” exception, there may be a common law remedy of bad faith or negligence on the owner’s part, which causes the delays.  That would depend on your particular state.

In the end, active interference to overcome a “no damages for delay” clause involves more than a turtle crossing the road. The dispute will be decided on the express contract language and the offending conduct giving rise to the additional damages and delays.

Last month, the Armed Services Board of Contract Appeals held that a public contractor could not recover $100k in construction costs incurred following the government’s decision to close down a base in Tennessee due to COVID-19.

APTIM Federal Services, LLC (ASBCA No. 62982) involved a contractor who sought to recover $99,076 in operational costs incurred on a construction contract during a two-month period in 2020.  The commander of Arnold Air Force Base closed the base in an effort to mitigate the spread of COVID-19.  The contractor also sought 59 days of time extension for the period the project was inaccessible.

The government argued that under the Sovereign Acts Doctrine actions taken by the United States in its sovereign capacity shielded it from contractual liability for those acts, including the actions taken in response to the COVID-19 pandemic.   The administrative law judge agreed:

Here, [the contractor] was excluded from Arnold Air Force Base equally along with many other contractors by act of the base commander, in pursuit of a larger public health danger, which itself threatened a national security impact. This exclusion made performance of each party’s contractual obligations impossible during the time period at issue.

The judge found similarities between the COVID-19 shutdown and the decision in Conner Bros. Constr. Co., Inc. v. Geren, 550 F.3d 1368 (Fed. Cir. 2008), wherein a government contractor sought compensation for being barred from a military base for 41 days following the 9/11 terrorist attacks. In that case, the court held that the government’s actions were not directed at nullifying the contractor’s contract rights, but rather were directed “at larger national security interests” which was permissible.

The APTIM decision expressly addresses the Sovereign Acts defense, which ultimately denied the contractor’s claim for additional compensation.  However, the case does establish implicitly that a work stoppage due to COVID-19 can support the basis for a time extension.

Last month, a construction worker died as a storm swept through a construction site in Lebanon, Indiana. The preliminary investigation determined that the contractor was on an elevated platform while working on an industrial warehouse that was under construction. The man and other workers were in the process of stopping due to approaching thunderstorms. While the platform was being lowered, strong winds knocked it over, leading to the man’s death.

Whether you are a developer, contractor or subcontractor/supplier, you undoubtedly understand that severe weather can add cost and time to project completion.  Indeed, that’s why force majeure clauses are generally included in parties’ contract.  While there are legal implications related to pursuing a claim for additional time or money, there are also practical considerations for both job site and the workers when a severe weather event occurs.

The following list was prepared by Jake Guimond at Assurance, and it gives nine steps to create a severe weather plan to protect your construction site and employees:

  1. Do this BEFORE a storm occurs; don’t wait until a storm is imminent, or worse, surprises you.
  2. Evaluate site-specific risks.
  3. Include emergency response, securing the jobsite, clean-up and trained personnel to assist with mitigating the damage.
  4. Make sure the plan covers all types of severe weather you may encounter in your area (e.g. strong winds, tornadoes, heavy rain, lightning, storms, etc.).
  5. Make sure all employees know and understand your jobsite severe weather plan.
  6. Have a process to notify all jobsite workers of impending severe weather or jobsite evacuation.
  7. Assign a jobsite foreman to perform a worker headcount during storm refuge and post-storm.
  8. Conduct post-storm job site evaluations.
  9. Identify and clearly mark locations for severe weather refuge.

In short, a risk management plan requires that you do it, you put it in writing, you train your leaders about it, and your practice it.

I have seven children. and two of them have flown the coop.  I also have two grandchildren who are ripe for spoiling. You see, grandchildren are a different type of kid, which means I get to treat them different than the kiddos living under my roof.  In construction, however, some courts have held that the type of contract delivery method do not change the treatment of the other contract clauses, such as the applicability of a differing site conditions clause.

Appeal of John C. Grimberg Co., Inc., ASBCA No. 58791 (Oct. 25, 2018) involved the construction of a biolab facility at Fort Detrick, Maryland. The contract was a design-build contract.  As is typical of a design-build contract, no unit prices for rock excavation were set for because the contractor’s foundation solution is not established at the time of award. Interestingly, this contractor had performed other contracts at Fort Detrick involving deep foundations that happened to be design-bid-build contracts containing unit prices for excavation.

During construction, the presence of incompetent rock forced the contractor to use more drilling rigs than anticipated.  This crowded the site and prevented scheduled commencement of grade beams and rough-in of underslab MEP work. By the time the contractor completed drilling piers, it had excavated nearly four times the amount it had anticipated in its proposal.  The contractor submitted a Request for Equitable Adjustment, alleging that it had encountered a Type I differing site condition—i.e, where the site differed materially from those represented by the government. The contracting officer denied the claim, and the contractor appealed.

To establish such a claim, a contractor must prove: (1) the conditions indicated in the contract differed materially from those actually encountered during performance; (2) the actual conditions were reasonably unforeseeable to the contractor at the time of bidding; (3) contractor reliance; and (4) damages.  In this case, the board rejected the government’s argument that the differing site conditions clause is applied more restrictively to a design-build contractor than in the design-bid-build context. The board reasoned:

The identical DSC clause is required to be included in fixed-price construction projects, whether the design-bid-build or design-build method of contracting is utilized. There is no justification for interpreting the clause differently in the design-build context. As appellant concedes, design risk is transferred to contractors in the design-bid context, but not the risk of DSCs. A design-builder does not forfeit its rights under the DSC clause to rely on solicitation representations of subsurface site conditions.

The board concluded the contractor had established Type I differing site conditions claim that the “quantities of rock encountered greatly exceeded the quantity reasonably foreseeable based on a fair reading of contractual indications, albeit the Project was constructed in highly-variable karst topography at the site.”

Ultimately the decision is a good lesson for contractors to document “all of the facts, circumstances and contractual indications of subsurface conditions,” which is what the board relied upon in making its decision.  Another lesson learned is the importance of “reasonableness” when drafting or submitting claims.  Although the board found that two of the borings used by the contractor were unreasonable, it was “more reasonable” than the government’s analysis.  In the end, reasonableness matters.

If you have Googled, “Virginia Pay If Paid” or “Virginia Pay When Paid” or “Pay if Paid Enforceable” or “best construction lawyer ever“, then you likely have found your way here (that last one is mere puffery). Let’s cut to the chase—Virginia has joined 11 other states that have expressly prohibited “pay if paid” clauses in construction contracts.  If you have construction projects in Virginia, then read on.  If you want know whether your state prohibits these clauses, then read on.  If you want to know the difference between the words “if” and “when”, then read on.

What’s the difference?  There are a lot of resources out there explaining the difference between the two types of construction contract provisions, but I like to make it a little simpler:

  • pay when paid is simply a function of the timing of payment (i.e., when you are going to get paid…”Contractor shall pay Subcontractor within 15 days after receipt of payment from the Owner.”);
  • pay if paid is a function of whether you get paid (i.e., shifting the risk of nonpayment … “Payment from the Owner to the Contractor is a condition precedent to payment from the Contractor to the Subcontractor.”)

Generally, most states that have addressed the issue allow “pay if paid” clauses so long as there is clear and unambiguous language shifting the risk of non-payment to the subcontractor. Many require more than just “pay-if-paid” language in the parties’ contract.  For instance, you may be required to include the magic words “condition precedent” or “risk of nonpayment” as outlined below.  In these tight times, you can understand how important payment provisions are to the parties’ transaction, particularly where costs are escalating and projects may stall mid-performance due to financing issues or owner-default.

Does my state prohibit pay-if-paid clauses? Again, there are a lot of resources out there providing summaries on the current status of the law.  One of the best I have found was created by Levelset, which has a 50-State-Guide on pay-if-paid clauses.  According to Levelset, the following states have prohibited pay-if-paid clauses:

  • California
  • Kansas
  • Illinois
  • Indiana
  • Nevada
  • Montana
  • North Carolina
  • New York
  • South Carolina
  • Utah
  • Wisconsin

You can now add Virginia to that list!   On April 27, 2022, Virginia Governor Youngkin signed into law SB550, which expressly prohibits “pay-if-paid” clauses in construction contracts.  The law goes into effect January 1, 2023.

What does the Virginia law say?  The new law will require prime contractors to pay subcontractors within 60 days from receiving an invoice, or seven days after receiving payment from the owner, whichever is earlier. Interest penalties apply for late payment. The law is codified as party of Virginia’s Prompt Pay Act (Va. Code 2.2-435) and Virginia’s wage theft statute (Va. Code 11-4.6).  The law has more application than simply prohibiting “pay-if-paid” clauses—it addresses numerous other items best summarized by Virginia’s LIS bill-tracking site:

  • the law applies to both public contracts and private contracts where there is at least one general contractor and one subcontractor;
  • The law requires a payment clause that obligates the contractors to be liable for the entire amount owed to any subcontractor with which it contracts;
  • the law provides that a contractor shall not be liable for amounts otherwise reducible due to the subcontractor’s noncompliance with the terms of the contract;
  • however, the contractor must notify the subcontractor in writing of the contractor’s intent to withhold all or a part of the subcontractor’s payment with the reason for such nonpayment;
  • the law states that payment by the party contracting with the contractor shall not be a condition precedent to payment to any lower-tier subcontractor (i.e., this is the “pay if paid” prohibition); and
  • in the owner-contractor agreement, there must be a payment clause that requires (i) the owner to pay the general contractor within 60 days of receipt of an invoice following satisfactory completion of the work, and (ii) a higher-tier contractor to pay a lower-tier subcontractor within the earlier of 60 days of satisfactory completion of the work for which the subcontractor has invoiced or seven days after receipt of amounts paid by the owner to the general contractor for work performed

So what?  Some states have attempted, but failed, to enact similar protections, which happened in Tennessee a few years ago.  In other states, the prohibition has been decided by the courts, such as the California Supreme Court’s decision in Wm. R. Clarke Corp. v. Safeco Ins. Co. (1997), which held that “pay if paid” clauses are unenforceable because it essentially forces a subcontractor to waive or forfeit his constitutionally protected mechanics lien rights if the owner fails to pay the general contractor.

One major lesson: WORDS MATTER.  It is important to understanding lien rights on a project, payment protections, and ultimately the risk of non-payment.  Review your contracts and understand your state’s law.