"Pay-when-Paid" provision struck down by Appellate Court

The District Court in Nassau County was faced with a claim by a contractor that sought to enforce a mechanic's lien and recover for alleged non-payment under a construction contract.   The contract at issue contained the following provision:

The obligation of Contractor to make any payment under this Agreement, whether a progress or final payment, or for extras or change orders, is subject to the express condition precedent of payment therefor by Owner and Owner's lender. Owner's and Owner's lender's determination of the percentage complete of Subcontractor's Work shall be final and binding and Subcontractor agrees that in no event shall Subcontractor receive payment from Contractor for a greater proportionate value of the Work than what is approved by Owner and Owner's lender.

The Appellate Term held that the provision was a "pay-when-paid" clause and thus, under long settled New York law, was void and unenforceable.  Unfortunately for this contractor-plaintiff the contract also contained a severability clause and six month limitations period.  Therefore, while the pay-when-paid portion was struck down, it did not void the entire agreement by virtue of the severability clause and the Court refused to strike down the six month limitations period.  Because the plaintiff failed to file its claim within six months, the claims were time barred and dismissed.  

The case was Polar Bear Mechanical, Inc. v. Walison Corp.

Limits on Retainage

Retainage on a contract is often a subject of bitter dispute between parties to a construction contract.  The partying that is receiving payment always wants the retainage to be minimal or eliminated all together.  The party that is paying always wants more retainage to protect it against potential deficiencies or problems.  Under New York law, retainage is permitted but the owner may only withhold a "reasonable amount".  The contractor may then withhold a reasonable amount from subcontractors and so on down the contract chain. However, nobody can withhold more than the owner is withholding from the general contract.  For example, if the owner is withholding 10% from the general contractor then the general contractor may not withhold more than 10% from its subcontractor and the subcontractor may not withhold more than 10% from its sub-subcontractor, etc. 

The owner must release the retainage no later than 30 days after final approval of the work under a construction contract (as defined in GBL Article 35E).  The general contractor must in turn release the retainage to the subcontractor and the release must likewise flow down the contract chain.  If the retainage is not released on time, then by statute it will accrue interest at a rate of 1% per month until released.

Vincent T. Pallaci is a partner at the law firm of Kushnick Pallaci, PLLC where his practice focuses primarily on construction law, including the review of retainage and payment terms in construction contracts. He can be reached at (631) 752-7100 or vtp@kushnicklaw.com

Court gives lesson to subcontractors: when your contract incorporates the terms of the prime contract READ IT

In CNP Mech. Inc. v. Allied Bldrs. Inc. the Appellate Division reduced a trial verdict that had been rendered in favor of a subcontractor and against a prime contractor.  While the trial judge awarded the subcontractor the full value of the change orders it submitted, the Appellate Division reduced the amounts of the award.  The reason behind the reduction was that the subcontract stated that it incorporated the terms of the prime contract between the owner and the prime contractor.  The prime contract contained a clause stating that the owner only had to pay for change orders in the amount approved by the owner.  Since the owner did not approve the full amount of the change orders related to the subcontractor's work, the general contractor was not required to pay the full value to the subcontractor.  Rather, the Appellate Division held, the general contractor only had to pay the subcontractor the value that was approved by the owner. 

Another interesting aspect of this case is that while the trial court awarded interest from the time the task was performed, the Appellate Division pointed out that the subcontract contained a valid "pay when paid" clause and, therefore, determined that the interest ran not from the time of performance but, pursuant to the contract, 15 days from the time that the general/prime contractor received payment from the owner. 

It is important to note the difference between a "pay if paid" contract, which is void in New York, and a "pay when paid contract", which is enforceable in New York.  Essentially the "pay if paid" provision shifts the risk of non-payment to the subcontractor.  If the general contractor is not paid, the general contractor is allowed to not pay the subcontractor.  A "pay when paid" provision on the other hand has been determined to be simply a timing mechanism for payment.  So, as in this case, it simply sets the time when payment becomes due.  Here, payment was due within 15 days of receipt of payment from the owner.

Vincent T. Pallaci is a partner at the New York law firm of Kushnick Pallaci, PLLC where his practice focuses primarily on construction law.  He can be reached at (631) 752-7100 or vtp@kushnicklaw.com

Contractor terminated for not paying subcontractors

In American Curtain Wall v. NTD Construction Corp. a contractor sued for breach of contract.  The defendant filed a motion to dismiss and argued that the contract was validly terminated because the contractor failed to pay its subcontractors and even after being given the opportunity to cure the breach by paying the subcontractor the contractor refused.  The appellate division agreed that the failure to pay the subcontractor was a breach justifying termination of the contract and therefore dismissed the claim for breach of contract. 

The lesson to be learned for subcontractors and lower tier subcontractors is that even if you are not paid you are required to pay everyone below you and do it on time.  If you do not, you are likely breaching your own contract.

Vincent T. Pallaci is a partner at the New York construction law firm of Kushnick Pallaci, PLLC where his practice focuses primarily on construction law.  He can be reached at (631) 752-7100 or vtp@kushnicklaw.com

Appellate Division Reaffirms that "pay-when-paid" is void

In JC Ryan EBCO/H & G, LLC v. Lipsky Enterprises, Inc., the Appellate Division, Second Department, reaffirmed the now well established princple that a "pay-when-paid" clause in New York, which forces the subcontractor to  assume the risk that the owner will fail to pay the general contractors is "void and unenforceable as contrary to public policy" as set forth in Lien Law Secdtion 34. 

For those of you that are unfamiliar with the pay-when-paid concept, the clause usually states something along the lines of "payment to subcontractor shall not be due until general contractor receives payment from the owner and subcontractor understands that payment to the general contractor is a condition precedent to payment to the subcontractor."  There are many variations of the clause but they all generally follow those ideas. 

Note that some courts in New York have differentiated between pay-if-paid clauses and pay-when-paid clauses.  The recent cases have held that a true pay-when-paid clause is enforceable if it is merely a timing mechanism for payment and does not pass the risk of non-payment on to the subcontractor. 

Vincent T. Pallaci is a partner at the New York law firm of Kushnick Pallaci, PLLC where his practice focuses primarily on the area of construction law.  He can be reached at (631) 752-7100 or vtp@kushnicklaw.com

"Pay if Paid Clause" in New York

In New York, unlike many other states, “pay if paid” clauses are void and unenforceable. West-Fair Elec. Contractors v. Aetna Cas. & Sur. Co., 87 N.Y.2d 148, 638 N.Y.S.2d 394 (1995). In Otis Elevator Co. v. Hunt Const. Group, 52 A.d.3d 1315, 859 N.Y.S.2d 850 (4th Dept. 2008) the plaintiff, Otis, sued for payment due from Hunt Construction Group. Hunt argued that payment from the owner was a condition precedent to the requirement to pay Otis. The Appellate Division held that the pay if paid clause in the contract was merely a timing mechanism and did not shift the risk of the owner’s non-payment to the plaintiff. The Court therefore ruled that Otis was entitled to payment despite the owner’s non-payment to Hunt. An identical result was reached in North Cent. Mechanical, Inc. v. Hunt Const. Group, Inc., 43 A.D.3d 1396, 843 N.Y.S.2d 894 (4th Dept. 2007).

 
Exactly what a pay-if-paid clause is may not be entirely clear. A contract provision stating that payment will occur upon a stipulated event is deemed to be a time for payment provision absent an express provision to the contrary. West-Fair. A true pay if paid clause specifically will state that payment to the general contractor by the owner is an express condition precedent to the general contractor’s obligation to pay the subcontractor. A pay if paid provision thus forces the subcontractor to assume the risk of non-payment from the owner and, as such, has been deemed to be void and unenforceable pursuant to Lien Law §34. On the other hand, a true pay when paid provision is simply a timing mechanism and does not pass the risk of non-payment on to the subcontractor. Pay when paid provisions are therefore routinely held to be valid. Part of the reasoning behind the prohibition against pay if paid clauses is that the subcontractor in effect has waived its right to ever enforce a mechanic’s lien. A necessary element of enforcing a mechanic’s lien is a showing by the subcontractor that there is presently an amount due and owing to it from the general contractor. However, a pay if paid clause means that payment would never become due to the subcontractor.

 
Notably, New York will enforce pay if paid clauses if the contract calls for the application of the law of a state that does allow pay if paid clauses. However, the Prompt Pay Act of 2003 (G.B.L. §757) specifically voids any contractual provision that calls for the law of another state to apply to a New York construction project. The Prompt Pay Act went into effect on January 14, 2003 so any contract entered into before that date may still provide a valid and enforceable pay if paid clause. However, there are likely very few construction contracts in effect today that were entered into prior to January 12, 2003.

Vincent T. Pallaci is a New York construction lawyer.  His practice includes review of construction project payment provisions.  He can be reached at vtp@nyconstructionlaw.com