Often subcontracts utilize language that states the prime contractor will pay the subcontractor for the portion of the subcontractor’s work within a certain number of days after the prime receives payment from the government. This type of clause is known as a pay-when-paid or pay-if-paid clause. Although contracting parties tend to use these terms interchangeably, courts distinguish between delayed payment (pay-when-paid) and the possibility of no payment (pay-if-paid). Generally, the rationale is that a pay-when-paid clause deals with the manner of payment, and a pay-if-paid clause is a condition precedent to payment.
Some jurisdictions void or limit contingent payment provisions like these, particularly pay-if-paid clauses. Texas courts recognize both, albeit with a requirement that a pay-if-paid clause be crystal clear in conveying the parties' intent. The seminal case on the enforceability of pay-when-paid versus pay-if-paid is Gulf Const. Co., Inc. v. Self, 676 S.W.2d 624 (Tex. App.--Corpus Christi 1984). There, the owner had filed for bankruptcy and could not pay the prime. The prime in turn did not pay its subcontractors, who then sued the prime for breach of contract. The prime contractor relied on the following (truncated) provision in the subcontract: “When the owner pays the general contractor, the general contractor shall be liable for and obligated to pay the sub-contractor. Under no circumstances shall the general contractor be obligated or required to advance or make payments to the sub-contractor until the funds have been advanced or paid by the owner.” Based on this clause, the prime claimed that payment from the owner was a condition precedent to its obligation to pay the subcontractors.
The court did not agree. It held the clause was a pay-when-paid provision and therefore a covenant to pay once funds were received - not complete absolution from payment. Specifically, the court determined that the prime contractor’s obligation to pay the subcontractor was not an “if” but an “until” it received payment from the owner. Effectively, the court determined the clause was a payment timing provision outlining when the payment should be made, not a payment contingency provision on whether the payment should be made. The basis of its reasoning rested on its finding that the risk of non-payment lies with the prime since the prime possesses privity of contract with the owner. And, any shifting of that risk to the subcontractor, a true pay-if-paid clause, while acceptable, must nevertheless be clear, unequivocal, and express. The language in this particular agreement was insufficient to create a pay-if-paid clause.
The payment provision in Gulf Const. Co. is similar to what is used in many subcontract agreements between partners working under a government contract. Obviously the parties in that case, like in many instances, had differing opinions on whether the clause created a “when” or a “whether” payment obligation. The lesson here for primes and subs, then, is to arrive at an unmistakable meeting of the minds as to which party will bear the risk of non-payment by the owner. If the risk is to shift to the subcontractor, the prime should ensure that the language in the subcontract specifically identifies the agreement between the parties on the risk of non-payment and that receipt of funds is a strict condition precedent to any obligation to pay the subcontractor.