Pay-If-Paid Provisions In Utah Article

As a result of today’s economic climate, owner insolvency and inability to pay is much more common than once was the case.  If an owner can’t pay, and there is insufficient equity in the project to pay for work and materials supplied to the job, who ends up holding the bag? Historically, the general contractor was on the hook because it had the contract with the owner, and separate contracts with its subcontractors that effectively required subcontractor payment regardless of the owner’s inability to pay.  Today, however, many subcontracts contain “pay-if-paid” provisions intended to shift the risk of owner non-payment from the general contractor to its subcontractors.

In most states, including Utah, pay-if-paid provisions should be enforceable if properly drafted.   It therefore is important for Utah subcontractors who agree to pay-if-paid provisions to satisfy themselves of the creditworthiness of the project owner, and for Utah general contractors to ensure that the pay-if-paid provisions in their subcontracts are drafted in an enforceable manner. [1] Contingent payment clauses have become much more common in construction contracts during the past three decades.  See Richard A. Lord, Williston on Contracts 19:58, at 491-92 (4th ed. 2004).  These provisions effectively transfer the risk of owner non-payment from general contractor to subcontractor by providing that the subcontractor is only entitled to be paid when or if the owner pays the general contractor. State legislatures in Delaware, North Carolina, South Carolina, and Wisconsin have invalidated pay-if-paid provisions by statute.  Del. Code Ann. Tit. 6, § 3507(e); N.C. Gen. Stat. § 22C-2; S.C. Code Ann. § 29-6-230; Wis. Stat. § 779.135(3).  Courts in California and New York have invalidated such provisions on “public policy” grounds, and Nevada evaluates their enforceability on a case-by-case basis, holding them invalid under some circumstances.  Wm. R. Clarke Corp. v. Safeco Ins. Co., 938 P.2d 372 (Cal. 1997); West-Fair Elec. Contractors v. Aetna Cas. & Sur. Co., 661 N.E.2d 967 (N.Y. 1995); Lehrer McGovern Bovis, Inc. v. Bullock Insulation, Inc., 197 P.3d 1032 (Nev. 2008).  Courts in other states, however, have upheld the enforceability of contingent payment provisions, so long as they are properly drafted. There are no reported Utah State Court decisions addressing contingent payment provisions. The federal appellate court which covers Utah, however, has noted that “the general weight and trend of authority holds that enforceable ‘pay-if-paid’ clauses may be created in contracts for private-sector construction projects by using language clearly indicating the intent to create a condition precedent.” MidAmerica Constr. Mgmt., Inc. v. MasTec N. Am., Inc., 436 F.3d 1257, 1266 (10th Cir. 2006).

In fact, courts in thirty-seven states and the District of Columbia have said or implied that pay-if-paid provisions are enforceable if the intent to transfer the risk of non-payment to the subcontractor is explicit and unambiguous.  Donald W. Gregory, Contingent Payment Clauses in the 50 States (2009)  In addition, the Tenth Circuit has followed a case enforcing a pay-if-paid clause when interpreting Utah law.  See Zions First National Bank v. Christiansen Brothers, Inc. 66 F.3d 1560, 1565 n.4 (following Ritz-Craft Corp. v. Stanford Mgmt. Group, 800 F. Supp. 1312 (D. Md. 1992)). Given this case law, and the lack of any Utah statute invalidating pay-if-paid provisions, it is likely that a Utah court would enforce such a provision.  For this reason, it is important that Utah subcontractors carefully evaluate the creditworthiness of an owner before signing a subcontract containing a pay-if-paid provision.  Subcontractors subject to pay-if-paid provisions should assume they will not be entitled to payment unless the owner pays the general contractor, and should make the decision whether to undertake work on a project accordingly.  In making this decision, it is important for subcontractors to consider project funding, the owner’s ability to pay, likely equity in the project in the event of a lien foreclosure, and the terms of any payment bond or other alternative sources for payment in the event of owner insolvency. General contractors, on the other hand, should be certain that the pay-if paid provision in their subcontracts is properly drafted.

When enforced, pay-if-paid provisions can result in non-payment to an otherwise deserving subcontractor.  As a result, courts limit the application of these provisions.  They do this by beginning with the presumption that such provisions grant the general contractor a reasonable period of time to obtain payment from the owner, rather than an absolute defense in case of owner insolvency.  To overcome this presumption, the pay-if-paid provision must expressly and carefully condition the general contractor’s obligation to pay its subcontractors on owner payment.  MidAmerica Constr. Mgmt, 436 F.3d at 1262.  As a result, it is critical for general contractors to ensure that their pay-if-paid provisions are properly drafted and enforceable.  Otherwise, the general contractor may not have the defense to owner non-payment it believed was included in its subcontract.