Contractor’s Conduct Negates Pay-If-Paid Clause

Michael C. Loulakis, Esquire, Wickwire Gavin, P.C.
(Originally printed in Legal Trends)

Under “pay-if-paid” clauses a subcontractor is not entitled to payment if the owner fails to pay the general contractor, regardless of whether the subcontractor was at fault. General contractors use these clauses to assign to their subcontractors the risk of owner nonpayment.

The inclusion of pay-if-paid clauses in subcontracts remains controversial in the construction industry. Several states have laws declaring such clauses void and unenforceable as a matter of public policy. Also, some courts have scant regard for pay-if-paid clauses and have adopted exceptions to their enforceability. The case Moores Bros. v. Brown & Root, Inc., offers an example in which the court held that the general contractor waived its right to assert a pay-if-paid clause as a defense against its subcontractors’ claims for payment for extra work.

In 1993 Brown & Root, Inc. was awarded a prime contract for the construction of the Dulles Toll Road Extension, a privately owned roadway from Washington Dulles International Airport to Leesburg, Virginia. Brown & Root had an investment interest in the extension. In its subcontracts, Brown & Root included pay-if-paid clauses that expressly made payment by the owner a condition precedent to its obligation to pay its subcontractors.

In negotiations covering the prime contract, Brown & Root and the new owner discussed possible design changes to the thickness of the pavement’s sub-base and drafted language indicating that such changes during construction would entitle Brown & Root to additional compensation. However, the project’s lenders objected to the proposal because they were reluctant to provide additional financing for work beyond the base contract. As a result, Brown & Root and the owner omitted from the prime contract language pertaining to the pavement design changes and assured the lenders that no substantial changes to the original work were anticipated.

Although references to the pavement design change were deleted from the prime contract, Brown & Root entered into a separate agreement with the owner that entitled it to additional compensation for possible changes during construction. However, this separate agreement was concealed from the project’s lenders. Also, Brown & Root failed to disclose to its subcontractors that the lenders had no knowledge of the separate agreement and that the project might not have adequate funding for additional work.

During construction, Brown & Root ordered its subcontractors to perform extra work because of the need for a thicker sub-base for the pavement. After completing the work, Brown & Root requested arbitration, claiming that the owner should pay for the extra work. Although found liable to Brown & Root, the owner was unable to pay the prime contractor because the project did not have adequate funding to cover the additional work.

In lawsuits filed by the subcontractors against Brown & Root, the company cited the subcontracts’ pay-if-paid clauses as a defense. Brown & Root argued that payment by the owner was a condition precedent to the subcontractors’ entitlement to payment from Brown & Root. Because the owner had not paid Brown & Root for the extra work, the prime contractor contended that it had no obligation to pay its subcontractors. The trial court, however, ruled in favor of the subcontractors. Brown & Root appealed.

In affirming the trial court’s decision, the appellate court noted that the subcontracts contained valid pay-if-paid clauses that made payment by the owner a condition precedent to Brown & Root’s obligation to pay its subcontractors. However, it held that Brown & Root waived its right to use the clauses as a defense because its actions materially contributed to the owner’s nonpayment for the extra work. In particular, Brown & Root knew that pavement design changes were likely, yet it assured the project’s lenders that no additional work would be necessary. By misleading the project’s lenders, Brown & Root hindered the fulfillment of the condition precedent to owner payment. As such, the pay-if-paid clauses were not valid defenses to the subcontractors’ claims for payment for extra work.