How to Know What You’re Signing and if it’s Best for You
If you’re in the construction business, there are two terms that you definitely need to know. The first is “Pay-if-Paid.” The second is “Pay-when-Paid.” At first glance, they look almost identical.
The only difference is that “if” is in the middle of one phrase and “when” is in the middle of another phrase. But those if/when word-games could translate into thousands of dollars either earned or lost in the real world. (Especially if you’re a subcontractor.)
So for tips on how to receive payment on time and stay in the construction biz, read on
1. The Parties
In almost every construction project, there are usually three players. These are the owner, the contractor, and the subcontractor. (When hotels or casinos go up, there are almost too many parties involved to name. So for this blog post, we’re focusing on simple renovations.)
The “contractor” gets his name because he draws up a contract for the owner to sign in return for payment. This agreement specifies what the contractor will do to the owner’s property. (Replacing baseboards, installing cabinets, laying hardwood, caulking the bathtub, and so on.) If the contract looks up to snuff, the owner signs it.
Usually, no single person can finish a whole project by himself in a limited timetable. So the contractor then contracts out to subcontractors. These are the painters and tile guys and cabinetmakers who swirl in and out of the owner’s house for weeks or months, getting it all done.
If you think about it, this situation sets up a tidy little hierarchy. The owner pays the contractor. The contractor pays the subcontractors. Money is moving downhill. Now let’s imagine you’re the guy putting in the kitchen cabinets. For the rest of this post, we’ll call you “Mr. Cabinet Subcontractor.”
You, Mr. Cabinet Subcontractor, have been going over to the owner’s house every day for weeks. You have measured the walls, sawed out the planks, and fit the boards into custom cabinets. You’re a craftsman. You’ve done your work.
And now you expect payment for that work. But here is exactly where the difference between “pay-if-paid” and “pay-when-paid” gets important. Because, depending on the language in your contract, you may not get paid at all. Let’s go over each term in turn.
See, the contractor signed an agreement with the owner to get this project done. But the contractor also signed an agreement with you to get just one part of that project done. And the agreement you signed either had a “pay-if-paid” or a “pay-when-paid” clause in it.
Imagine that you signed a “pay-if-paid” agreement. You have now agreed that the contractor only has to pay you if the owner pays the contractor. Yep, you read that right.
To take on a fancier turn of phrase, the contractor is “under no legal obligation” to pay you. In other words, if the owner can’t, or has decided not to, pay the contractor, you don’t get paid, period. And that can be disastrous to your family, your mortgage, or your business.
Certain courts view the pay-if-paid clause of a contract as a “condition precedent.” That means that the owner paying the contractor is a condition of the contractor paying you. If one doesn’t happen, neither does the other. The pay-if-paid clause is also known as a “payment clause.”
The subcontractor’s payment depends on the contractor fulfilling his agreement with the owner. The owner may not have to pay the contractor if he reneged on any one part of that agreement. And that stings for the subcontractor. Let’s say his contribution to the reno was masterful.
No matter. The contractor never waterproofed the basement, which he and the owner had agreed on. So the owner doesn’t have to pay the contractor, and the subcontractor is left holding the bag.
Okay, what about the second option, “pay-when-paid”? You probably already guessed it: If you signed a pay-when-paid clause with your contractor, he has to pay you after the owner pays him. True, in both scenarios, the owner might run out of money and not be able to pay the contractor. (In which case everyone is left holding that proverbial bag.)
If the owner doesn’t pay the contractor for a year, the contractor still doesn’t have to pay you. (Which makes sense. He still hasn’t got his share of the funds.) But the sting here shouldn’t be as bad as it is in a pay-if-paid clause. That’s because courts have referred to this legal clause as a “timing mechanism.”
Payment due to you will depend on when the contractor gets the money from the owner. The operative word here is when, not if. You’ll get paid. It just might take a while. But the moment the owner pays the contractor, the clock starts ticking for the contractor to fork over some of the cash to you, Mr. Cabinet Subcontractor.
Keep in mind that the subcontract you signed might not specify a timeline of payment terms. (Here’s an example of that: “The contractor must pay the subcontractor within two weeks of the contractor receiving payment from the owner.”)
If that’s the case, fear not. Most courts have found that the contractor still has to pay you “within a reasonable amount of time.” In other words, the guy can’t promise to Venmo you the money for 25 years and never come through on his end of the bargain.
4. If Not Now, When?
At this point, you might be thinking that contractors love swindling subcontractors and owners can’t wait to halt construction projects because of nonpayment issues. Quite the opposite. Everyone makes money, strengthens connections, and watches their property values go up if a project gets done and all parties go away happy.
But when the market crashes or someone’s finances go south, pressure often shifts down the ladder onto the contractor or Mr. Cabinet Subcontractor. So, then, which is better – pay-if-paid or pay-when-paid? Well, there’s not necessarily one right answer.
From the perspective of the contractor or subcontractor, sometimes it’s best to accept any job to get your business off the ground or network within the construction and real estate worlds. Then again, you don’t have to be a law professor to figure out that when you get paid sounds a whole lot better than if you get paid.
The implication of the pay-when-paid clause is that the subcontractor is owed his fair share of payment for a project completed. For that reason, many courts allow a subcontractor to sue a contractor for payment if enough time has passed and the contractor still hasn’t paid the subcontractor. Remember, that safeguard does not exist in pay-if-paid clauses.
5. Last Thoughts
In the end, it’s imperative that you comb through any contract that you sign. As Seth Smiley writes, “contract issues” are one of the biggest reasons that contractors and subcontractors don’t get paid in Louisiana. (And that likely applies to the rest of the nation.) Avoiding litigation is best for owners, contractors, and subcontractors alike. So here are some steps that all parties should take to make sure no one gets sued:
- Owner and contractor should go through the standard steps of hammering out an agreement. For instance, the contractor passes a reference or background check. The owner demonstrates that he has enough funds to finance the project. And both parties agree to a set construction timeline and payment plan.
- If you’re a sub-contractor, look out for you. You need to know when you’re getting paid – and that you’re getting paid at all. Avoid signing pay-if-paid clauses. Be wary of pay-when-paid clauses. If you can’t avoid these clauses, always choose the one in which you’re guaranteed payment within a reasonable timeframe.
- If you’re a contractor, take pains that the agreement you give your sub-contractors is written in clear language. Whether they’re signing a pay-if-paid or a pay-when-paid agreement, they should understand the pros and cons of these clauses so that there’s no confusion in the future.If you’re an owner, make sure that your agreement imposes a reasonable time-limit on the construction. (Contractors can get overwhelmed with different projects. That’s possibly the easiest way to drag construction on, which can cause non-payment issues for everyone.) Also, putting all your finances in order will ensure that the project gets paid in time and no one files a mechanic’s lien on you. (Which is a nightmare that may result in preventing your property’s sale, freezing your funds, or securing your debt in any construction projects.)