The pandemic has created extraordinary challenges for Pacific Northwest businesses, and the construction industry is no exception. With project closures, the addition of rigorous safety requirements and supply chain disruptions, construction projects may be facing more uncertainty in the near future.
In particular, the costs associated with reduced workforce availability, scheduling limitations, and changes in material pricing and accessibility are forcing owners to put projects on hold, or worse, terminate them. Owners of projects who are able to move forward are having to seek out increased funding to offset the unexpected costs driven by a paralyzed national economy.
Subcontractors and suppliers are particularly at risk: without direct contracts with owners, those further down the supply chain are most impacted by reduced or delayed payments.
Subcontractors and suppliers are in a vulnerable position because they must wait the longest to get paid and are often afforded few contractual protections. Fortunately, both subcontractors and suppliers can mitigate their financial risk by reviewing their contracts with the following provisions in mind:
“Pay-when-Paid” vs. “Pay-if-Paid” Clauses
Two of the most important contract provisions for subcontractors and suppliers to scrutinize are “pay-when-paid” and “pay-if-paid” clauses. These provisions are critical because they determine when and if payments to the subcontractor or supplier become due.
A pay-when-paid clause ties payment from the general contractor to the subcontractor to when the general contractor receives payment from the owner. An example of a pay-when-paid clause is, “Subcontractor will be paid within 10 days after General Contractor receives payment from Owner.” Most state courts have determined, however, that contractors cannot indefinitely withhold payment from subcontractors based upon a “pay-when-paid” clause. Rather, courts in Oregon and elsewhere interpret a “pay-when-paid” clause to require a general contractor to pay its subcontractors within a “reasonable time” of the completion of satisfactory work, even in circumstances where the general contractor has not yet received payment from the owner.
Pay-if-paid clauses, by contrast, make payment by the owner to the general contractor a prerequisite to the general contractor’s obligation to pay the subcontractor or supplier. An example of pay-if-paid clause is, “Subcontractor will be paid within 10 days after General Contractor receives payment from Owner and General Contractor’s receipt of payment by Owner is a condition precedent to General Contractor’s payment to Subcontractor.” This type of provision is less common but is particularly perilous because it means that the lower tiered project entity could potentially never get paid.
While Oregon courts generally disfavor “pay-if-paid” clauses, they will be enforceable if the language is “definite and unambiguous.” In other words, to create a “pay-if-paid” clause, the contract must clearly state that payment to the subcontractor or supplier by the general contractor is contingent upon receipt of payment by the owner.
Takeaway: Subcontractors and suppliers should always check to see if their contracts contain a “pay-when-paid” or “pay-if-paid” clause. While the former is construed to mean that payment will be made in a reasonable time, the latter should be avoided to reduce the chance of deferred payments.
Joint Check Agreement
Another helpful contract provision that can help streamline payment and lower risk of non-payment to lower tiered parties — particularly material suppliers — is to negotiate a “joint check agreement.”
A joint check agreement is usually entered into between a general contractor, a subcontractor and a material supplier. In that situation, all three parties agree that any payments made by the general contractor for work involving the supplier’s materials will be written jointly to the subcontractor and the material supplier. Since there is no statutory basis for a joint check agreement, it only comes into play by contractual agreement.
A joint check agreement has many benefits. First and foremost, the material supplier is protected against the risk of the subcontractor not paying them. In turn, the general contractor is safeguarded from the risk of the supplier not getting paid and subsequently filing a construction lien on the project. It also gives the general contractor more control over the payment flow by enabling it to issue checks directly to lower tier parties instead of having to follow the more time-consuming protocol of paying the subcontractor and then relying on that the subcontractor to pay people down the line. This process can ultimately prevent — or at least reduce — delays caused by non-payment and ensures that payment is streamlined.
Despite the benefits, general contractors might not always agree to a joint check agreement because it will impose additional obligations on the general contractor, such as: (1) having to keep track of which lower tiered parties have joint check agreements and which do not; (2) taking on the administrative task of parsing out payments to each lower tier party based on their portion of the work performed; and (3) creating the possibility of payment errors that can require additional efforts to fix. Nevertheless, the practical values of the joint check agreement are worth negotiating if the opportunity arises.
Subcontractors and suppliers should be thinking ahead during contract negotiations to reduce the chances of being negatively impacted by payments that are delayed or reduced. While financial disagreements are unavoidable in the construction business, these disputes can be minimized if the parties carefully examine the payment terms at the outset and ensure that they are clearly stated in the contracts.
Vanessa Triplett Kuchulis is an attorney with Miller Nash Graham & Dunn. Her practice focuses on complex construction management and defect claims, commercial property disputes, and construction contract drafting. Vanessa can be reached by phone at 503-205-2328 or by email at firstname.lastname@example.org.