Construction subcontracts often contain “pay-if-paid” provisions. The intended purpose of these clauses is to condition a contractor’s obligation to pay its subcontractor upon the contractor’s receipt of payment from the entity with whom it is in privity. Some jurisdictions, like New Jersey, generally enforce “pay-if-paid” clauses if the contractual language explicitly and unambiguously shifts the risk of non-payment to the subcontractor. Other jurisdictions, such as New York, refuse to enforce the provisions on the basis that they are contrary to public policy.
“Pay-If-Paid” Defined: The “pay-if-paid” provision is a common contractual tool intended to alter payment obligations between contracting parties. If drafted correctly and utilized in jurisdictions that enforce them, the clause prescribes that receipt of payment is a condition precedent to the obligation to make payment under the contract. In other words, the existence of an enforceable “pay-if-paid” provision means that a contractor is under no obligation to pay its subcontractor for work performed unless and until that contractor receives payment from the owner for the work performed by the subcontractor.
New Jersey’s Take: Properly drafted “pay-if-paid” provisions will generally be enforced under New Jersey law. To be enforceable, the clause must demonstrate the parties’ clear and unambiguous intent to shift the risk of non-payment to the subcontractor. For example, the United States District Court for the District of New Jersey enforced a “pay-if-paid” clause wherein the parties expressly agreed that: “as a condition precedent to any obligation of the Contractor” the “Contractor shall never be obligated to pay the Subcontractor under any circumstances, unless and until funds are in hand received by the Contractor in full.” Consistent with that decision, the New Jersey Appellate Division determined that the following “pay-if-paid” provision was enforceable because it unambiguously communicated the parties’ intent to transfer the risk of non-payment to the subcontractor:
It is expressly understood and agreed that the receipt by the Contractor of payment for the Subcontractor’s work shall be a condition precedent to the Contractor’s obligation to pay the Subcontractor. That is, the Contractor shall have no liability or responsibility for any amounts due or claimed to be due the Subcontractor for any reason whatsoever except to the extent that the Contractor has actually received funds from the Owner specifically designated for disbursement to the Subcontractor.
New York’s Take: “Pay-if-paid” clauses are generally considered unenforceable under New York law as violative of the public policy prohibiting enforcement of contractual terms prejudicing a party’s lien rights. Specifically, New York courts have held “pay-if-paid” provisions impair the rights of a potential lienor to file a lien independent of the entity in privity with the owner. Indeed, under the New York Lien Law, entities permitted to file liens have a right to do so independent of the entity with whom they are in privity with.
Although “pay-if-paid” provisions are unenforceable under New York law, courts in New York may interpret the contractual language to be a “pay-when-paid” provision. These provisions merely fix a reasonable time for payment, rather than prescribe an indefinite condition precedent to the duty to make payment for work performed. For instance, courts in New York have enforced agreements establishing a payment due date of “the fifteenth day of the succeeding month” with final payment due “thirty days after the completion and acceptance of the project.” Conversely, New York courts have refused to enforce “pay-when-paid” provisions that, if applied, would extend the payment due date for more than two years after completion of the project.
Takeaway: The enforceability of “pay-if-paid” provisions is contingent on the jurisdiction and the contractual language used. Prior to executing a construction contract, the contracting parties must be mindful of the actual language used and the jurisdiction of the project. This is particularly important for contractors who perform work in both New York and New Jersey.