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“Pay-when-paid” Construction Contract Requirement: Bane of the Subcontractor’s Existence

Real Property, Probate and Trust Law

Increasingly, subcontractors are finding it more difficult to cope with the ever-present and potentially fatal “pay-when-paid” provision in their agreements with general contractors. Much has been written about this contract clause by jurists and others whose day-to-day contact with the life of a construction project and the travails of the small/medium sized subcontractor is extremely limited.

This author proposes to dispel some myths and suggest some solutions to this vexing problem facing subcontractors whose fear of “losing business” overcomes their natural instinct to “stay in business.” First, however, the historical perspective should be reviewed against a background of misunderstanding more often perpetuated by those with law diplomas in their hands rather than shovels.

Out of Touch

Unfortunately, the Florida Supreme Court gave impetus to the continuing vitality of the “pay-when-paid” provision by underplaying the significance of a contractual covenant that essentially deprives the subcontractor of payment solely because the general contractor chose to do business with a recalcitrant owner. In Peacock Construction Co. v. Modern Air Conditioning, Inc. , 353 So. 2d 840 (Fla. 1977), the Supreme Court without the benefit of any statistical data or supporting evidence concluded:

If an issue of contract interpretation concerns the intention of the parties, that intention may be determined from the written contract, as a matter of law, when the nature of the transaction lends itself to judicial interpretation. A number of courts, with whom we agree, have recognized that contracts between small subcontractors and general contractors on large construction projects are such transactions. Cf. Thos. J. Dyer Co. v. Bishop International Engineering Co., 6 Cir., 303 F.2d 655 (1965). The reason is that the relationship between the parties is a common one and usually their intent will not differ from transaction to transaction, although it may be differently expressed.

That intent in most cases is that payment by the owner to the general contractor is not a condition precedent to the general contractor’s duty to pay the subcontractors. This is because small subcontractors, who must have payment for their work in order to remain in business, will not ordinarily assume the risk of the owner’s failure to pay the general contractor.

The court’s assumptions were wrong for two reasons. First, the “intent” of this risk-shifting provision is to free the general contractor of risk so that payment from the owner becomes a condition precedent to paying the subcontractor. Secondly, the court’s conclusion that small contractors will not ordinarily assume the risk of an owner’s failure to pay the general contractor is just not the case. Subcontractors do assume the risk not because it is benign, but because it is frequently the only way they can compete with others for the work.

Although the Peacock decision ultimately concluded that the language of the provision did not act in that case to unambiguously shift the risk, succeeding decisions have been a mixed bag.

In Dyser Plumbing Company v. Ross Plumbing and Heating, Inc. , 515 So. 2d 250 (Fla. 2d DCA 1987), the court was faced with the following provision:

Final payment, inclusive of retention, shall be made within thirty days of completion of the construction project, acceptance of the same by the Owner, and as a condition precedent, receipt of final payment of Dyser Plumbing Company and Mechanical from the Owner or Prime Contractor, as the case may be.

Citing Peacock, the court reasoned, “In reading the contract clause above, it is hard to imagine a more clear expression of an intent to shift the risk of payment failure by the owner to the subcontractor.”

One year after Dyser, the Third District in Robert F. Wilson, Inc., v. Post-Tensioned Structures, Inc., 522 So. 2d 79 (Fla. 3d DCA 1988), confirmed that the following provision shifted the risk of nonpayment to the subcontractor:

No Change Orders will be issued for additional work of any kind unless so approved by the Architect and Owner prior to its issuance. In the event a controversy occurs between the Owner and the General Contractor concerning the Contract with the Owner or these Change Order(s), then it is expressly agreed that no compensation for these items shall be due the Subcontractor from the Contractor until payment for them is received by the Contractor, regardless of the fact that payment is delayed due to the Contractor negotiating with the Owner, arbitration, administrative actions, litigation, appeals or other similar activities.

In 1990, the Supreme Court, quoting from its earlier reasoning in Peacock, again held a “pay-when-paid” clause to be a condition precedent to payment from the general contractor to the subcontractor. DEC Electric, Inc., v. Raphael Construction Corporation, 558 So. 2d 427 (Fla. 1990). However, that same year the Supreme Court decided OBS v. Pace Construction Corporation, 558 So. 2d 404 (Fla. 1990), and concluded that an ambiguity existed between the general conditions to the subcontract and the apparent intent of the subcontract itself, thereby nullifying an attempt to shift the risk of nonpayment.

The OBS decision was impetus for the legislature’s enactment of F.S. §713.245 (conditional payment bond) in order to insulate sureties along with general contractors if the payment bond met the statutory criteria. Nevertheless, various district courts in Florida have been sensitive to the dire situation of most small and medium sized subcontractors in striving to hold that the “pay-when-paid” provision as drafted was intended to act as a timing mechanism rather than an absolute condition precedent to payment from the general contractor to the subcontractor.1

Two cases from the Third District and Fourth District one year apart reflect the divergence in approaching the problem either by embracing the risk shifting provision as unambiguous or grappling to avoid its constraints.

In J.J. Shane, Inc. v. Aetna Casualty & Surety Company, 723 So. 2d 302 (Fla. 3d DCA 1998), the Third District applied the provision on the strength of Peacock ’s reasoning that “[i]n most subcontract agreements, payment by the owner to the contractor ordinarily is not intended to be a condition precedent to the contractor’s duty to pay the subcontractor because small subcontractors, who must have payment for their work in order to remain in business, will not ordinarily assume the risk of the owner’s failure to pay the general contractor.”

On the other hand, the Fourth District, in North American Specialty Insurance Co. v. Hughes Supply, Inc., 705 So. 2d 616 (Fla. 4th DCA 1998), refused to exculpate a surety from liability when the bond it issued included the conditional payment language mandated by F.S. 713.245, but the subcontract agreement omitted the risk-shifting “pay-when-paid” provision.

In a 1999 article on the “pay-when-paid” provision, the authors concluded, “Often, ‘pay-when-paid’ provisions are not discovered or really understood until the parties are well into a job.”2 Respectfully, time has proven this assumption as questionable as the Peacock court’s conclusion that small subcontractors will not ordinarily assume the risk of nonpayment from the owner to the general contractor.

A “Modest Proposal”

Most subcontractors have few palatable options simply because of the superior bargaining power often enjoyed by the general contractor. The options that do exist would seem to be the following:

1) Legislation should be considered to prohibit the “pay-when-paid” provision unless each party had legal counsel in the negotiations of the subcontract and each party enjoyed relative equality in bargaining power. Up to now, such legislative efforts have failed. Yet, precedence exists for the legislature to block inherently unfair construction practices as in the case when general contractors and owners sought to prohibit construction liens in advance of the work. The legislature prohibited this kind of provision by enacting F.S. §713.20(2).

2) Subcontractors should consider more public work in the future. While the conditional payment bond on private construction can include the risk-shifting protection authorized by F.S. §713.245, no such corresponding statutory authorization exists for the public payment bond language of F.S. §255.05. As such, while the general contractor on a public project may include a “pay-when-paid” provision in its subcontract, the surety issuing the payment and performance bond has no statutory authority to do the same.

3) Amicus briefs by organizations committed to protecting subcontractors may attempt to have the appellate courts modify their rulings on the basis of unconscionability.

4) Subcontractors should simply avoid taking jobs where they are required to execute agreements containing the “pay-when-paid” provision. While this may seem unrealistic at present given its popularity with general contractors, sufficient numbers of subcontractors negotiating to exclude the provision may, in time, limit its application.

Ideally, construction contracts should reflect a set of fair provisions designed to get the job done well and timely, but not otherwise putting the subcontractor under the risk of nonpayment from an owner the subcontractor rarely knows. The general contractor may decide to assume the risk of nonpayment after meeting and negotiating with the owner. However, shifting that risk to a subcontractor with limited or no knowledge of the owner is simply unfair. Perhaps, subcontractors should ask general contractors to assume the risk that suppliers fail to timely deliver materials to the job site.

This author believes that subcontractors under the gun of a “pay-when-paid” provision sometimes do what they ordinarily would avoid doing by taking shortcuts, or reducing manpower to a project. In the long run, this is not conducive to the timeliness or quality of the construction, thereby jeopardizing the interests of the general contractor and owner. It is, therefore, respectfully suggested that lawyers urge their respective clients to avoid risk-shifting devices that put other parties under the kind of pressure that often all parties end up regretting.

1 Charles R. Perry Construction, Inc. v. Barry Gibson & Associates, Inc ., 523 So. 2d 1221 (Fla. 1st D.C.A. 1988); Snead Construction Corp., v. Langerman , 369 So. 2d 591 (Fla. 1st D.C.A. 1978).
2 Patrick C. Barthet and Nadine H. Goodman, Waiting to Get Paid: Are Pay When Paid Provisions a Matter of When or If? , 73 Fla. B.J. 64, 67.

Howard J. Hollander has been a practicing attorney in the state and federal courts of Florida since 1964. Since 1970, he has concentrated in construction litigation. Mr. Hollander earned his B.A. from the University of Florida in 1961 and his J.D. from the University of Miami in 1964. He is the founding partner of Hollander & Bartelstone, P.A., practicing out of Miami-Dade County.

This column is submitted on behalf of the Real Property, Probate and Trust Law Section, J. Michael Swaine, chair, and William P. Sklar and Dresden Brunner, editors.

Real Property, Probate and Trust Law