Subcontractors: Beware of Pay-if-Paid Clauses

Subcontractors must beware of “Pay-If-Paid” clauses that may be included in their subcontracts.

While some contracts include a clause that says payment will be made WHEN the contractor receives payment from the owner, some carry greater risk, and say that payment will be made to the subcontractor only IF the contractor is paid by the owner.

A pay-if-paid clause in a construction contract could signal bad news for sub-contractors. This type of clause shifts the risk of non-payment by the owner to the sub-contractor. Under these circumstances, if the owner does not pay the general contractor, then the clause says that the general contractor does not have to pay the sub-contractor.

Pay-if-paid clauses raise numerous questions: are such clauses enforceable? If so, does the contractor have to try to recover from the owner to deny payment? What if the owner’s non-payment to the contractor has nothing to do with the subcontractor, or is attributable to the contractor’s alleged defaults under the prime contract? When will such clauses be interpreted as ‘pay-if-paid’, and what about the subcontractor’s lien rights: can it still lien if it is not entitled to be paid by the contractor because of such a clause?

Having payment be conditional on something the subcontractor has no control over is very risky. The clauses are generally broad, and generally apply even when non-payment by the owner has nothing to do with the work/deficiency of the sub-contractor.

While there is little case law on Pay-If-Paid clauses in BC, a Nova Scotia Court of Appeal decision, found that if a general contractor is going to rely on a Pay-If-Paid clause, the clause must be very clear.  The court stated that “an intention so important cannot be buried in obscure language that would not alert the subcontractor that payment for the subcontract work was conditional on the owner paying the (prime) contractor”: Arnoldin Construction & Forms Ltd. v. Alta Surety Company, 1995 NSCA 16.

In addition to clear language, a pay-if-paid clause is more likely to be enforced if:

  • It explicitly creates a condition that must be satisfied prior to payment (a “condition precedent”) and
  • It includes an acknowledgement on the part of the sub-contractor that the subcontractor clearly assumes the risk of non-payment by the owner to the contractor.

Three things to know:

Based on Canadian case law generally, we can draw three lessons.

First, for a “pay if paid” clause to be enforceable, the intention of the clause must be clear. Sub-contractors who want to avoid the impact of such clauses should, of course, not agree to them. Whether or not the clause is somewhat buried in ‘fine print’ might be a factor the Court will consider.

Second, the clause must create a condition requiring satisfaction before payment.

Finally, the fact that there is a “pay when paid” or “pay if paid” clause will not impact the lien claimant’s right to make a claim of lien. The lien may be filed, but whether it can be enforced would be assessed in relation to whether the contractor was owed any payment (per the Pay-If-Paid clause).

Though not settled law, in a recent case (in which our firm is involved), the Court had reason to discuss the holdback in relation to pay if paid clauses. A strong argument can be made that collection by subcontractors from holdback funds (or alternate security) should not be held up due to a pay if paid clause.

We generally recommend that our subcontractor clients avoid such clauses wherever possible.  If, for reasons of competitiveness or strong desire to gain the contract, they are willing to proceed despite such a clause, we seek to ensure that our clients understand when and how they might be enforced. Sometimes, acceptance of risk may justify alteration of other terms in the agreement, or an increase to the contract price.

Please contact Synthesis Legal if you have questions about the enforceability of Pay-If-Paid clauses, or if you would like assistance to negotiate more favourable terms in an upcoming project contract.

By Ali Al-Samak/ Stephanie Streat