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’Pay-If-Paid’ Clauses Should Be ’Unenforceable,’ Says ASA

Who should shoulder the burden when a client refuses to pay up?

Wed July 17, 2013 - Midwest Edition
Construction Equipment Guide

On June 20, the American Subcontractors Association and ASA of Ohio filed an amicus brief before the Supreme Court of Ohio, arguing that “pay-if-paid” clauses in construction contracts should be “unenforceable.”

A decision by the Supreme Court of Ohio in Transtar Electric, Inc. v. A.E.M. Electric Services Corporation will determine whether prime contractors can shift financial risk of construction projects to subcontractors and suppliers through “pay-if-paid” clauses.

“These clauses unreasonably and improvidently transfer the risk of loss from the party best able to analyze and control the loss and their own profit, the prime contractor, to all of the other parties in the construction process,” ASA, ASA of Ohio and the Ohio/Michigan chapter of the National Electrical Contractors Association said in their brief.

A pay-if-paid clause makes payment by the owner to the prime contractor a condition that must be satisfied before the prime contractor must pay its subcontractors. Such a clause shifts the risk of nonpayment by the owner from the prime contractor to its subcontractors. In many circumstances where such clauses are present, the subcontractors never receive payment. In essence, a pay-if-paid clause completely shifts the burden of financial risk for a delay or default on the job site from the prime contractor to its subcontractors.

In the brief, the organizations urged the Ohio Supreme Court to affirm an appeals court’s decision “determining that pay-if-paid clauses should either be extraordinarily explicit so as to convey the inherent risk of nonpayment by the project owner, a condition completely uncontrolled by the subcontractor, or eliminated as a method of subjugation of subcontractors as being void and unenforceable as against public policy.”

A.E.M. Electric Services was the general contractor on the construction of a swimming pool at a Holiday Inn in Maumee, Ohio. In January 2007, A.E.M. entered into a subcontract agreement with Transtar for certain electrical work to be performed on the project. The subcontract provision in question included:

“Receipt of payment by contractor from owner for work performed by subcontractor is a condition precedent to payment by contractor to contractor to subcontractor for that work.”

Transtar invoiced A.E.M. for work performed in the amount of $186,709, and A.E.M. paid Transtar $142,620.10. The remaining balance was not paid. On Sept. 27, 2010, Transtar sued A.E.M. for the unpaid amount, and A.E.M. denied liability. A.E.M. did not dispute the unpaid amount, but argued that “the project owner had failed to pay” A.E.M. that amount and more. A.E.M. said it would continue to attempt to collect the money from the project owner and pledged to pay Transtar if collection efforts were successful. Absent such payment, however, A.E.M. insisted it was not contractually obligated to pay. Transtar argued that the contractual provision that A.E.M. characterized as a pay-if-paid clause should be deemed a pay-when-paid clause.

The trial court concluded that the contract clause at issue was a pay-if-paid provision, but the appeals court reversed, saying, “Because we conclude that the purported pay-if-paid contract provision does not manifest the intent of the parties to shift the risk of owner non-payment from the general contractor to the subcontractor, we reverse,” the court of appeals wrote.

“Only inequity and injustice will arise if large prime and general contractors are able to unjustly shift the entire financial risk of the construction industry on the small subcontractors and suppliers who can least afford to shoulder such risk,” ASA, ASA of Ohio, the Ohio/Michigan chapter of NECA wrote in their brief.

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