Payment Merry-Go-Round: Pay-When-Paid

Typical subcontractor dilemma: Contractor doesn't make progress payment to sub because contractor has not received payment from owner. The subcontract agreement has a "pay-when-paid" clause which provides that subcontractor will be paid when the contractor receives payment from the owner. Contractor doesn't get payment from owner so he doesn't pay sub.

Subcontractor's suppliers lien the job and contractor and owner become irate with subcontractor-insisting that the subcontractor won't get paid unless he gets lien releases from his suppliers.

The subcontractor has three choices:

( 1 ) finance the job by paying off the liens of his suppliers;

(2) get his suppliers to cooperate by releasing their liens without payment, or

(3) yell, kick, scream and sue (or arbitrate). There is no easy solution to these "chicken and egg" scenarios.

The Illinois Court of Appeals hasn't helped. Most of the state courts which have ruled on the effect of the "pay-when-paid" clauses have ruled that such provisions do not forever excuse payment by the general contractor-they only allow him a reasonable time within which he may attempt to recover from the owner. If that is impossible because of the owner's insolvency, bankruptcy or for some other reason, the general contractor must nevertheless pay his subcontractor.

However, in the recent Illinois case of A.A. Conte, Inc. v. Campbell Lowrie-Lauthermilch Corp., 477 N.E.2.d 30 (Ill. App. 1985) the Illinois appellate court applied a strict interpretation to the '~pay-when-paid" clause. It held that the contractor did not have to pay the subcontractor because the owner didn't pay him.

Although courts of many other states have held differently, the threat still remains in those states, like Colorado, where there is no legal precedent on this issue.

Solution: READ THE CONTRACT! If "pay-when-paid" language appears in the subcontract, potential subs should consider asking for a modification of the clause or refuse to sign-unless satisfied with his mechanic's lien or payment bond remedies. General contractors should be aware of such language in their subcontract forms in the event that they do not receive payments due from the owner under their contracts.

Moral: KNOW YOUR CONTRACT! F-11