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Pay-If-Paid vs Pay-When-Paid

Construction contracts often contain provisions that determine when a subcontractor will be paid by a general contractor. General contractors typically wanted to pay their subcontractors after the owner has paid the general contractor. Subcontractors on the other hand don't want to wait for an owner to pay in order to receive compensation for their work on a project. To address these issues there are two commonly used contract clauses in construction contracts: Pay-if-Paid and Pay-When-Paid.

Pay-If-Paid:

Pay-If-Paid clauses dictate that a general contractor is only required to pay a subcontractor for completed work if the general contractor is paid by the owner. Under these clauses, if the owner never pays the general contractor, then the general contractor does not have to pay the subcontractor. These types of contract clauses have been unenforceable in California since 1997 when the Supreme Court ruled in William R. Clark Corp. v. Safeco Ins. Co. (1997) 15 Cal. 4th 882. The Court reasoned that enforcing such a clause would indirectly forfeit or waive a Subcontractor's lien rights; which is incompatible with California Civil Code ยง3262's provision governing waiver of lien rights. The Court therefore concluded that such clauses are unenforceable. Those entering into construction contracts should be aware of this in order to reduce their risk and avoid portions of the contract being thrown out.

Pay-When-Paid:

Pay-When-Paid clauses establish the timing by which a general contractor will pay a Subcontractor after receiving payment from the Owner. In the 1972 case, Yamanishi v. Bailey & Collishaw, Inc., (1972) 29 Cal.App.3d 457, appellate court upheld the Pay-When-Paid clause as being valid. However, the general contractor may avoid payment for a reasonable period of time only. To be enforceable these type of clauses must guarantee payment within a reasonable time, regardless of whether the owner pays the general contractor. Without the guarantee, the clauses would be unenforceable as it would be equivalent to a Pay-If-Paid clause. The question of what is a "reasonable" amount of time will depend on the situation, and subcontractors often seek to define what is "reasonable" in the contract.

Conclusion:

Pay-if-Paid clauses are unenforceable in California. Contractors should exclude such clauses in their contracts to reduce the risk of the clause being thrown out in litigation. Pay-When-Paid clauses are enforceable, but the wording needs to be precise, otherwise they can accidentally become unenforceable.

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