Construction / 3 min read
“We never agreed to ‘Pay if Paid’ terms.” In negotiating construction agreements, I’ll often hear positions like this from the parties. Being aware of provisions that may compromise your position is a good first step, but understanding the broader context of these terms and their function within the construction agreement is essential.
This Spring, I had the opportunity to teach the Construction Documents course in the Construction Management Program at the University of Houston. These students are on a degree path that will guide them into construction project management or related fields. Each Thursday night for 15 weeks, I met with around 100 students and discussed construction contracts, plans, specifications, change orders, force majeure, liquidated damages, and other kinds of construction document issues. For someone who has been working in the industry more than a little while, it was refreshing and provided some new perspective.
For a midterm paper, the students were asked to listen and respond to a supreme court argument about a dispute around a “pay if paid” clause in a construction contract. "Pay if paid" means the contractor’s obligation to pay the subcontractor is conditioned on the contractor receiving payment from the Owner. "Pay when paid" is more about timing, which effectively delays when the contractor needs to pay the subcontractor. While clauses like this are common in construction agreements, the students generally found it outrageous that a subcontractor could do the work and not get paid by the contractor. Many of the students felt this was the sort of clause that should never be agreed to by a subcontractor and several stated that these should always be redlined out of contracts.
Context and relationships matter. For the next assignment, I gave the students clauses from actual contracts and divided them into teams of contractors and subcontractors. They were to negotiate the best deal given their role. For example, a higher tier party like a general contractor would prefer to shift as much risk as possible, such as the risk of nonpayment, to the owner. In contrast, the lower tier parties would generally resist these risk transfers entirely.
In addition to the contract clauses, each group was provided a slip of paper with “secret” information for them to consider. It was theirs to use, ignore, share, or keep secret. Each piece of secret information provided either an advantage or disadvantage for the party. For example, a contractor team would receive information like, “Need to replace the sub who initially bid the job. Work starts Monday and you need to get this contract signed.” While a subcontractor would receive information like, “You have found an issue in the plans that will allow you to make significant profit on a change order.” The lesson provided an opportunity to consider extra-contractual issues which could affect the negotiation process.
After our negotiation exercise, we discussed how legal questions often have complex answers. There’s a reason why lawyers always say the two words dreaded by clients: “It depends.” While a “pay if paid” provision does transfer risk of owner nonpayment to the lower tier party and has its disadvantages, there are ways to mitigate this risk. It’s a risk benefit equation and there are things that can be done to protect the lower tiers, even in a “pay if paid” situation. For instance, in dealing with a pay if paid clause, the subcontractor should confirm financial ability of the Owner to pay and carefully protect its lien rights up front.
I’m reminded of the wise words of Don Farber, a visiting contracts professor when I was in law school. He talked about common sense contract negotiation. Figure out what your client needs from the transaction and everything else is meaningless. To negotiate a contract effectively, the context, or “secret” information, is essential. What does the client need from the deal?
In closing, I have a few insights from my end of term student evaluations. “Enjoyed the professor's sense of humor and knowledge of his profession.” I’m glad someone thinks I’m funny. Humor can be helpful in the learning process. “There was too much talking.” In honor of this student’s insight, I’ll wrap this up here. I look forward to learning more from my students in future classes.