Construction contracts, whether between owner and general contractor, owner and construction manager, general contractor and subcontractor, or between other parties, inevitably include a provision describing when payment is due. Often these provisions will be most favorable to the party higher up the food chain and closer to the source of financing for the construction project. In many cases, the payment clause will read as though the party receiving payment will not be entitled to payment until the party making payment first receives payment, either by way of an advance from the bank or payment from the owner. Does this type of payment clause mean that if the party making payment is never itself paid, then the party to receive payment under the contract is never entitled to get paid for its work or materials? This post will explore the guidance New Jersey courts have given to date as to the interpretation of such clauses in construction contracts.
In New Jersey, the answer to the above question depends upon whether the provision is considered a “pay when paid” clause or a “pay if paid clause.” The question of how a payment clause in a construction contract will be interpreted depends upon the precise language appearing in the clause. Figuring out which type of clause is in your contract may be a close call, and if disputed, may ultimately be a question that is decided by a judge or arbitrator.
There is no published New Jersey State court decision dictating when a payment clause in a construction contract is a pay when paid or a pay if paid clause. However, New Jersey State and Federal Courts have dealt explicitly with pay when paid versus pay if paid provisions in construction contracts. The existing case law, which relies on industry custom, is likely to be relied upon by judges and arbitrators charged with interpreting a given payment clause.
The key to differentiating between the two types of payment clauses is whether or not the language in the payment provision is absolutely clear that the risk of nonpayment is being transferred downstream, whether by the owner to the general contractor or construction manager, by a general contractor or construction manager to a subcontractor, and so on down the line. If the language in the payment clause is at all unclear, it will most likely be construed as a pay when paid clause.
Under the existing case law, a pay when paid clause requires the paying party to make payment within a reasonable amount of time, even if it does not receive money it is owed in relation to the same construction project. By contrast, a pay if paid clause requires the paying party to make payment only if, and not until, it has received payment from the bank, owner or general contractor. Thus, if the clause is a pay if paid clause, it is possible that an obligation to make payment never arises.
In an important Federal case on this issue, the court deemed the payment provision at issue to be a “pay when paid” clause. Seal Tite Corp. v. Ehret, Inc., 589 F. Supp. 701 (D.N.J. 1984). The provision provided that money was:
[P]ayable in the following manner: Ninety (90) percent monthly of work completed, within seven (7) days of receipt of payment by the Owner, or his Agent, provided statements of such work completed are rendered by the TWENTY-FIFTH OF EACH MONTH and are approved for payment by the architect. The balance to be paid within thirty (30) days after acceptance and receipt of final payment by the owner of the building and after complete release of all liens arising out of this contract have been delivered to [the general contractor].
Id. at 702. The Seal Tite Court concluded that “because the payment clause did not make reference to the possibility of the owner's insolvency, but did refer to the amount, time and method of payment, the clause was merely a provision ‘designed to postpone payment for a reasonable period of time after the work was completed, during which the general contractor would be afforded the opportunity of procuring from the owner the funds necessary to pay the subcontractor.’" Id. at 704.
In an unpublished New Jersey State court decision, the court deemed the payment provision to be a “pay if paid” clause. O.A. Peterson Construction Co., Inc. v. Englewood Hospital and Medical Center,Docket No. A-1536-08T1 (App. Div. July 1, 2010). There, the payment clause read:
It is expressly understood and agreed that the receipt by the Contractor of payment for the Subcontractor's work shall be a condition precedent to the Contractor's obligation to pay the Subcontractor. That is, the Contractor shall have no liability or responsibility for any amounts due or claimed to be due the Subcontractor for any reason whatsoever except to the extent that the Contractor has actually received funds from the Owner specifically designated for disbursement to the Subcontractor.
(emphasis in original). It is this degree of clear and explicit language that was necessary to justify interpretation of the payment clause as requiring payment of the subcontractor only if, and not until, the owner paid the general contractor.
Our firm devotes a significant amount of its practice to New Jersey construction law and litigation. As part of this practice, we prosecute/defend lawsuits in which disputes over payment are asserted. We welcome you to contact us for further information.
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