By: Jennifer M. Horn
In a precedential opinion that overturned a Pennsylvania District Court ruling, the United States Court of Appeals for the Third Circuit (the Third Circuit) interpreted several important provisions of a construction contract. This blog post addresses the Third Circuit’s discussion of the payment provisions commonly referred to as “pay-if-paid/pay-when-paid.” Future posts will highlight other aspects of the Third Circuit’s recent decision in Sloan v. Liberty Mutual Insurance Company including the force and effect of liquidating agreements in construction contracts.
What Are Pay-If-Paid/Pay-When-Paid Clauses?
As the Third Circuit noted, in construction contract parlance, a “pay-if-paid” clause means that a subcontractor is entitled to payment from the general contractor only if an owner pays the general contractor for the work. Pay-if-paid clauses shift the risk of an Owner’s non-payment to the subcontractor and, where sophisticated construction entities have so agreed, the Third Circuit held that there is nothing inherently unfair about such clauses.
A “pay-when-paid” provision, on the other hand, “does not establish a condition precedent, but merely creates a timing mechanism for the general contractor’s payment to the subcontractor.” Importantly, when certainty is lacking as to whether a provision is pay-if-paid or pay-when-paid, “Pennsylvania courts tend to interpret payment provisions as pay-when-paid.” Unfortunately for subcontractor Sloan, the Third Circuit upheld the pay-if-paid and, as discussed below, other risk-shifting language.
What Happened in Sloan?
Isla of Capri Associates LP (IOC) owned and sought to develop waterfront condominiums in Philadelphia and, in this regard, contracted with general contractor Shoemaker Construction Company (Shoemaker) to build the project. Shoemaker, in turn, entered into subcontracts with various entities, including drywall and carpentry subcontractor Sloan & Company (Sloan). Sloan performed work; however, Shoemaker failed to pay the balance on its Subcontract. Sloan made a claim under the payment bond provided by Liberty Mutual Insurance Company (Liberty Mutual).
Liberty asserted that Sloan was not entitled to payment because one of the provisions in the parties’ Subcontract, paragraph 6.f, conditioned Sloan’s right to payment on Shoemaker’s receipt of payment from the Owner. In particular, paragraph 6.f of the Subcontract provides, in relevant part,
“Final payment shall be made within thirty (30) days after the last of the following to occur, the occurrence of all of which shall be conditions precedent to such final payment . . .”
* * *
[IOC] shall have accepted the Work and made final payment thereunder to [Shoemaker]
* * *
[Shoemaker] shall have received final payment from [IOC] for [Sloan’s] Work
In short, Liberty Mutual argued that this provision was a “pay-if-paid” clause. Sloan, on the other hand, contended that the provision was a “pay-when-paid” clause and pointed to a second subparagraph of 6.f which described a process whereby Sloan could sue Shoemaker for final payment if IOC fails to make final payment.
In ruling for Liberty Mutual, however, the Third Circuit found that the provision was a “pay-if-paid,” not “pay-when-paid” clause, and read the first part of paragraph 6(f) in conjunction with a pass-through or liquidating agreement in paragraph 20 of the same contract. In other words, the Third Circuit held, among other things, that IOC’s payment to Shoemaker was a “condition precedent” to Shoemaker’s obligation to pay Sloan and the risk of nonpayment was properly shifted to Sloan in accordance with the intent of the parties when they entered into the Subcontract.
Impact Moving Forward
All parties to a construction contract, whether owner, general contractor, or subcontractor, would be wise to study the Third Circuit’s recent opinion in Sloan and compare the language in their standard form contracts to that which the Court upheld in Sloan. For all involved, a clear understanding of payment provisions and the risk each party will suffer in the event payment is not made, is best clarified and understood before a job goes bad.
Jennifer M. Horn is Senior Counsel at Cohen Seglias and a member of the Construction Group. She concentrates her practice in the areas of construction litigation and real estate.