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“Paid-if-Paid” v. “Paid-When-Paid” Clauses

On May 24, 2018, the Court of Appeals of Maryland filed its decision in Young Electrical Contractors, Inc. v. Dustin Construction, Inc. In its decision, the Court of Appeals analyzed a Subcontract under Virginia law to determine whether the payment provisions in the Subcontract were “paid-if-paid” or “paidwhen-paid” provisions.

The Circuit Court held that a “paid-if-paid” provision in the Subcontract applied to the damages sought in the action, determined that there was no dispute that the Owner had not paid Contractor with respect to the matters in issue, and awarded summary judgment in favor of Contractor. The Court of Special Appeals affirmed that decision on slightly different grounds. The Court of Appeals held that the “pay-if-paid” clause relied upon by the Circuit Court, which was cited by neither party in motion papers or argument concerning summary judgment, does not necessarily apply to the issues in this case. Accordingly, the Court of Appeals vacated the judgment and remanded the matter to the Circuit Court for further factual development.

At the outset, the Court defined and distinguished “paid-if-paid” clauses from “paid-when-paid” clauses. The Court stated:

Some provisions, sometimes called pay-when-paid clauses, concern the
timing of payment by the general contractor, but do not relieve the
general contractor of its liability to the subcontractor under the
subcontract. Other provisions, sometimes called pay-if-paid clauses,
make the project owner’s payment of the general contractor a condition
precedent of the general contractor’s obligation to pay the
subcontractor and thus can relieve the general contractor of liability to
the subcontractor, even though the subcontractor has fully performed
its part of the subcontract.

The Court of Appeals then went on to discuss the majority approach, in which a court will construe such a clause narrowly and interpret it to be a payment timing provision – i.e., a “pay-when-paid” clause – unless the language of the provision clearly and necessarily creates a risk-shifting provision – i.e., a “payif-paid” clause. The Court of Appeals relied on Thomas J. Dyer Co. v. Bishop International Engineering Co., 303 F.2d 655 (6th Cir. 1962), which stated:

The tendency of the courts is to hold that, unless the contract shows
clearly that such an action is an express condition, the provision with
reference to such act is inserted in order to fix the time of performance,
but not to make the doing of such act or the happening of such event a
condition precedent. If this is the intention of the parties, the fact that
such act is not performed or that such event does not happen, does not
discharge the contract, and the act which the parties agree to do upon
the performance of such act or upon the happening of such event, is to
be performed in at least a reasonable time.

The majority approach, therefore, appears to be based, at least in part, on a general principle that disfavors construing a contract provision to effect a forfeiture, particularly when the condition precedent is outside the control of the party at risk of forfeiture. In the context of a subcontract for a construction project, this principle favors construing a conditional payment provision as a timing provision rather than a risk-shifting provision.

Consistent with Dyer, Maryland Courts have stated that such provisions are to be construed as timing provisions – “pay-when-paid” clauses – unless the contract language clearly indicates that the parties intended otherwise. The Court of Appeals also looked to Gilbane Building Co. v. Brisk Waterproofing Co., 86 Md. App. (1991) (a case later relied upon by the Virginia Supreme Court) to determine what contract language would suffice to shift the risk of owner insolvency from the general contractor to the subcontractor. The subcontract provision at issue in Gilbane stated, “it is specifically understood and
agreed that the payment to the trade contractor is dependent, as a condition precedent, upon the construction manager receiving contract payments, including retainer from the owner.” The Court of Special Appeals concluded that the reference in the subcontract to owner payment as a “condition precedent” was sufficient to shift the risk of owner insolvency to the subcontractor as a matter of objective contract interpretation, regardless of whether the parties had actually discussed the risk of owner insolvency during their negotiations.

Next, since Virginia law applied to the case at bar, the Court of Appeals considered Virginia law regarding “paid-if-paid” v. “paid-when-paid” clauses. In Galloway Corp. v. S.B. Ballard Construction Co., 250 Va. 493 (1995), the Virginia Supreme Court was asked to determine whether the following contract language was a “paid-if-paid” clause or a “pay-when-paid” clause: “The Contractor shall pay the Subcontractor each progress payment within three working days after the Contractor receives payment
from the Owner.” The Virginia Supreme Court concluded that this contract language was not as clear as the contract language at issue in Dyer or Gilbane. As a result, the Virginia Supreme Court determined that the phrases “after the Contractor receives payment from the Owner” and “has received payment from the Owner” constituted latent ambiguities in the contract. The Virginia Supreme Court then relied on parol evidence to determine the intent and understanding of the parties. The court ultimately concluded that some of the subcontractors shared the general contractor’s understanding that it was a “paid-if-paid” clause. On the other hand, at least one subcontractor’s understanding of the clause is that it was a “paid-when-paid” clause.

Here, Contractor filed a Motion for Summary Judgment asserting that it was not liable for two of Subcontractor’s change orders that the Owner had rejected. Contractor’s Motion for Summary Judgment cited to two clauses in the Subcontract that it argued were risk-shifting – “paid-if-paid” clauses. The Subcontract provisions upon which Contractor relied read as follows:

Section 13(c) – Regarding Changes:
Contractor shall pay to Subcontractor that amount paid by the Owner to
Contractor on account of any such change to this Subcontract, less any
markup and other amounts due Contractor on account of such change.
Contractor shall have no liability to Subcontractor on account of any
such Owner initiated change except for such amount, if any.

Section 27(f) – Resolution of Disputes Involving Owner:
Contractor shall have no liability to Subcontractor on account of any
claim, suit or appeal arising under or relating to the Prime Contract or
the Owner’s conduct thereunder except that recovered by the
Contractor from the Owner on Subcontractor’s behalf, if any, less any
markups and other amounts due Contractor on account of such claim,
suit or appeal.

The Circuit Court granted Contractor’s Motion for Summary Judgment, but not on the provisions upon which Contractor relied in its Motion for Summary Judgment. Rather, the Circuit Court based its decision on Section 2(c) of the Subcontract and Section 37(a)(1) of the standard conditions incorporated in the Prime Contract between Owner and Contractor. Section 2(c) of the Subcontract states, in relevant part:

Contractor’s obligation to pay all or any portion of the Subcontract Sum
to Subcontractor, whether as a progress payment, retainage or final
payment, is contingent, as a condition precedent, upon the Contractor’s
receipt of payment from the Owner of all amounts due Contractor on
account of the portion of the Work for which the Subcontractor is
seeking payment

Section 37(a)(1) of the standard conditions references a Virginia statute that requires a contractor in a Virginia state contract to pay a subcontractor within seven days of receiving payment from the owner of a project or to notify the state agency and the subcontractor why payment is being withheld.

The Court of Special Appeals affirmed the Circuit Court’s ruling. It agreed with the Circuit Court that Section 2(c) was a “pay-if-paid” clause that made payment by Owner to Contractor under the Prime Contract a condition precedent to payments by Contractor to Subcontractor under the Subcontract. However, it held that Section 13(c) was the payment provision “most relevant” to the current dispute and construed the language of Section 13(c) and Section 27(f), when read alone, to be “pay-when-paid” clauses similar to the provision at issue in Dyer rather than “paid-if-paid” provisions. However, the Court of Special Appeals reasoned that any payments covered by those provisions were also subject to the condition precedent set forth in Section 2(c), a “pay-if-paid” clause.

The Court of Appeals disagreed with the Court of Special Appeals. The Court of Appeals noted that Section 2(c) applies to “Contractor’s obligation to pay all or any portion of the Contract Sum.” Unlike the payment clauses in Gilbane and Dyer, this clause does not concern Contractor’s contract liability to Subcontractor generally, but specifically payments to be made with respect to the Subcontract Sum. Thus, to decide whether Section 2(c) applies to the damages sought by Subcontractor, one must first determine whether the alleged damages are part of the Subcontract Sum. The notion that Section 2(c)
would be “generally applicable” to all contract liability of Contractor is at odds with the language of that section relating it to the Subcontract Sum and other provisions of the Subcontract related to particular types of damages.

The Court of Appeals then went on to state that Subcontractor had alleged the following bases for its contention that Contractor had breached the Subcontract: Contractor’s failure to coordinate and sequence work, Contractor’s direction to Subcontractor to perform additional work and uncompensated overtime and Contractor’s failure to pay for the costs of the extended period of contract performance.  The Court of Appeals observed that at least some of these damages appeared to be outside the scope of Section 2(c) and that the general application of Section 2(c) to payments other than those related to the
Subcontract Sum would transform it into a blanket waiver by Subcontractor of delay damages, something that appears to be contrary to the intent of the parties.

However, the Court of Appeals also noted the Contractor seeks other damages that are not necessarily related to delay, and that may be governed by Section 2(c). In particular, the complaint alleged that the Contractor breached the Subcontract by directing the performance of additional work which it failed and refused to pay for, and by directing overtime work which it has failed and refused to pay for. The Court of Appeals also noted that the record before it is insufficient to say those matters are governed by a clause with a condition precedent, particularly where no discovery has been conducted.

As for the Court of Special Appeals’ reliance on Section 37(a)(1), the Court of Appeals held that the Virginia Prompt Payment Statute requires Virginia state agencies to obligate their contractors to pay subcontractors promptly after the agency pays the contractor, or to notify the agency and subcontractor why it is not doing so. It is designed to ensure that subcontractors are paid without delay, not to create a pre-condition to their payment. Thus, Section 37(a)(1) would not be a basis for awarding summary judgment in favor of Contractor in this case.

The Court of Appeals considered whether there was any other ground upon which the Contractor’s Motion for Summary Judgment could be granted. Therefore, the Court of Appeals reviewed the applicability of Sections 13(c) and 27(f) (relied upon by Contractor in its Motion for Summary Judgment). The Court of Appeals held that the Circuit Court would not be required to resolve these issues in Contractor’s favor as a matter of law on the current state of the record, as there appear to be open
factual issues as to both elements of Contractor’s argument. The ruling on the Motion for Summary Judgment occurred prior to any opportunity for discovery and thus deprived the Subcontractor of the opportunity to produce additional information relevant to the issues.

First, the Court of Appeals reasoned that it was not at all clear, as Contractor argues, that it is undisputed that damages sought by Subcontractor relate to “Owner-initiated changes.” Contractor based its argument by pointing to select quotations from the Owner-rejected change orders. However, the Subcontract explicitly stated, “Nothing said or written in the prosecution or defense of any claim(s) against the Owner shall constitute or be regarded as an admission or declaration against interest of
either party in any litigation or arbitration between Contractor and Subcontractor.” The Court of Appeals observed that neither party apparently wanted to make what was said in a change request to the Owner binding in future litigation between the Contractor and Subcontractor. Thus, placing conclusive weight on a statement made in a change request to resolve litigation between the Contractor and Subcontractor, particularly on Motion for Summary Judgment prior to discovery, appears to be
contrary to the intent of the parties. The Court of Appeals finally noted that although delay is associated with the changes Owner made, it could also be that Contractor failed to implement those changes efficiently. The two are not necessarily mutually exclusive, and this record is not sufficient to say that Subcontractor agrees that Contractor did not contribute to the delays.

Second, the Court of Appeals noted with approval the Court of Special Appeals’ observation that Sections 13(c) and 27(f) of the Subcontract, when considered on their own terms, are somewhat similar to the payment provision at issue in Dyer. Therefore, these provisions could be construed as “paywhen-paid” provisions that go to the timing of payments, but do not relieve Contractor of liability to Subcontractor, even if Owner declined to pay Contractor. If the parties are unable to identify other
language in the Subcontract (apart from supplanting them with Section 2(c)) that indicates that these provisions should be construed as either “pay-when-paid” or “pay-if-paid” clause, a court could find them latently ambiguous. Therefore, consideration of parol evidence concerning the parties’ intentions may thus be necessary to discern whether these provisions were intended to operate as risk-shifting “pay-if-paid” clauses. No such evidence has yet been submitted by either party. Accordingly, the Court of Appeals remanded the case back to the Circuit Court for further trial development.

For additional information on construction law in Maryland, contact Jennifer S. Taff at 410-583-2400 or
via email at taff@bowie-jensen.com.

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