November 2019
Level With Me By JeremyWyatt
Reversing the Perverse Incentives of the ‘Pay-if-Paid’ Clause
Have you ever had a frustrating conversation with a general contractor (GC) similar to this one? You: When are you going to pay me on the pay app I submitted 45 days ago? GC: I’d love to, but I just haven’t been paid from the owner for that work, yet. You: Well, I need payment, because I need to cover my payroll for this project and the material supplier is beating my door down. GC: That’s too bad, but you signed a pay-if-paid clause, so I don’t owe you anything right now. Isn’t it just plain fair to be paid on time, every time, for the timely, correct, and valuable work you perform on construction projects? Well, yes, but the industry’s pay-if-paid clause gets in the way. “Risk Transfer Vehicle”: Another Term for Funding a Project with YOUR MONEY! The pay-if-paid clause —which is almost ubiquitous in modern construction subcontracts — states essentially that a GC has no obligation to pay subcontractors for project labor or materials unless and until the owner pays the GC for that work or materials. What this boils down to is risk transfer. On any construction project, there is a risk (large or small based on the project) that the owner won’t pay for all of the work. In a fair and open situation, the GC, being the party that has a contract with the owner, would take on the risk that the owner doesn’t pay, and as the party most able to pressure the owner, would work to protect everyone from the risk of owner nonpayment. That is, without a pay-if-paid clause, the GC is at
risk because it must still pay subcontractors for their work even if the owner doesn’t pay the GC. What the pay-if-paid clause does is transfer that risk of owner nonpayment down to the subcontractor. Now, if the owner doesn’t pay, the GC can avoid paying subcontractors for their work. But subcontractors still have to pay for labor and materials, so they now own the risk of loss. That is, under a pay-if-paid regime, if the owner doesn’t pay, the subcontractors are at risk of getting stuck with the bill for the labor and materials they supplied, even though they often have no direct communication with the owner. In practical (or maybe inherently impractical) terms, what this means is that subcontractors are the unsung funders of construction projects. You pay for the labor and materials in the normal course of business. Then you wait sometimes many months to get paid. And you don’t even get paid interest on what you are owed, the way a bank would. Perverse Incentives: How the Pay-if-Paid ClauseWreaks Havoc. One huge problem with the pay-if-paid clause is that is perverts the GC’s incentives on a construction project. What should happen is that – as the party liaising with the owner and “in charge” of getting everyone paid – the GC should be incentivized to fight every day to get fair payment out of the owner. Without a pay-if- paid clause, the GC is properly incentivized because it might have to pay subcontractors out of its own pockets if it doesn’t collect from the owner. Under a pay-if-paid clause, however, the GC isn’t really losing out if the owner slow-walks or refuses to pay for portions of a project. Instead, it’s the subcontractors that are losing out. The result is that
Continued on Back ...
jwyatt@harrisonlawgroup.com
www.HarrisonLawGroup.com
(410) 832-0000
Made with FlippingBook Online newsletter