THE APPLICATION OF “PAY WHEN PAID” PROVISIONS

IN CONSTRUCTION SUB-CONTRACT

NASYIRA BINTI IBRAHIM

UNIVERSITI TEKNOLOGI MALAYSIA

PSZ 19:16 (Pind. 1/07)

UNIVERSITI TEKNOLOGI MALAYSIA

DECLARATION OF THESIS / UNDERGRADUATE PROJECT PAPER AND COPYRIGHT

Author’s full name : NASYIRA BINTI IBRAHIM Date of birth : 14 MAY 1986 Title : THE APPLICATION OF “PAY WHEN PAID” PROVISION S IN CONSTRUCTION SUB-CONTRACT Academic Session : 2008/2009 I declare that this thesis is classified as:

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CONFIDENTIAL (Contains confidential information under the Official Secret Act 1972)*

RESTRICTED (Contains restricted information as specified by the organization where research was done)*

OPEN ACCESS I agree that my thesis to be published as online open access (full text)

I acknowledged that Universiti Teknologi Malaysia reserves the right as follows:

1. The thesis is the property of Universiti Teknologi Malaysia. 2. The Library of Universiti Teknologi Malaysia has the right to make copies for the

purpose of research only. 3. The Library has the right to make copies of the thesis for academic exchange.

Certified by:

SIGNATURE SIGNATURE OF SUPERVISOR 860514-29-5652 EN NORAZAM BIN OTHMAN

NEW IC NO. /PASSPORT NO. NAME OF SUPERVISOR Date: 7 JULY 2009 Date:

NOTES : * If the thesis is CONFIDENTAL or RESTRICTED, please attach with the letter from the organization with period and reasons for confidentiality or restriction.

“I hereby declare that I have read this thesis and in

My opinion this thesis is sufficient in terms of scope and

quality for the award of the degree of

Master of Science (Construction Contract Management)”

Signature : …………………………………...

Name of Supervisor : EN. NORAZAM BIN OTHMAN

Date : …………………………………...

THE APPLICATION OF “PAY WHEN PAID” PROVISIONS IN CONSTRUCTION

SUB-CONTRACT

NASYIRA BINTI IBRAHIM

A project report submitted in partial fulfillment of the

requirements for the award of the degree of

Master of Science (Construction Contract Management)

Faculty of Built Environment

Universiti Teknologi Malaysia

JULY 2009

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DECLARATION

I declare that this project report entitled “The Application of “Pay When Paid”

Provisions in Construction Sub-Contracts” is the result of my own

research except as cited in the references. The project report has not been accepted

for any degree and is not concurrently submitted in candidature of any other degree

Signature : ………………………………

Name : NASYIRA BINTI IBRAHIM

Date : ………………………………

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DEDICATION

Specially dedicated ………

To my parents …… ‘Encik Ibrahim Mohd Amin & Puan Jaradah Hj Abdul Majid’

To my sisters …… ‘Nadya Alina, Nadwanie Harniza, Nazlin, Nazirah’

To my brother …… ‘Mohd Nazriey’

To my lovely friends …… ‘Sakina, Hairani, Roslinda, Haizan’

………………………………… Thank you for everything

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ACKNOWLEDGEMENT

A debt of gratitude is owed to many individuals who have given me the benefit of

their unconditional help, tolerance and knowledge in writing and completing this master

project. First for all, I would like to express my highest gratitude to my supervisor, Encik

Norazam Othman for his guidance, advice and support in order to complete this master

project.

Next, to my special thanks are due to all the lecturers for the course of Master of

Science (Construction Contract Management), for their patient and kind advice during the

process of completing of master project.

Not forgetting my dearest parents, brothers and sisters, a token of appreciation

goes to then for giving full support. Lastly, I would like to express my special thanks my

fellow classmates, who have in their own way helped me a great deal throughout the

preparation and production stages of this master project.

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ABSTRACT

For years, general contractors have often enclosed a contractual provision of “pay when

paid” in their subcontracts providing that payment to the subcontractor is conditioned

upon the general contractor’s actual receipt of payment from the owner. “Pay-when-paid”

clauses while seemingly straightforward at first glance but many are actually ambiguous.

Instead of “pay when paid” arrangement waiving the right of the subcontractor to be paid,

there is competing argument that this clause speaks to timing of payment. Hence, this

research intends to identify whether “pay when paid” arrangement in construction sub-

contract waiving the right of the subcontractor to be paid or simply a timing mechanism.

This research was carried out mainly through documentary analysis of law journals and

law reports. Results shows that 8 out of 11 cases identify that “pay when paid” provision

in the sub-contract constitute as timing mechanism. “Pay When Paid” provision may

become either as timing mechanism and waiving the subcontractor right to be paid. Most

of the cases cited that wording of the contractual language in the sub-contract is critical in

identify the application of “pay when paid” provis ion. Unambiguously and sufficiently

clearly contractual language must have been used in order for a court to construe such a

clause imposed payment to the main contractor as condition precedent to the

subcontractor’s right to be paid, rather than limiting the time for payment. Once a judge

decides that provision is ambiguous there is nothing for the jury to decide or interpret.

Therefore, the subcontractor may take the legal action to challenge the enforceability of

the clause to seek immediate payment when they have suffering the risk of non-payment

due to the performance problems unrelated to their own work.

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ABSTRAK

Selama bertahun-tahun, kontraktor utama kerap kali memasukkan peruntukan berkontrak “bayar apabila dibayar” dalam sub-kontrak pembinaan dengan memperuntukkan bahawa pembayaran kepada subkontraktor berdasarkan keadaan kontraktor menerima pembayaran sebenar daripada pemilik. Kluasa “bayar apabila dibayar” sekilas pandang jelas dan mudah maknanya tetapi kebanyakkannya adalah kabur maknanya. Selain daripada provisyen “bayar apabila dibayar” mengenetepikan hak subkontrak untuk mendapat pembayaran, terdapat percaturan lain yang menyatakan bahawa klausa ini bercakap mengenai masa untuk mendapatkan pembayaran. Oleh itu, kajian ini bertujuan untuk mengenalpasti samada peruntukan “bayar apabila dibayar” di dalam sub-kontrak pembinaan mengenepikan hak subkontraktor untuk mendapatkan pembayaran atau ianya mengenakan tempoh masa untuk membuat pembayaran. Kajian ini dijalankan melalui analisis dokumen, iaitu laporan dan jurnal undang-undang. Kajian ini menunjukkan 8 daripada 11 kes menunjukkan klausa “bayar apabila dibayar” mengenakan tempoh masa untuk membuat pembayaran. Peruntukan “bayar apabila dibayar” boleh dianggap sebagai mekanisme masa dan juga sebagai mengenepikan hak subkontraktor untuk mendapat pembayaran. Kesuluruhan kes menyatakan bahawa bahasa kontrak adalah kritikal (amat penting) dalam menentukan aplikasi klausa “bayar apabila dibayar”. Klausa yang cukup jelas dan terang tanpa maksud yang samar adalah penting untuk memastikan mahkamah memutuskan bahawa klausa tersebut mengenakan pembayaran kepada kontraktor adalah duluan kepada hak subkontraktor untuk dibayar, selain daripada menghadkan tempoh pembayaran. Apabila hakim memutuskan apabila klausa tersebut samar maknanya adalah tiada kemungkinan untuk juri dan hakim untuk memutuskan dan mengolahkannya lagi. Oleh itu, subkontraktor boleh mangambil tindakan mahkamah dalam mencabar keberkuatkuasaan klausa tersebut dalam mendapatkan pembayaran secara cepat apabila mereka dalam risiko tidak dibayar berdasarkan masalah perlaksanaan yang tiada kaitan dengan kerjanya.

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TABLE OF CONTENT

CHAPTER TITLE PAGE

DECLARATION....................................................................................... ii

DEDICATION.......................................................................................... iii

ACKNOWLEDGEMENT....................................................................... iv

ABSTRACT ............................................................................................... v

ABSTRAK ................................................................................................ vi

TABLE OF CONTENTS ....................................................................... vii

LIST OF TABLES .................................................................................... x

LIST OF ABBREVATIONS ................................................................... xi

LIST OF CASES .................................................................................... xiii

LIST OF APPENDICES ...................................................................... xvii

1 INTRODUCTION..................................................................................... 1

1.1 Background of Research ....................................................................... 1

1.2 Problem Statement ................................................................................ 3

1.3 Objective of Research ........................................................................... 8

1.4 Scope and Limitation of Research ........................................................ 8

1.5 Significance of Research ....................................................................... 9

1.6 Research Methodology.......................................................................... 9

1.6.1 Stage 1: Identifying the Research Issue ..................................... 10

1.6.2 Stage 2: Literature Review ......................................................... 10

1.6.3 Stage 3: Data Collection............................................................. 11

1.6.4 Stage 4: Data Analysis ............................................................... 11

1.6.5 Stage 5: Conclusion and Recommendations .............................. 12

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2 LIABILITY OF THE SUB-CONTRACTOR ...................................... 13

2.1 Introduction ......................................................................................... 13

2.2 The Contractual Chain ........................................................................ 14

2.3 The Contractual Status of a Subcontractor with the Owner................ 15

2.4 Liability of the Sub-Contractor ........................................................... 16

2.4.1 Liability in Contract .................................................................... 16

2.4.2 Liability in Tort ........................................................................... 17

2.5 Legal and Contractual Background of Subcontractor Rights

to Payment ........................................................................................... 18

2.6 Relationship of Subcontractor’s Statutory Right to Recover

for Non-Payment with “Pay When Paid” Provisions in the

Sub-Contract ......................................................................................... 19

2.6.1 Security of Payment ..................................................................... 19

2.6.2 Enforcement of Payment .............................................................. 21

2.7 Summary .............................................................................................. 22

3 APPLICATION OF “PAY-WHEN-PAID” PROVISIONS

IN SUB-CONTRACT .............................................................................. 23

3.1 Introduction .......................................................................................... 23

3.2 Definition of “Pay When Paid” ............................................................ 25

3.3 “Pay When Paid” Provisions in Sub-Contracts.................................... 26

3.4 Non-Payment by the Employer/Owner

(Relying on “Pay When Paid” Provision in Sub-Contract) .................. 29

3.4.1 Contractor Contribution to Non-Payment by the Employer ........ 29

3.4.2 The Insolvency by the Employer ................................................. 30

3.4.3 Final Payment Pending Dispute between the Employer

and the Main Contractor ............................................................... 32

3.5 Application of “Pay When Paid” Provisions in Sub-Contract ............ 33

3.5.1 The “Pay When Paid Clause is a Covenant Establishing

the Time of Payment ..................................................................... 33

3.5.2 “Pay When Paid” Provisions as Condition Precedent .................. 40

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3.6 Reasonable Time ................................................................................. 55

3.6.1 A Mechanism to Determine When Payment is due ................... 56

3.7 Issues Regarding to “Pay When Paid” Provisions .............................. 59

3.7.1 Prevention Doctrine ................................................................... 59

3.7.2 Summary Judgment.................................................................... 61

3.7.3 Payment Bond Surety................................................................. 63

3.7.4 Contractor’s Own Default .......................................................... 65

3.8 Conclusion........................................................................................... 67

4 ANALYSIS ON THE APPLICATION OF “PAY WHEN PAID”

PROVISIONS IN SUB-CONTRACTS .................................................. 69

4.1 Introduction .......................................................................................... 69

4.2 The Application of “Pay When Paid” Provision in Sub-Contract ....... 70

4.2.1 “Pay When Paid” Suggest Time of Payment .............................. 72

4.2.2 “Pay When Paid” As Condition Precedent ................................. 95

4.3 Conclusion.......................................................................................... 106

5 CONCLUSION AND RECOMMENDATIONS ................................. 109

5.1 Introduction ........................................................................................ 109

5.2 Summary of Research Finding ........................................................... 109

5.3 Problem Encountered during Research .............................................. 128

5.4 Conclusion.......................................................................................... 128

REFERENCES ....................................................................................... 129

APPENDIX A ......................................................................................... 133

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LIST OF TABLES

TABLE NO TITLE PAGE

3.1 The Application of the “Pay When Paid” Provisions 48

In Construction Sub-Contracts

5.1 Judgment on the Application of the ‘Pay When Paid”

Provisions in Construction Sub-Contracts 111

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LIST OF ABBREVATIONS

AC Law Report Appeal Cases

ALJ Australian Law Journal

ALR Australian Law Report

CA Court of Appeal

CIDB Construction Industry Development Board

DC Division Court England

DLR Dominion Law Reports

FC Federal Court

HL House of Lords

HKC Hong Kong Case

HKLR Hong Kong Law Reports

IEM The Institution of Engineers, Malaysia

LGR Local Government Reports

LR Law Reports

JP Justice of the Peace

MBAM Master Builders Association

MLJ Malayan Law Journal

NS Nova Scotia

NZLR New Zealand Law Reports

PAM Pertubuhan Arkitek Malaysia

PWD Public Work Development

PD Probate, Divorce, and Admiralty Division of High Court

xii

SLR Singapore Law Report

UM University of Malaya

USA United State of America

WLR Weekly Law Report

WR Weekly Reports

xiii

LIST OF CASES

CASES PAGE

Timbro Development Ltd. v. Grimsby Diesel Motors Inc. et. al. (1988) 32 C.L.R. 32 (Ontario Court of Appeal) 6,44 Arnoldin Construction & Forms Limited v. Alta Surety Co (1995) 19 C.L.R. (2d) 1 (Nova Scotia Court of Appeal) 6 Schindler Lifts (Hong Kong) Ltd v. Shui On Construction Co Ltd (1984) 7 Nin Hing Electronic Engineering Ltd v. Aoki Corporation (1987) 7 Brightside Mechanical & Electrical Services Group Ltd v. Hyundai Engineering & Construction Co Ltd (1988) 7 Thomas J Dyer vs. Bishop International Engineering Co. 303 F 2d 655 (1962) 7,31,

35,37 Markel & Co. Contractors vs. Christian Co 7 Tweddle v. Atkinson (1861) IB & S 393 14 R&G Engineering Sdn Bhd v. ESPL (M) Sdn Bhd[2004] 4 CLJ 674 20 Kah Seng Construction Sdn Bhd v. Selsin Development Sdn Bhd [1997] 1 CLJ Supp 448 21 DEC Elec., Inc. v. Raphael Construstion. Corp 558 So. 2d 427 (Fla. 1990) 25,30, 34,43

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North Market Assn., Inc. v. Case 25 Lezzi Construction Pty Ltd v. Watkins Pacific (Queensland) Pty Ltd (1995) 2QdR350 28 Moore Brothers Co. v. Brown Root Inc. (2000) 207 F.3d 717 29 Aqua Design and Play International Limited and Fenlock Hansen Limited v. Kier Regional Limited (2002) CA 31 United Plate Glass Co. v. Metal Trims Indus Inc. (1987) 106 Pa. Commw. 22,525 A.2d 468 32 Pace Construction Corporation v. OBS Co[1988] 531 So. 2d 737 Fla. Dist. Ct. App. David C. Olson, Inc. v. Denver & Rio Grande W.R.R. Co., 789 P.2d 492 (Colo. Ct. App. 1990) 33 Power & Pollution Services, Inc. v. Suburban Power Piping Corp 47 Ohio App. 3d 89 (Cuyahoga County 1991) 36 Seal Tite Corp. v. Ehret, Inc589 F. Supp. 701 (D.N.J. 1984) 37 Mignot v. Parkhill391 P.2d 755, 758 (Or. 1964) 37 Berkel & Company Constractors v. Christman Company 210 Mich. App. 416, 533 N.W.2d 838 (1995) West-Fair Electric Contractors v. Aetna Casualty & Surety Company 87 N.Y. 2d 148, 638 N.Y.S. 2d 394, 661 N.E.2d 967 (1995) 38 A.J. Wolfe Co. v. Baltimore Contractors Inc., 244 N.E.2d 717, 720 (Mass. 1969) 38 Southern States Masonry Inc. v. JA Jones Construction Company (1987) 507 So. 2d 198 39 John J. Calnan Co. v. Talsma Builders, Inc., 395 N.E.2d 1076, 1080 (lll App. Ct. 1979). 41 Harvey Concrete, Inc. v. Agro Construction & Supply Co. 939 P.2d 811 (Ariz. Ct. App. 1997) 41 Printz Services Corp. v. Main Electric Ltd. 949 P.2d 77 (Colo. Ct. App. 1997) 42

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Robert F. Wilson, Inc., v. Post-Tensioned Structures, Inc., 522 So. 2d 70 (Fla. 3d DCA 1988) 42 Peacock Construction Co., Inc. v. Modern Air Conditioning, Inc353 So.2d 840 (Fla. 1977) 44,45 OBS v. Pace Construction Corporation 558 So. 2d 404 (Fla. 1990) 44 Kor-Ban Inc. v. Pigott Construction Ltd. 44 J.J. Shane v. Aetna Casualty & Surety Company 723 So. 2d 302 (Fla. 3d DCA 1998), reh. den. 46 Smith & Smith Glass Ltd. v. Winstone Architectural Cladding System Ltd. (1991). 60 Goldblatt v. Longacre Const. Co. 170 N.Y.S. 54 (1st Dept. App.T. 1918) 61 Wetter v. Kleinert139 A.D. 220, 123 N.Y.S. 755 (2nd Dept. 1910) 61 ADF Int’l, Inc. v. Baker Mellon Stuart Court., Inc. Case No. 6:98-cv-1310-Orl-31B, (M.D.Fla.Dec.28, 2000), 2000 U.S.Dist.LEXIS 22597 62 R&L Acoustics v. Liberty Mut. Ins. Co. (September 27, 2001) Conn. Super., LEXIS 2854 62 Framingham Heavy Equip. Co. v. John T. Callahan & Sons No.02-P-1159 (2003) 61 Mass. App. Ct. 171, 807 N.E.2d 851 62 Lafayette Steel Erectors, Inc. v. Roy Anderson Corp. 71 F. Supp. 2d 582; (S.D. Miss. 1997) LEXIS 23587 63 Lowy and Donnath, Inc. v.New York98 A.D.2d 42, 469 N.Y.S.2d 760 (1st Dept. 1983), aff’d 62 N.Y.2d 746, 476 N.Y.S.2d 830 (1984). 64 Grossman Steel and Aluminum Corp. v. Samson Window Corp., 78 A.D.2d 871, 433 N.Y.S.2d 31 (2nd Dept. 1980), aff d 54 N.Y.2d 653, 442 N.Y.S.2d 769 (1981) Galloway Corp. v. S.R. Ballard Constr. Co. 250 Va 493, 494 S.E.2d 349 (1995) (Virginia Supreme Court) 64

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Blakeslee Arpaia Chapman v. EI Construction, Inc. 239 Conn. 708, 687 A.2d 506 (1997) 64 Moore Brothers Co. v. Brown & Root, Inc. 207 F.3d 717 (2000) 66,69 Northeast Drilling, Inc. v. Inner Space Services, Inc. 66 Alloy Automotive Sdn Bhd v. Perusahaan Ironfield Sdn Bhd [1986] 1 MLJ 382 (SC) 67 Malayan Insurance (M) Sdn Bhd v. Asia Hotel Sdn Bhd [1987] 2 MLJ 183 (SC), 67 Hong Kong Teakwood Works Ltd. v. Shui On Construction Co. Ltd. [1984] HKLR 23 68 Schindler Lifts (Hong Kong) Ltd. v. Shui On Construction Co. Ltd. [1985] HKLR 118 68 United States ex rel. Walton Technology v. Weststar Engineering Inc. 290 F.3d 1199 (9th Cir. 2002) 69 Brown & Kerr, Inc. v. St. Paul Fire and Marine Insurance Co. 940 F. Supp. 1245, 1249 (N.D. III. 1990) 70 Casey Indus. Inc. v. Seaboard Surety Co 2006 WL 2850652, *7 (E.D. Va. 2006) 71 Durabella Limited v. J. Jarvis & Sons Limited (2001) 70 Sassenrath v. Sassenrath657 S.W. 2d 671, 674 (Mo. Ct. App. 1983) 73 AEE-EMF v. Passmore906 S.W. 2d 714 (Mo. Ct. App. 1995) 73 Preload v. Marino Construction1991 WL 202651 (N.D. I11. 1991) 73

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LIST OF APPENDICES

APPENDIX TITLE PAGE

A Contingent Payment Clauses in the 50 States” by the

Foundation of the American Subcontractors Association 133

(FASA)

1

CHAPTER 1

INTRODUCTION

1.1 Background of Research

The modern construction project is so marvelously complex that is amazing that

anything ever gets built1. Construction projects can best be understood in the context of

the whole industry. Technological complexity ranges from the familiar, well known-

materials and trades through to highly complex facilities involving multiple interacting

sub-systems2. Besides that, it is labor intensive with manpower remaining the most

important and critical resources for a cons truction project3. Project have multitude of

1 Fullerton, J.D. (2008). Changes, Delays and Other Claims. 2 Murdoch, J. and Hughes, W. (2008). Construction Contracts: Law and Management 4th Edition. London and New York: Taylor & Francis. Pg 3 3 Ng Chu Yin (2006). Problems Associated With Nominated Subcontractor in Malaysian Construction Industry. Johor: Universiti Teknologi Malaysia. Pg1

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players, including owners, general contractors, subcontractors, architects, engineers, and

various material suppliers and laborers4.

Letting work to subcontractors is a very common practice in construction

industry. It is common for 80 percent to 90 percent of the work to be performed by

subcontractors5. Subcontractor is specialized providers of particular construction

services and often the necessary materials for their work. Subcontractors include

masons, plumbers, electricians, painters, glaziers, roofers, and other mechanics.

Traditionally, subcontractors enter into contracts with the Contractor (not the Owner)

and acquire the materials necessary to perform the subcontracts from Supplier. First-tier

Subcontractors often subcontract various portions of their responsibilities to lower-tier

subcontractors, each of which may acquire their materials from numerous suppliers6.

The general contractor is responsible for coordination of all these subcontractors.

Variance in experience or competence in this coordination can dramatically impact a

project7.

Subcontracting has always been important in the construction industry,

particularly in building construction where the production process is divided into

number of discrete. These task or activities are often carries out sequentially and may

require specialized labor. Subcontractors help contractors overcome problems including

the need of special expertise, shortage in resources, and limitations in finance8. The

successful completion of construction contracts, particularly in building construction,

depends in large measure on the quality and timely performance of the subcontractor.

4 Rippeon, Z. (2007). Conditional Payment Clauses in Construction Contracts. Georgia: Georgia State University College of Law. 5 Ng Chu Yin (2006). Problems Associated With Nominated Subcontractor in Malaysian Construction Industry. Johor: Universiti Teknologi Malaysia. Pg 2 6 McCarroll, B. (2006). The Construction Process from Start to Finish in Texas. Lorman Education Services, Texas. Pg4-5 7 Fullerton, J.D. (2008). Changes, Delays and Other Claims. 8 Ng Chu Yin (2006). Problems Associated With Nominated Subcontractor in Malaysian Construction Industry. Johor: Universiti Teknologi Malaysia

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Contingent payment provisions are found in nearly every construction contract,

particularly for commercial development9. A contingent payment clause is a contractual

provision that makes payment contingent upon the happening of some event. In

construction subcontracts, the typical contingent payment clause makes the

subcontractor’s payment contingent upon the payment of the contractor by the owner10.

One common form is the “pay when paid” clause, which establishes a reasonable

timeframe for subcontractor payment to occur, not when the relevant sum was certified

by the contract administrator, but only when the general contractor actually received the

money from the employer11. The “pay when paid” clause does not shift the risk of

owner nonpayment to the subcontractor, unless specifically and unambiguously stated

otherwise12.

1.2 Problem Statement

Contractors and subcontractors in the construction industry know the real

meaning of the famous phrase “cash flow is the lifeblood of the industry”. A contractor,

who pays a subcontractor before being paid by the employer, is effectively funding the

project. Add to this the cost of pursuing the employer for non-payment and the

precarious nature of construction becomes obvious. Insolvency of the employer in that

9 Rippeon, Z. (2007). Conditional Payment Clauses in Construction Contracts. Georgia: Georgia State University College of Law. 10 Hill, K.B. & Ritter (2008). Contingent Payment Clauses in the 50 States. Ohio: Foundation of the American Subcontractors Association 11 Murdoch, J. and Hughes, W. (2008). Construction Contracts: Law and Management 4 th Edition. London and New York: Taylor & Francis. Pg 276 12 Rippeon, Z (2007). Conditional Payment Clauses in Construction Contracts. Georg ia: Georgia State University College of Law.

4

situation can threaten the continued existence of the contractor. In the Government -

Inspired Banwell Report in 196413, Sir Harold Banwell commented that:

“The operation of the payment system is not always smooth. Payments to

the main contractor by the clients are often slow and uneven, with

consequential delays in payment to suppliers and subcontractors. This has

an adverse effect on the efficiency and stability of the whole industry …”

A recent survey done by the Construction Industry Development Board (CIDB)

in collaboration with the University Malaya (UM) ‘merely’ formally documents what

many in the construction industry already know is there is a chronic problem of delayed

and non-payment in the Malaysian construction industry affecting the entire delivery

chain14. Master Builders Association (MBAM) has long been lamenting on the problems

of delayed and non-payment in the construction industry.

Industry form documents can be used to create a fair contract for both parties.

Those same documents, however, can also be manipulated to gain unbalance the

agreement. While there are a multitude of clauses that can cause substantial and

unexpected financial trouble for the company, one of the most flagrant is the payment

clause15. In every construction contract, the general contractor and its subcontractors

must allocate the risk that the owner of the project either cannot, or will not, pay for the

work performed. The allocation of the risk can have a significant impact on the

profitability of the project for all parties, and can lead to protracted litigation16.

13 Pettigraw, R. (2005). Payment under Construction Contracts Legislation . Thomas Telford Ltd: London. Pg 2 14 Sr Nourshad Ali Naseem Ameer Ali (2006). A “Construction Industry Payment and Adjudication Act”: Reducing Payment-Default And Increasing Dispute Resolution Efficiency In Construction . Master Builders Journal 3rd Quarter 2006. Pg 4. 15 Russell, R. (2003). The Right Contract Means Preserving Cashflow. Builder Exchange Magazine Vol 8 Issue 03 16.Goodin, P.W. and Dickinson, J.C. (2002). Who Bears the Risks of Owner Non-Payment.? Midwest Construction Law, Contracts and Claims.)

5

General contractors sometimes try to avoid being stuck with liability for

subcontractor claims which can be passed through by writing “pay-when-paid” clauses

into their contract. These clauses attempt to pass the risk of the owner not paying on to

the subcontractor. This is something that may be missed by the subcontractor and can

work unfairly, especially where the subcontractor as in no position to assess the financial

strength of the owner17. In the absence of any such clause, if an owner fails to pay the

contractor for the work performed by the subcontractor, the main contractor is still

responsible for making any contractual payments due to the subcontractor 18.

Dealing with contingent payment clauses is a frequent headache for

subcontractors. Contingent payment clauses make subcontractors bear numerous risks

completely unrelated to their own performance. Delayed approval of applications for

payment by the architect, cash flow problems, pending and unpaid claims, and defective

performance by other subcontractors all may prevent payment to the general contractor

through no fault of the subcontractor. The resulting delay in payment impairs the

subcontractor's credit rating, depletes operating capital and lines of credit, and hurts the

subcontractor's relationships with its own trade creditors. Even worse, contingent

payment clauses compel subcontractors to continue to work even though they have not

been paid19.

The Employer may for instance withhold payment because of default by the

contractor or other subcontractors. Not surprisingly, contractors argue that “pay-when-

paid” clauses are a valid and legitimate protection against these risks. The subcontractor

on the other hand has an equally valid argument against “pay when paid” clauses. If he

has properly carried out the work, he argues, he should be entitled to be paid; otherwise

17 Logan, J.M. Pay-When-Paid Clauses-Construction Law. Canada. Pg1 18 Beckwith, A (2002). Pay-When-Paid Clauses: Risk Allocation and the need for Careful Drafting. Miller Thomson Construction Law Newsletter Summer 2002, Miller Thomson LLP:Washington DC, Pg 1 19 Nadine, H. G. and Patrick, C. B. (1999). Waiting to Get Paid: Pay When Paid Provisions a Matter of When or If. The Florida Bar Journal Volume LXXII No.9, October 1999, pg 64

6

he will run the risk of continued existence instead of the contractor. He should not

become involved in disputes between the employer and contractor, which may have

nothing at all to do with his work20.

Huxtable (1988) cited that, the way in which “pay when paid” clauses shift the

risks on to subcontractors has for a long time been criticized as unfair but they are still in

everyday use in standard form of sub-contracts in the countries of South-East Asia

(Murdoch, 2008). Therefore, it is no surprise that the courts have struggled. From the

cases of Timbro Development Ltd. v. Grimsby Diesel Motors21 and Arnoldin

Construction & Forms Limited v. Alta Surety Co.22, there are two lines of arguments.

The first is that if a clause indicates that the subcontractor will be paid when the

contractor is paid, that is a clear indication that “unless and until the contractor is paid

the subcontractor has no right to be paid and the risk of non payment by the owner is

borne by the subcontractor.” The competing argument is that the “pay-when-paid”

clause speaks to the timing of the payment but is not conclusive right to be paid. In other

words, in the ordinary course “the subcontractor will have to wait until the contractor is

paid but does not give their right to recover against the contractor in the event the

owner never pays the subcontractor23.” Therefore, the issue is whether a payment clause

is a true “pay when paid” arrangement waiving the right of the subcontractor to be paid

which payment to the subcontractor is condition precedent to payment by the owner to

the main contractor or is simply a timing mechanism.

Throughout the country, courts have differed on the interpretation of “pay-when-

paid” clauses which purport to make a general contractor’s duty to pay a subcontractor

conditional on its receiving payment from the owner. Some courts maintain that these

clauses should be loosely construed to mean that the general contractor’s obligation to

20 Atkinson, D (2001). Payment-Pay-When-Paid Clauses. England: Daniel Atkinson Limited. 21 Inc. et. al. (1988) 32 C.L.R. 32 (Ontario Court of Appeal) 22 (1995) 19 C.L.R. (2d) 1 (Nova Scotia Court of Appeal) 23 Logan, J.M. Pay-When-Paid Clauses- Construction Law. Pg 1

7

pay is not excused in the event of nonpayment by the owner24. Courts in Hong Kong and

Singapore have treated “pay when paid” clauses as valid and enforceable, at least to the

extent of protecting the main contractor’s cash flow by merely delaying the obligation to

pay the subcontractor 25. Courts in several jurisdictions have followed the reasoning of

Dyer26 to conclude that such a clause merely establishes a reasonable time in which

contractor can delay payment, but that is does not completely excuse payment. The

Michigan Court of Appeals in the case of Markel & Co. Contractors vs. Christian Co27

has held that such provisions are enforceable and that they indefinitely suspend the

contractor’s obligation to pay subcontractors until it has received payment from the

owner. However, such a provision may be excused under some circumstances, and they

may be unenforceable.

“Pay-when-paid” provisions may vary widely from state to state. Just because a

contractor presents a subcontractor with a contract provision does not mean that

provision is legally enforceable28. So, this research is looking to identify the application

of “pay when paid” clauses in construction sub-contracts, either “pay when paid”

arrangement in construction sub-contracts waiving the right of the subcontractor to be

paid or simply a timing mechanism. To what extend the “pay when paid” provisions

constitutes as a timing mechanism and as waiving the right of subcontractor to be paid.

24 Reeves, G.D. (1999). Enforceability of Conditional Payment Provisions in Construction Subcontracts. CAM Magazine August 1999 Edition 25 Schindler Lifts (Hong Kong) Ltd v. Shui On Construction Co Ltd (1984); Nin Hing Electronic Engineering Ltd v. Aoki Corporation (1987); Brightside Mechanical & Electrical Services Group Ltd v. Hyundai Engineering & Construction Co Ltd (1988) 26 The 1962 6th Circuit United States Court of Appeal decision in Thomas J Dyer vs. Bishop International Engineering Co. 303 F 2d 655 (1962). The approach taken principles in mind, which has been followed by most courts, is to examine the principles in mind: (1) the clear intention of the parties’ control; (2) ambiguous contracts should be construed against the drafter; and (3) conditions precedent is generally disfavored. 27 Reeves, G.D. (1999). Enforceability of Conditional Payment Provisions in Construction Subcontracts. CAM Magazine August 1999 Edition 28 Danner, P.D. Enforceability of Pay-When-Paid and Pay-If-Paid Clauses May Vary From State to State .

8

1.3 Objective of Research

Following the issues stated above, this research attempts:

1. To identify whether “pay when paid” arrangement in construction sub-

contract waiving the right of the subcontractor to be paid or simply a timing

mechanism.

1.4 Scope and Limitation of Research

The approach adopted in this study is case law based. The court cases referred in

this study include Malaysia, Singapore, Hong Kong, Florida, Ohio, Ontario, Illinois and

English cases. There is no limit to the cases chosen in terms of time frame, as long as it

has not been overruled by higher court and establishes a good law.

9

1.5 Significance of Research

Basically, this study is expected to answer some of the uncertain issues that arise

in “pay-when-paid” provisions in construction sub-contract. In accordance to that, issues

will be analysed based on the judge interpretation and judgment by the courts in various

state. Thus, by identifying the application of “pay when paid” arrangement either

waiving the right of the subcontractor to be paid or is simply a timing mechanism, it is

hope that this study would contribute toward enhancement of the subcontractor’s

knowledge and more understanding on how to defense their rights and take the legal

action to challenge the enforceability of the clause to seek immediate payment when

they have suffering the risk of non-payment due to the performance problems unrelated

to their own work. Finally, hopefully it assists in avoiding unnecessary disputes while

assuring the success and better relationship among the contractual parties.

1.6 Research Methodology

In order to achieve the objectives of this study, a systematic process of

conducting this study had been organized. Basically, this study process comprised of

five major stages, which involved identifying the study issue, literature review, data

collection, data analysis, conclusion and recommendations.

10

1.6.1 Stage 1: Identifying the Research Issue

The study issue arises from intensive reading of books, journals and articles

which can be attained from the UTM library and from internet. At the same time,

discussion with supervisors, lecturers, as well as friends, were held more ideas and

knowledge relating to the topic could be collected. Based on the study issue, the

objective of the study has been identified. In addition to that, this research is executed to

review the relevant court decisions, with the intention of identifying and determining the

application of “pay-when-paid” arrangement, either merely as timing mechanism or a

true “pay when paid” arrangement waiving the subcontractor(s) rights to be paid. To

what extend the court judgment tend to held that the application of “pay when paid”

provisions constitutes as a timing mechanism and waiving the right of subcontractor to

be paid.

1.6.2 Stage 2: Literature Review

Afterward, a research outline will be prepared in order to identify what kind of

data will be needed in this research. Collection of various documentation and literature

regarding the study field is of most important in achieving the research objectives.

Besides, secondary data is collected from reading materials in printing form like books,

journals, research paper, magazines, reports, proceedings, seminar paper as well as

information from internet and also by referring to standard contract forms (the PAM

1998 Form, PAM 1998 Sub-Contract Form, JKR PWD Form 203A and JKR PWD Form

203N).

11

Books, articles and journals relating to sub-contracting, “pay-when-paid”

clauses, and payment under construction contract will be read to know depth the theories

relating to the research field. All sources are important to complete the literature review

chapter.

1.6.3 Stage 3: Data Collection

Data will be collected mainly through documentary analysis. All collected data

and information were recorded systematically. Data collected to analyse mainly from

Malayan Law Journal, Hong Kong Law Report, Singapore Law Report, Building Law

Report, All England Law Report, and other law journals via UTM library electronic

database, namely Lexis-Nexis Legal Database. All the cases relating to the research

topic will be sort out from database. Important cases will be collected and used for the

analysis at the later stage.

1.6.4 Stage 4: Data Analysis

Once the previous related court cases are collected, it will be conducted by

reviewing and clarifying all the important facts of the cases and critical issues and

judgments. The application of “pay when paid” arrangement where the judges tend to

held that the contingent payment provision on “pay when paid” clauses in construction

subcontract merely as a timing mechanism or as waiving the subcontractor(s) rights to

be paid will be determined from the relevant cases. After issues presented by each cases,

thorough discussion and comparison will be done in order to achieve objectives of this

study.

12

1.6.5 Stage 5: Conclusion and Recommendations

The last stage of the research mainly involves writing up and checking the

writing. In this stage, reviews on the whole process of the study will be made with the

intention to identify whether the study objective has been achieved. Conclusion and

recommendation were made based on the findings during the stage of analysis.

13

CHAPTER 2

LIABILITY OF THE SUB-CONTRACTOR

2.1 Introduction

Construction was in highly technical in its nature. Even for those in the industry,

every trade in the team has varying levels of understanding and individual areas to focus

for the same item of work and, as such, everyone experience and point of view may be

unique.29 Construction projects generally involve a complex network of complimentary

and occasionally conflicting contractual rights and obligations. Standard forms of

contract exist which, with varying degrees of success, are meant to address the

29 Teresa Cheng, Evia Wong and Gry Soo (2004). Construction Law and Practice in Hong Kong . Sweet & Maxwell Asia. Pg 7

14

commercially reasonable balancing of rights and obligations, risks and rewards that is

necessary to the orderly functioning of this important construction industry30.

The used of standard form provides many advantages, and although standard

forms are not mandatory in practice their used should be encouraged in all possible

circumstances31. Sub-contracting as a phenomenon is not unique to the construction

sector. There are many influences on a business that encourage sub-contracting, and it is

useful to distinguish those pressures that are general (affecting all business) and those

that are specific (affecting the unique position of construction).32

This chapter provides an overview on the sub-contracting in the construction

industry. This include the contractual chain, the liability of the sub-contractor in contract

and tort, the subcontractors right to payment and the statutory rights to recover non-

payment by the main contractor relying to the “pay when paid” provision in sub-contract.

2.2 The Contractual Chain

The basic position in law that the main contract and sub-contract and the sub-

sub-contract (if there is one), are regarded as links in a chain33. The doctrine of privity of

contract means that the rights and obligations contained in each contract apply only to

30 Sternlieb (2007). Subcontractor’s Right to Payment. New Jersey Law Journal Vol. CXC-No.4-Index 399 October 22, 2007. 31 Ashworth, A. (1986). Contractual Procedures in the Construction Industry. London and New York: Logman. Pg 8 32 Murdoch, J. and Hughes, W. (2008). Construction Contracts: Law and Management 4 th Edition. London and New York: Taylor & Francis. Pg 267 33 Ibid. Pg 270

15

those who are parties to it34. The ‘chain liability’ works perfectly well as long as all the

links are intact. However, a chain can only as strong as its weakest link, and considerable

problems arise as soon as one of the links breaks35.

2.3 The Contractual Status of a Subcontractor with the Owner

There are normally exists no what one could call, in legal terms, ‘privity of

contract36’ between an Owner and his contractor’s sub-contractor. An owner is not

normally liable to a sub-contractor for payment, whether or not there is a “pay-when-

paid” provision in the sub-contract. The simple reason for this is that the owner is not a

party to the sub-contract. In the case of nominated sub-contracts under P.A.M. Form, it is

the case that the sub-contract entered into is instructed by the Owner or by the Architect

acting as an agent of the Owner, but the contractor in all such instances accept as a term

of his contract with the Owner that he will enter into the sub-contract and will take the

risk of non-performance by the sub-contractor37.

34 Ibid Pg 270 35 Ibid Pg 276 36 “Privity of Contract” provides that only the parties to the contract can claim benefits under it or be subject to the obligations which it imposes, See Tweddle v. Atkinson (1861) IB & S 393 37 Ir. Oong Chee Keng (2004). Institution of Engineering Public Forum On “Pay-When-Paid” Clauses in Construction Sub-Contracts-Held on 27 November 2004. Kuala Lumpur: IEM

16

2.4 Liability of the Sub-Contractor

As with other relationship in construction, liability may in principle arise either in

contract or in tort.

2.4.1 Liability in Contract

The doctrine of privity of contract means that it is not possible for a subcontractor

to be made directly liable to the employer for a breach of the main contract. Equally the

employer, who is not a party to the sub-contract, cannot claim damages for breach of it.

This means that, unless the main contractor is liable to reimburse the employer for the

loss caused by the sub-contractor, neither of them can sue the sub-contractor for the loss.

The only possible exception to this would be if the sub-contractor specifically undertakes

not to raise the ‘no loss’ defence when sued by the main contractor38.

The normal contractual structure consist a ‘chain of contract’ does not provide for

a direct claim by an employer against a sub-contractor. However, it is common for

nomination procedures to include a requirement that the sub-contractor and the employer

should enter into a direct contractual agreement. Where this is done, the agreement is

likely cover such matter as design warranty from the subcontractor and a direct payment

undertaking by the employer.39

38 Murdoch, J. and Hughes, W. (2008). Construction Contracts: Law and Management 4 th Edition. London and New York: Taylor & Francis. Pg 273 39 Ibid Pg 289

17

In addition to direct contracts that are expressly entered into, there is the

possibility that a court may construct, which means invent a collateral contract between

the employer and a subcontractor or supplier.40

2.4.2 Liability in Tort

There is at least the possibility that a nominated sub-contractor might incur direct

liability to the employer in tort of negligence in respect of work which is simply

defective. However, even if such liability can arise, it appears very unlikely that it will

extend to domestic sub-contractors, since their relationship with the employer is not

normally of sufficient ‘proximity’ to carry with a legal duty of care.41

As for the domestic sub-contractors who negligently cause physical damage,

either to the contract works or to existing structures (in cases where the contract is not a

new build), a different legal problem surfaces. It is whether something that appears to be

a straightforward case of negligence may be affected by the way in which the main

contract and sub-contract have chosen to allocate the risk among the parties.42

A nominated subcontractor is specifically selected by the employer raises an

additional possibility. This is that the reliance placed on the sub-contractor by the

employer may give rise to a relationship of such ‘proximity’ that the sub-contractor will

owe the employer a duty of care in tort not to cause pure economic loss through

negligence of performance of the sub-contract.

40 Murdoch, J. and Hughes, W. (2008). Construction Contracts: Law and Management 4 th Edition. London and New York: Taylor & Francis. Pg 289 41 Ibid Pg 273 42Ibid Pg 274

18

2.5 Legal and Contractual Background of Subcontractor Rights to Payment

The vast majority of commercial construction is performed by subcontractors. It

has been estimated that subcontractors accomplish between 80 percent and 90 percent of

the commercial construction. Subcontractors provide the majority of labor and materials

and have more capital invested in a construction project than general contractors and

design professionals. Thus, it could be argued that the subcontracting industry has more

at risk that those other segments of the construction industry43.

A subcontractor’s rights against the main contractor are concerned mainly with

payment. A straightforward application of contract law leads to the conclusion that the

payment rights of a sub-contractor are to be found exclusively within the terms of the

relevant sub-contract and that the main contract has no bearing on “pay-when-paid”

issue44.

A prime contractor prefers not to pay subcontractors until it is paid for their work

by the owner. If the contractor must pay despite the owner’s inability or refusal to pay,

the contractor in effect is acting as the owner’s surety, a role for which it is not really

suited. On the other hand, the subcontractor if anything is less equipped to handle owner

nonpayment. It has no direct contractual rights against the owner. Its contract instead is

with the prime. Unless the subcontracts validly provides otherwise, the failure of an

owner to pay the prime will not relieve the prime of its duty to pay a subcontractor 45.

43 Thomas , R.G. (2007). Killer Subcontractor Clauses. Texas:Thomas, Feldman & Wilshusen, L.L.P. 44 Murdoch, J. & Hughes, W. (2008). Construction Contracts Law and Management-Fourth Edition. London: Taylor & Francis Group 45 Lybeck, K.L. and Shreves, H.B. (1998). The Law of Payment Bonds. American Bar Association. Pg 262

19

2.6 Relationship of Subcontractor’s Statutory Right to Recover for Non-

Payment with “Pay When Paid” Provisions in the Sub-Contract

2.6.1 Security of Payment

It has been suggested that there are only three effective legal mechanisms to

provide security of payment, i.e the concept of the lien, trust and bond. Federal and

statutes govern mechanics’ liens (absent in Malaysia) on private projects and

performance and payment bonds on public projects that for subcontractors remain the

primary techniques for remedying nonpayment by a contractor. Legislation of these

remedies guarantees a subcontractor’s right to receive payment. Subcontractors, which

typically stand in a weaker bargaining position vis -à-vis contractor, depend on this

legislation to guarantee that contractors do not utilize their greater leverage during

contract formation to avoid payment for their subcontractors’ work46. The availability of

bonding and mechanics’ lien remedies may offer addition protections to alleviate the

subcontractor risks under “pay-when-paid” clause47.

The problem of security is to a considerable extent addressed in USA and Canada

by way of mechanic lien statutes which is absent in Malaysia. In gist, any unpaid

claimant who has expended labour or material to build has the right to apply for a lien to

be attached to the land whereon the building was constructed. After the entry of the lien,

the claimant can then apply to auction the building wherein the proceeds of sale will then

be utilized for payment. The dispute thus always centers on the unpaid claimant’s

application for lien which is often resolved via arbitration. The lien security nevertheless

usually takes effect from visible construction of the building long before the conclusion

46 Crushman , R.F. and Myers, J.J. (1999). Construction Law Handbook . Published by Aspen Publishers Online. Pg 895 47 Hughes, T.R. (2008). To Pay or Not to Pay. Hughes & Associates P.L.L.C.

20

of the arbitration and this makes the unpaid claimant a secured creditor usually second

only to the lending financier bank taking first priority as an even earlier secured

creditor48.

The trust concept is not alien in Malaysia in respect of retention monies. It is

provided in PAM 1969/1998 Form, CIDB 2000 Form and PAM NSC Form. The trust is

however a conditional one in that it permits the employer or the contractor to set off

permissible deductions there from. In the absence of the set off, the employer or the main

contractor may be compelled by way of an injunction to set aside the retention money

into a trust account. However, most of the time, the application is defeated by set offs. In

the unusual case of R&G Engineering Sdn Bhd v. ESPL (M) Sdn Bhd49, the Malaysia

Court of Appeal found that the progress payment under a sub-contract was subject to an

express trust and the Court ordered that the corpus of the trust i.e. unpaid progress

payment money be interlocutory secured pending trial notwithstanding set offs50.

Courts find that conditions precedent do not waive a subcontractors’ statutory

rights to file a mechanic’s lien or collect on a surety bond unless, in the case of

mechanic’s lien s, the legislation does not explicitly preclude the enforcement of

conditions precedent or, in the case of surety bonds, the subcontract has met the

requirements for an effective waiver51.

48 Lim Chong Fong . The Malaysian Construction Industry-The Present Dilemmas of the Unpaid Contractors. 49 [2004] 4 CLJ 674 50 Lim Chong Fong. The Malaysian Construction Industry-The Present Dilemmas of the Unpaid Contractor. 51 Crushman R.F. and Myers, J.J. (1999). Construction Law Handbook . Published by Aspen Publishers Online. Pg 895

21

2.6.2 Enforcement of Payment

In United Kingdom, New Zealand, the states of New South Wales, Victoria and

Western Australia and now Singapore, the principal mode of construction dispute

resolution has shifted to adjudication. This is a swift dispute resolution process that

results in a decision which carries “temporary finality” unless reversed in arbitration or

litigation. In the meanwhile the successful claimant is at liberty to enforce the decision52.

There are limited remedies and security pending dispute resolution for the unpaid

claimant in Malaysia. There is no general common law right of suspension of work for

non payment. In the Kah Seng Construction Sdn Bhd v. Selsin Development Sdn Bhd53,

Low Hop Bing J succinctly held:-

“In my judgment, it is trite law that a contractor can only terminate his contract

with his employer (at common law, as opposed to the exercise of an express

termination clause) if he shows, inter alia, a repudiatory breach by the employer

in the sense that the employer has evinced an absolute refusal not to perform his

side of the contract. There is no intermediate right in a building contract to

suspend works. If the contractor insists on the continued performance of the

contract, i.e. he affirms the contract he must himself continue to perform his

primary obligations under the contract, i.e. to continue performing the contract

works. This is why suspension of the works by the contractor, i.e. not continuing

with his primary obligations, becomes itself a repudiatory breach by the

contractor. Even if the plaintiff can establish that the defendant is in repudiatory

breach of contract, the plaintiff would have no right to suspend works, but instead

would have had to elect to wither terminate the contractor or insist on due

52 Lim Chong Fong. The Malaysian Construction Industry-The Present Dilemmas of the Unpaid Contractors. 53 [1997] 1 CLJ Supp 448

22

performance. By suspending works without valid legal cause, the plaintiff has in

fact repudiated its contractual obligations.”

The standard forms of construction contract do not provide for such a remedy

other than the CIDB 2000 Form and the PAM-NSC Form. The right of suspension is

quite useless if the sub-contracts are subjected to a “pay-when-paid” condition which is

rather common unless of course the contractor has absconded with the money paid by the

employer54.

2.7 Summary

The practice of efficient and timely payment in construction projects is a major

factor leading to a project’s success. Payment had been referred to as the lifeblood of the

construction industry due to latter’s inherent nature that takes relatively long durations

and large amounts to complete. Payment, or rather late and non-payment issues are

considered to affect many players in the local construction industry, whether in

government or private projects

54 Lim Chong Fong. The Malaysian Construction Industry-The Present Dilemmas of the Unpaid Contractors.

23

CHAPTER 3

APPLICATION OF “PAY-WHEN-PAID” PROVISIONS IN SUB-CONTRACT

3.1 Introduction

For years, throughout the country up-stream contractors, such as general

contractors, have often included a contractual provision in their subcontracts providing

that payment to the subcontractor is conditioned upon the general contractor’s actual

receipt of payment from the owner55. If drafted correctly, these clauses require the

subcontractor to wait for payment on their completed work until the general contractor

receives payment from the owner56. This essentially passes on the owner’s solvency risk

to the downstream subcontractor. No payment from the owner means no payment is due

55 Perlmuter, G.E. (2007). Michigan’s Winning Economy Wallops Construction Contractors. Has the Sting of a Pay-When-Paid Clause Gotten Your Attention?. Foster, Swift, Collins & Smith Construction Law Newsletter, November 2007. 56 Ibid

24

to the subcontractor. This clause, depending on their language, is commonly known as

“pay when paid” clauses57.

“Pay when paid” clauses while seemingly straightforward at first glance but many

are actually ambiguous58. Therefore, a subcontractor may want to take legal action to

challenge the enforceability of the clause and seek immediate payment from the general

contractor 59.

Construction sub-contracts which include the “pay when paid” clauses are the

most troublesome for the subcontractors and suppliers. One practical reason for risks

allocation in this manner is that owners were frequently successful transferring many of

these risks to general contractors in prime contracts. Having contractually accepted these

risks in prime contracts, it’s become prudent for general contractors to attempt to pass

them along the subcontractors. Regardless of the merits of the rationale behind the

extreme shifting of risks to subcontractors, the practice had many practical effects. First,

most subcontractors were smaller than the general contractors and less sophisticated in

these matters. That created unequal bargaining position in favor of the general

contractors. The studies conducted by the Construction Industry Institute60 find that the

risks shifting practice, unfortunately, promoted an adversarial attitude between the parties

which promoted disharmony on projects. Disharmony, in turn, created disputes on the job

site resulting in legal battles where no one is the real winner. In the end, unreasonable and

inequitable risk shifting in contracts worked to the detriment of overall project

performance61.

57 Sklar, A.J. & Sternlieb, M. (2007): The “Pay-If-Paid” Clause-A Suspect Subcontract Provision. Cole Schotz Docket, Fall 2007 58 Goodman, N.H. and Barthet, P.C. (1999). Waiting to Get PAID: Are Pay When Paid Provisions A Matter of When or If? The Florida Bar Journal, October 1999 Volume LXXIII, No.9 59 Sklar, A.J. & Sternlieb, M. (2007): The “Pay-If-Paid” Clause-A Suspect Subcontract Provision. Cole Schotz Docket, Fall 2007 60 Thomas R.G. (2007). Killer Subcontractor Clauses. Texas:Thomas,Feldman & Wilshusen, L.L.P. 61 Ibid.

25

This chapter provides the discussion on the non-payment regarding to the issues of

“pay when paid” provision in construction sub-contract. This discussion also concentrates

on the application of “pay-when-paid” provisions or arrangement in sub-contract and the

reasonableness of time the subcontractor have to wait to get paid from the general

contractor in the present of “pay when paid” provision in the sub-contract.

3.2 Definition of “Pay When Paid”

In the case of DEC Elec., Inc. v. Raphael Const. Corp.62, the “pay when paid”

language can be interpreted on the one hand as establishing a condition precedent in

which payment must first be received from the owner before it can be paid out to the

service provider, or, on the other hand, as simply fixing a reasonable time frame for when

payment is to be made 63.

Rosenberg (2007) stated that a clause that provides that payment is due when a

certain performance is completed is a pay-when-paid clause, imposing the obligation to

pay upon the general contractor within a specified or reasonable time. Further, in North

Market Assn., Inc. v. Case, a clause providing that payment is due if and when funds are

available was held to be pay-when-paid clause.

62 558 So. 2d 427 (Fla. 1990) 63 Goodman, N.H. and Barthet, P.C. (1999). Waiting to Get PAID: Are Pay When Paid Provisions A Matter of When or If? . The Florida Bar Journal, October 1999 Volume LXXIII, No.9

26

Pay-when-paid clauses are those clauses which defer the time when payment is

due from say a main contractor to a sub-contractor until the main contractor has received

payment from the client 64. Devine (2006) stated, the “pay-when-paid” language is an

absolute agreement of the general contractor to pay the subcontractor within a period of

time after the general contractor is paid by the owner. The general contractor has made an

unconditional promise to pay with the time payment postponed until happening of a

certain event, or for a reasonable period of time if the owner’s payment does not happen.

Such provisions do not absolutely bar payment, but merely delay the payment by the

contractor to the subcontractor for only a reasonable period of time to allow the general

contractor to attempt to collect payment from the project owner65.

Unlike a “pay-if-paid” clause, where the obligation to pay the subcontractor may

never ripen, a “pay-when-paid” clause is arguably only acts to delay payment to the

subcontractor 66.

3.3 “Pay When Paid” Provisions in Sub-Contracts

None of the nominated sub-contracts published in Malaysia including under the

PAM 69, PAM 98, PWD 203 series, IEM or CIDB 2000 contracts contain a “pay when

paid” clause. They all have “pay when certified” clauses. In other words, payment must

64 Sr Nourshad Ali Naseem Ameer Ali (2006). A “Construction Industry Payment And Adjudication Act”: Reducing Payment-Default And Increasing Dispute Resolution Efficiency In Construction . Master Builders Journal 3rd Quarter 2006. Pg 11 65 Devine, P. (2006). When Must A Subcontractor Be Paid Under A “Pay-When-Paid” Clause. Business Credit July/August 2006. National Association of Credit Management 66 Sklar, A.J. & Sternlieb, M. (2007). The “Pay-If-Paid” Clause-A Suspect Subcontract Provision. Cole Schotz Docket, Fall 2007.

27

be made by the main contractor upon certification by the certifier whether or not the main

contractor is paid in a timely manner as provided under the main contract67.

In PAM 98 contract form Clause 27.2 (vii) and Clause 11.3 in PAM Subcontract

form, the main contractor has to pay within 14 days to the nominated subcontractor after

he received payment certificate from the architect. It does not states that the contractor

has to wait until receipt of payment by the employer. So, in PAM 98 contract form, the

condition precedent of a nominated subcontractor to get his payment is certificate issued

to the main contractor.

Many contractor drafted ‘domestic’ sub-contract or sub-sub-contract contain

“pay-when-paid” provisions. Domestic sub-contracts are contracts which a contractor

enters into with a sub-contractor chosen by the contractor. The only standard terms of

‘domestic’ sub-contract published in Malaysia is the ‘Model Terms of Construction

Contract for Subcontract Work’ published in September 2006 does not have “pay-when-

paid” provision68.

Section 113(1) of the Housing Grants, Contract (sic “Construction”) and

Regeneration Act 1996 provides:

“(1) A provision making payment under a construction contract conditioned on

the payer receiving payment from a third person is ineffective, unless that third

person, or any other person payment by whom is under the contract (directly or

indirectly) a condition of payment by that third person, is insolvent.

67 Sr Nourshad Ali Naseem Ameer Ali (2006). A “Construction Industry Payment And Adjudication Act”: Reducing Payment-Default And Increasing Dispute Resolution Efficiency In Construction . Master Builders Journal 3rd Quarter 2006. Pg 10. 68 Ibid. Pg 11

28

It is submitted that under the 1996 Act, ‘pay when paid’ arrangement is

illegitimate. Hence, all contractors need to pay subcontractor despite they may not

receive interim payment from the Employer, unless the Employer is insolvent. This is the

UK scenario.

In Australia, the main contractor would be required to pay the subcontractor even

when the Employer went into liquidation as reported in an Australian case Lezzi

Construction Pty Ltd v. Watkins Pacific (Queensland) Pty Ltd (1995) 2QdR350.69

According to Hudson’s70 , under a Joint Venture attitude, the Contractor should not be

liable to pay nominated subcontractor (NSC) when the Employer goes bankrupt.

The proposed Construction Industry Payment and Adjudication Act (CIPAA)

aims to prohibit the practice of “pay when paid” in all construction contracts. All work

done and all services rendered must be paid upon the services being rendered. If there is

default up the chain of contracts the parties must resolve it themselves and not pass that

risk to third parties.

The effect of “pay when paid” clauses is that sub-contract may well end up not

being paid for reasons beyond their control. Worse still is a situation where s client may

set off amounts due to main contractor due to the main contractor’s own fault. The

subcontractor then does not get paid although they may have done their work properly

and were not in breach of their contract.

69 Bernard S C Wu (2005). Pay When Paid/Pay If Paid Under the Standard Form of Building Contract 2005. Hong Kong: Surveyors Times. Pg 38-39 70 Hudson’s Building & Engineering Contracts 11th Edition

29

3.4 Non-Payment by the Employer/Owner (Relying on “Pay When Paid”

Provision in Sub-Contract)

As stated in standard form of contract, the contractor have to pay the nominated

subcontractor when he receives payment certificate from the employer (PAM 98) or

when he receive payment from the employer (JKR 203N). The problems occur when the

employer does not pay the main contractor. There are three reasons contribute to non-

payment by the employer which are contractor contribution to non-payment by the

employer, the insolvency by the employer and final payment pending dispute between the

employer and the main contractor.

3.4.1 Contractor Contribution to Non-Payment by the Employer

The non-payment by the employer does not necessarily due to the employer

default in payment but the employer might withhold the payment due to the contractor

default. Question arises when the subcontractor request for payment but there is a pay-

when-paid provision in construction subcontract between general contractor and

subcontractor(s).

It was illustrated in the case Moore Brothers Co. v. Brown Root71. The case arose

out of construction of a toll way in Virginia. Brown & Root was the general contractor

and also was an equity owner in the project. The developer was Toll Road Investors

Partnership II (TRIP). Moore Brothers (Moore) was a subcontractor on the project. In the

subcontract, there was “pay when paid” provision. The lender (financing company for

client) insisted that Brown & Root provide assessments of the total project cost with a

71 Inc. (2000) 207 F.3d 717

30

high degree of certainty. TRIP and Brown made changes of scope of works but those

changes were not revealed to the lender and the subcontractor. The subcontractors were

instructed by Brown & Root to perform the work. Because the lenders had not been made

aware of the change orders, financing had not been arranged for the extra work. TRIP

was unable to obtain sufficient funding to pay Brown & Root, thus triggering the pay-

when-paid clause in the subcontractor.

The issue arose in this case was whether the contractor can based on the pay-

when-paid provision and withhold the payment to the subcontractor. It was held that the

main contractor has misled the lenders regarding possible costs of the project and thus,

the lender refused additional funding for the changes orders, the owners lacked sufficient

funds to pay Brown & Root, which then did not pay the subcontractor. So, the main

contractor was not entitled to the protection of the clause.

3.4.2 The Insolvency by the Employer

Problems arose when the main contractor refused to make payment to the

subcontractor when the employer become insolvent before full payment was made. This

problem is illustrating in the following cases. There are two different decision held

regarding to the issue of “pay when paid”, which is “pay when paid” provision in

enforceable and unenforceable.

There are some cases which held that the pay-when-paid clauses enforceable. In

DEC Electric, Inc. v. Rapheal Construction Corp.72., the subcontractor provided that ‘No

funds will be due to the subcontractor unless the general contractor is paid by the owner

72 (1989) 538 So. 2d 963, 964

31

in accordance to the sworn statement’. The court found, as a matter of law, that the

language was a condition precedent and that the subcontractor was not entitled to

payment from the general contractor because the general contractor had not been paid by

the owner.

Besides that in Aqua Design and Play International Limited and Fenlock Hansen

Limited v. Kier Regional Limited (2002) CA, Kier were the main contractors for fitting

out of a health and fitness centre at Chelmsford in Essex for a company called Heathland.

Aqua was engaged as subcontractor for the supply and installation of a swimming pool,

sauna room, and showers. Fenlock was subcontractor for glazed screens. Both

commenced proceedings against Kier who had refused payment on Clause 32 of the

contract, stated that “ Notwithstanding anything to the contrary elsewhere in this

subcontract, if the employer is insolvent as defined in Clauses 32.2, 32.3 and 32.4, the

Contractor shall not be obliged to make any further payment to the subcontractor of any

amount which is due or may become due to the subcontractor unless the Contractor has

received payment in respect thereof from the Employer and only to the extent of such

receipt”, Healthland went into administration. It was held that Kier was entitled to rely

upon the pay-when-paid provision afforded by the clause following the insolvency of its

client. It means that the contract clearly provides that payment is not due from the general

contractor to the subcontractor until the general contractor has been paid by the owner or

it is clearly stated that the contractor does not need to pay the subcontractor if the

employer has not pay the main contractor on the event of employer’s insolvency, such

clauses are enforced.

In the case of Thomas J.Dyer v. Bishop International Engineering Co.73, the

owner become insolvent before full payment was made to the general contractor, who in

turn refused to make full payment to the subcontractor. The court reviewed a provision

which stated that payment to the subcontractor shall not be due ‘until five days after the

73 (1962) 303 F.2d 655, 659

32

owner shall have paid the contractor’. It was held that ‘… it seems clear to us under the

facts of this case that it was the intention of the parties that the subcontractor would be

paid by general contractor for the labour and materials put into the project. We believe

that to be the normal construction of the relationship between the parties. If such was not

the intention of the parties it could have been expressed in unequivocal terms dealing

with the possible insolvency of the owner … to construe it as requiring the subcontractor

to wait until the general contractor has been paid by the owner, which may never occur,

is to give it an unreasonable construction which the parties did not intend at the time the

subcontract was entered into’. The court concluded that such a clause merely establishes

reasonable time in which the general contractor can delay payment, but that it does not

completely excuse payment.

Next, in the case of United Plate Glass Co. v. Metal Trims Indus74, the court

found that under the glass contracts in question, payment by the owner to the contractor

and approval by the architect were not absolute prerequisites to the contractor’s duty to

make final payment to the subcontractor. Rather, those conditions were timing

mechanism. Besides, the courts are reluctant to find that a subcontractor assumed the risk

of the owner’s insolvency absent extremely clear and unambiguous language.

3.4.3 Final Payment Pending Dispute between the Employer and the Main

Contractor

The problem which frequently arises is the subcontractor’s right to receive final

payment when there is a dispute pending between the employer and the contractor. It was

described in Pace Construction Corporation v. OBS Co.75. In this case, the agreement

between the contractor and the subcontractor contained a pay-when-paid clause, which 74 Inc. (1987) 106 Pa. Commw. 22,525 A.2d 468 75 [1988] 531 So. 2d 737 Fla. Dist. Ct. App.

33

provided that final payment of the subcontractor would not be made until the contractor

received final payment for the subcontractor’s work from the owner. The subcontractor

successfully completed its work. The court stated that this “pay when paid” clause clearly

shown that payment from the owner was a condition precedent to the contractor’s

obligation to make final payment to the subcontractor. The subcontractor was found to

have assumed the risk of owner non-payment. It was held that because the owner had not

make final payment to contractor, neither the contractor nor the surety could be held

liable unless the contractor received payment for the subcontractor’s work.

3.5 Application of “Pay When Paid” Provisions in Sub-Contract

3.5.1 The “Pay When Paid Clause is a Covenant Establishing the Time of Payment

Courts take a uniform stance on a general contractor’s duty to pay subcontractors,

stating that absent a contrary contractual provision, failure of an owner to pay a general

does not relieve the general contractor of the obligation to pay a subcontractor or

supplier76. Inclusion of a third – party payment provisions (“pay when paid” provisions)

refutes the presumption that the contractor has an absolute duty to pay the subcontractor

for services despite the nonperformance of the owner. Nonetheless, the majority of

jurisdictions still find a duty for the general contractor to pay any subcontractors or

suppliers when the construction contract includes a “pay when paid” provision. Instead of

interpreting such a clause as waiving the contractor’s financial obligations to the

76 David C. Olson, Inc. v. Denver & Rio Grande W.R.R. Co., 789 P.2d 492 (Colo. Ct. App. 1990)

34

subcontractor, courts hold that the clause merely delays the time of payment for a

reasonable time77.

In arriving at this conclusion, courts typically concentrate on the specific contract

language used as expressing the intention of the parties. When analyzing a “pay when

paid” provision, courts generally find that “if a provision is clear and unambiguous, it is

interpreted as setting a condition precedent to the general contractor’s obligation to pay.

If a provision is ambiguous, it is interpreted as fixing a reasonable time for the general

contractor to pay78.” While a general understanding persists on when a court will find a

“pay when paid” provision as only delaying the time of payment, no clear guidelines

exist for when a court will find the terms of a particular provision to be ambiguous.

However, analysis of some of the cases reveals a visible trend79.

The “pay when paid” clause is interpreted by courts across the country to relate

only to the timing of payment. A subcontractor still will be entitled to payment from a

general contractor after a reasonable period even if the building owner has not paid the

general contractor. Although there is no set time period to define what constitutes a

reasonable period, the critical lega l point is that the subcontractor ultimately is entitled to

payment 80. If the event that was to trigger payment does not occur for reasons not within

the subcontractor’s control, the subcontractor will be entitled to payment within a

reasonable time after completion81.

77 Crushman, R.F. and Myers, J.J. (1999). Construction Law Handbook . Published by Aspen Publishers Online. Pg 891 78 DEC Elec., Inc. v. Raphael Constr. Corp., 558 So. 2d 427, 429 (Fla. 1990) 79 Crushman, R.F. and Myers, J.J. (1999). Construction Law Handbook . Published by Aspen Publishers Online. Pg 892 80 Felin, M.S. and Philips, S.M. (2003). Understanding Payment Provisions. Roofing Magazine February 2003; Crushman, R.F. and Myers, J.J. (1999). Construction Law Handbook . Published by Aspen Publishers Online. Pg 891 81 Bruner, P.L. and Haley, T.L. Managing and Litigating the Complex Surety Case. American Bar Association. Tort Trial and Insurance. Pg 749

35

Timing mechanism means the clause merely provide general contractor with some

reasonable time period within which to make payment. When the payment provisions

seen as fixing a reasonable time frame for payment, the “pay-when-paid” language is

treated as absolute, unconditional promise by the general contractor to pay the

subcontractor, with the understanding that the payment may be delayed for some

reasonable time while the general contractor obtains payment from the owner82.

Specifically, when the “pay-when-paid” provision omits key words, or if the

provision contains language that mentions an amount of time when payment becomes

due, courts find the provision ambiguous83. Those jurisdictions that uphold conditional

payment clauses do so only where the intent of the contracting parties is unquestionably

clear84. In Thomas J. Dyer Co. v. Bishop International Engineering Co.85, it is stated that

the court rejected the general contractor’s defense that the contractual language which

provided that “no money owed to the subcontractor was due until five days after the

contractor’s receipt of funds from the owner” was a condition precedent that prevented

payment where the owner was insolvent. Concluding “that it was the intention of the

parties that the subcontractor would be paid by the general contractor for the labor and

material put into the project,” the Sixth Circuit determined that the provision was

designed to allow the contractor a reasonable period of time in which to pay the

subcontractor for work performed. Id. at 661. The Sixth Circuit opined that the credit risk

inherent in the general contractor’s undertaking could be shifted to the subcontractor, but

only where the contract contained express language “clearly showing that to be the

intention of the parties.’ The court interpreted these standard “pay-when-paid” clauses,

not as creating an absolute condition precedent to payment to the subcontractor, but

rather as affording the general contractor a postponement of payment for a reasonable

period of time to allow the general contractor an opportunity to collect funds due from

82 Goodman, N.H. and Barthet, P.C. (1999). Waiting to Get PAID: Are Pay When Paid Provisions A Matter of When or If? . The Florida Bar Journal, October 1999 Volume LXXIII, No.9) 83 Crushman, R.F. and Myers, J.J. (1999). Construction Law Handbook . Published by Aspen Publishers Online. Pg 892 84 Perry II, R.L. (2005). Nos. 31869 and 31870. Supreme Court of Appeals of West Virginia. Pg 3 85 303 F.2d 655, 661 (6th Cir. 1962)

36

the owner to pay the subcontractors, and not to require the subcontractor to wait an

indefinite period of time until the general contractor was paid by the owner.

Most court, including an Ohio appellate court in Power & Pollution Services, Inc.

v. Suburban Power Piping Corp86., has agreed with the analysis in Dyer. The general rule

in most jurisdictions is that, unless the contract clearly shows that the parties intended to

make payment from the owner a “condition precedent” to payment of the subcontractor,

the pay-when-paid clause governs only the timing of payments to the subcontractor but

does not allow the general contractor to avoid paying the subcontractor altogether. As in

Dyer, most courts interpret pay-when-paid clauses to require the general contractor to pay

the subcontractor within the “reasonable time” after the work is completed, even if the

owner has not paid the general contractor 87

In paragraph 13.111 Hudson’s Building & Engineering Contracts 11th Edition, it

is stated:

“In the United States, however, there have undoubtedly been a number of cases of

where the courts have held ‘pay-when-paid’ provision to be no bar to

subcontractor recovery once the subcontract has been properly completed.”

Hudson’s continues in paragraph 13.113 that ‘…those United States judgments

which have followed this trend have paid insufficient regard, it is submitted, to the

commercial background underlying subcontracting in the construction industry, and in

particular to the factor of potential owner insolvency…(for example, administration

severity by government or supervisory officers) it might also be intended that the risk

should be similarly shares … For this reasons, it seems unlikely that English Courts

86 47 Ohio App. 3d 89 (Cuyahoga County 1991) 87 Gurney, D.S. (2007). “Pay-When-Paid” Clauses: What Happens When the Owner Doesn’t Pay?. Published in The Constructor. Ohio: Frost Brown Todd LLC

37

would afford assistance to an unpaid subcontractor … or would afford dispense with the

condition imposed by a “pay-when-paid” provision … provided they considered that the

intention of the language was clear”

The 1984 Federal District of New Jersey case, Seal Tite Corp. v. Ehret, Inc.88 and

a 1962 Sixth Circuit Ohio law, Thomas J. Dyer Co. v. Bishop International Engineering

Co.89 decision also suggested that the parties to a subcontract could shift the risk of the

owner’s insolvency to the subcontractor, and make payment to the general contractor an

absolute condition precedent to payment to the subcontractor, provided that the

subcontract clearly and unequivocally so provides.

In Mignot v. Parkhill90, the Oregan Supreme Court construe a clause stating that

the “It is fully understood by and between the parties hereto that Contractor shall not be

to pay Subcontractor for any of the work until such time as Contractor has himself

received the money from [ the Owner]” only affected the time of payment. The court

concluded that:

“Where the contract contains a definite and unambiguous promise to pay for

labor and materials performed and furnished, or for other services, equally clear

an unambiguous language, expressing the intention that the happening of a

contingency over which the promise has no control shall be a condition precedent

to payment, must be found in the contract before the positive and absolute

agreement to pay will be considered as superseded.”

The key words of this provision, “until such time as,” combined with the absence

of any clear language that expresses the parties’ intention to create a condition precedent,

88 589 F. Supp. 701 (D.N.J. 1984) 89 303 F.2d 655, 661 (6th Cir. 1962) 90 391 P.2d 755, 758 (Or. 1964)

38

appeared as a stipulation for payment on receipt of a fund “ ‘inserted merely for the

purpose of fixing the time at which performance shall become due.’ ” Initially, this

provision seems to clearly express an intention to make payment to the subcontractor

conditional upon the owner’s payment to the general contractor, but the court required

language of a more specific nature. Short of any precise terms, such as “condition

precedent,” the contractual language could not be construed as anything but merely fixing

the time for payment.

In Berkel & Company Constractors v. Christman Company 210 Mich. App. 416,

533 N.W.2d 838 (1995), a subcontractor argued that the clause at issue was merely a

provision that postponed payment for a reasonable period of time, not indefinitely. The

Michigan Court disagreed, holding that: “The contract clearly provides that all payments

made to the subcontractor are to be made only from equivalent payments received by [the

general contractor] for work done, “the receipt of such payments by the [general

contractor] is being a condition precedent to payments to the subcontractor.”

In West-Fair Electric Contractors v. Aetna Casualty & Surety Company91, the

New York Court of Appeal held that “a “pay when paid” provision which forces the

subcontractor to assume the risk that the owner will fail to pay the general contractor is

void and unenforceable as contrary to public policy.” However the court also said “by

contrast, a pay-when-paid provision which merely fixes a time for payment does not

indefinitely suspend a subcontractor’s right to payment upon the failure of an owner to

pay the general contractor and does not violate public policy.”

A Massachusetts in the case of A.J. Wolfe Co. v. Baltimore Contractors92, court

found that a contract which provided that “payment will be made on monthly requisitions

91 87 N.Y. 2d 148, 638 N.Y.S. 2d 394, 661 N.E.2d 967 (1995) 92 Inc., 244 N.E.2d 717, 720 (Mass. 1969),

39

for progress payments “within 10 days after … [the owners’] payment of such monthly

progress payments … [has] been received’ ” by the contractor merely set the time for

payment and did not create a condition precedent. The court concludes that this language

did not amount to a clear provision “should be viewed only as postponing payment by the

general contractor for a reasonable time.”

In Southern States Masonry Inc. v. JA Jones Construction Company (1987) 507

So. 2d 198, the Supreme Court of Louisiana had interpreted a clause reading:

“3 … Contractor shall pay to Sub-contractor upon receipt of payment

from the Owner…”

“A final payment … shall be made within forty-five (45) days after the last

of the following to occur: (a) full completion of the Work by Sub-

contractor, (b) final acceptance of the work by the Architect … (c) final

payment by Owner …”

The court there held that clause could not be interpreted to mean “if” the sub-

contractor was to be paid but rather “when” it was to be paid. It interpreted the clauses in

that case as relating to the time when a contractor must pay the subcontractor and not to

the issue of whether the sub-contractor got paid at all.

Other reasons exist for rejecting an interpretation of third-party payment

provisions besides ambiguous contractual language. Invariably, courts hesitate to enforce

these provisions as conditions precedent if enforcement of the terms would result in an

extreme forfeiture by the subcontractor. Courts do not look favorably upon conditions

precedent, and if failure to meet conditions precedent results in a windfall to the general

contractor, courts may consider the condition excused. Furthermore, courts consider

general contractors to be in the best position to assess the solvency of the owner and bear

40

the risk of nonpayment. Unless absolute certain, courts do not transfer this risk from the

general contractor to the subcontractor. Finally courts have even determined that

subcontractors are an oppressed class that needs protection. Liberal application of third-

party payment provisions as conditions precedent adds another commercial advantage for

genera contractors, who already stand in a position of a greater resourcefulness and

bargaining power93. The courts decisions noted above, do acknowledge that third-party

payment clauses can constitute condition precedent. When the contractual language

explicitly stated the conditional nature of the payment relationship between the three

parties, courts have upheld the third-party payment provisions as precluding

subcontractors from recovery.

The court decisions noted above, however, do acknowledge that third-party

payment clauses can constitutes conditions precedent when the contractual language

explicitly stated the conditional nature of the payment relationship between the three

parties, courts have upheld the third-party payment provisions as precluding

subcontractors from recovery.

3.5.2 “Pay When Paid” Provisions as Condition Precedent

Despite the fact that one jurisdiction may conclude that a third-party payment

provision merely delays the time of payment, certain language, such as an agreement

with terms that explicitly state that the provision function as a condition precedent, may

lead the same jurisdiction to a different result94. An analysis of jurisdictions that have

ruled in favor of contractors on this issues helps to explain when “pay-when-paid”

93 Crushman, R.F. and Myers, J.J. (1999). Construction Law Handbook . Published by Aspen Publishers Online. Pg 894 94 Crushman, R.F. and Myers, J.J. (1999). Construction Law Handbook . Published by Aspen Publishers Online. Pg 894

41

provisions do not create an absolute duty to pay subcontractors95. When payment

provisions interpreted as a condition precedent, the provider will get paid only after

payment by the owner96.

Most courts have held that a “pay when paid” clause constitutes a conditional

promise and thus a condition precedent to the contractor’s obligation to pay the

subcontractor. These courts, however, have generally done do only after finding the

clause clearly and unambiguously expressed the intention of the parties to have the clause

work as a condition precedent 97. If there is a valid condition precedent in a contract, the

party in whose favor the condition exists is not obligated to perform an action required by

the contract until the condition has been satisfied98.

Most obviously, when the language within a third-party payment provision

explicitly states that the owner’s payment to the contractor is a condition precedent to the

contractor’s payment to the subcontractor; courts enforce the provision as a condition

precedent 99. In other word describe intend of the general contractor to shift the risk of

non-payment to the subcontractor 100. The Arizona Court of Appeal in Harvey Concrete,

Inc. v. Agro Construction & Supply Co.101, held that the following clause was plain

enough to shift the credit risk to the subcontractor:

“Subcontractor agrees as a condition precedent to payment…that the owner shall

have first paid the payment…to the contractor, and that payment for wither

95 Crushman, R.F. and Myers, J.J. (1999). Construction Law Handbook . Published by Aspen Publishers Online. Pg 894 96 Goodman, N.H. and Barthet, P.C. (1999). Waiting to Get PAID: Are Pay When Paid Provisions A Matter of When or If? . The Florida Bar Journal, October 1999 Volume LXXIII, No.9 97 Bruner, P.L. and Haley, T.L.. Managing and Litigating the Complex Surety Case. American Bar Association. Tort Trial and Insurance. 98 See John J. Calnan Co. v. Talsma Builders, Inc., 395 N.E.2d 1076, 1080 (lll App. Ct. 1979). 99 Crushman, R.F. and Myers, J.J. (1999). Construction Law Handbook . Published by Aspen Publishers Online. Pg 894 100 Gurney, D.S. (2007). “Pay-When-Paid” Clauses: What Happens When the Owner Doesn’t Pay?. Published in The Constructor. Ohio: Frost Brown Todd LLC 101 939 P.2d 811 (Ariz. Ct. App. 1997)

42

progress payments or final payment is not due and owing to the subcontractor as

provided for herein until the owner has made such payment to the contractor”

The language that included the term “condition precedent” sufficed to create an

enforceable condition. Furthermore, the court held that a condition precedent is

established when expressions like “exclusively” or “only” demonstrate that payment was

to be made from a particular fund and no other. Without these key words, one may

assume that these provisions would only effect the time of payment and not waive the

contractor’s duty to pay for services rendered by the subcontractor. In order to create a

condition precedent to the subcontractor’s payment, there must be contractual language

demonstrating the parties ‘unequivocal intent’ that the subcontractor will only be paid if

the contractor is paid.

However, in Printz Services Corp. v. Main Electric Ltd.102, the court found that a

third – party payment provision that stated the contractor would pay the respective

subcontractor “ ‘provided like payment shall have been made by the Owner to

Contractor’ ” did relieve the contractor of the obligation to pay a subcontractor absent

the contractor’s receipt of full payment from the owner. This ruling, as noted by the

court, represents a minority position. Typically, a court requires a third-party payment

provision in a construction contract to contain more definite language than “provided like

payment shall have been made” to create a condition precedent.

The Third District in Robert F. Wilson, Inc., v. Post-Tensioned Structures, Inc.,103

confirmed that the following provision shifted the risk of nonpayment to the

subcontractor:

102 949 P.2d 77 (Colo. Ct. App. 1997) 103 522 So. 2d 70 (Fla. 3d DCA 1988)

43

No Change Orders will be issued for additional work of any kind unless so

approved by the Architect and Owner prior to its issuance. In the event a

controversy occurs between the Owner and the General Contractor concerning

the Contract with the Owner or these Change Order(s), then it is expressly agreed

hat no compensation for these items shall be due the Subcontractor from the

Contractor until payment for them is received by the Contactor, regardless of the

fact that payments is delayed due to the Contractor negotiating with the Owner,

arbitration, administrative actions, litigation, appeals or other similar activities.

In 1990, the Supreme Court in DEC Electric, Inc., v. Raphael Construction

Corporation, quoting from its earlier reasoning in Peacock Construction Co., Inc. v.

Modern Air Conditioning, Inc.104, held a “pay-when-paid” clause to be condition

precedent to payment from the general contractor to the subcontractor. However, the

same year the Supreme Court decided OBS v. Pace Construction Corporation105 and

concluded that an ambiguity existed between the general conditions to the subcontract

and the apparent intent to the subcontract itself, thereby nullifying an attempt to shift the

risk of nonpayment.

Payment by the owner to the contractor is a precondition to payment to a

subcontractor. In Timbro Development Limited v. Grimsby Diesel Motors Inc., Timbro

performed construction work for Grimsby. When the owner failed to pay Timbro, it

refused to pay its subcontractors, relying on a clause in its purchase orders:

“Payments will be made not more than 30 days after the submission date or 10

days after certification or when we have been paid by the owner, whichever is the

later”.

104 353 So.2d 840 (Fla. 1977) 105 558 So. 2d 404 (Fla. 1990)

44

The pay-when-paid clause was printed in red ink on the general contractor’s

Purchase Order. The Ontario Court of Appeal found in 1988 that the clause specified the

condition governing the subcontractors’ legal entitlement to payment and not merely the

time of payment. The court further found that, under the clause the subcontractors clearly

assumed the risks if the owner did not pay the contractor. Since Timbro was not paid, it

was not obliged to pay the subcontractors. The subcontractors had effectively waived

their right to paid until the contractor had been paid. Further appeal to the Supreme Court

of Canada was refused.

Another variation of a pay-when-paid clause was considered by an Ontorio

Superior Court in Kor-Ban Inc. v. Pigott Construction Ltd.106. Payment to be made as

follows:

“Ninety percent (90%) of the value of the completed work done by the

subcontractor and ninety percent (90%) of the value of the materials delivered to

the site from time to time as the Work progresses, provided the amounts of such

payments are certified by the Architect under the terms of the contract between

the owner and contractor, and Five (5) days after payment of such amount has

been received by the contractor from the owner. The balance of the contract Price

will be paid in accordance with the Construction Lien Act 1983 and Ten (10) days

after payment of such amounts has been received by the contractor from the

owner and provided the subcontractor has fulfilled all of its obligations under this

agreement”.

The court in Kor-Ban also found that the subcontractor assumed the risk of non-

payment by the owner to the general. The court also held that on the evidence, it was

apparent that the subcontractor had been made aware of the pay-when-paid clause in

106 (1993) 11 C.L.R. (2d) 160 (Ont. Gen. Div.)

45

contract even though it was not as obvious as the red inked clause in Timbro. Again, the

court interpreted the payment clause as a waiver of the entitlement to be pa id.

If the intent of the general contractor is to not be responsible for owner’s

insolvency or refusal to pay, then the contract language must be precise to shift the risk of

payment failure by the owner to the subcontractor107. How do contractors shift the burden

of nonpayment by the owner? Say it clearly in a contract provision. What should be said?

The contract which stated that:

i. The subcontractor is paid only if the general contractor is paid or the

subcontractor will not be paid unless the general contractor receives payment

from the owner; and

ii. The subcontractor assumes the risks of nonpayment by the owner due to

insolvency or the inability to pay.

Such contract language has been held by many courts to sufficiently shift the burden of

nonpayment to the subcontractor 108.

The court in Peacock Construction Co. v. Modern Air Conditioning109, did

recognize that nothing prevents parties from shifting the risk of an owner’s nonpayment

provided the contract expressly and unambiguously states such intent. The burden of

clear expression is on the party seeking to pay only when paid, and any ambiguity will be

construed against it as a matter of law.

107 Devine, P. (2006). When Must A Subcontractor Be Paid Under A “Pay-When-Paid” Clause. Business Credit July/August 2006. National Association of Credit Management 108 Fortney & Klingshirn . Contingent Payment Clauses. Ohio. 109 Inc., 353 So. 2d 840 (Fla. 1977)

46

In J.J. Shane v. Aetna Casualty & Surety Company110, a subcontractor found itself

in the unexpected position of waiting to get paid until the party with whom it contracted

was paid by the owner. The dispute involved the interpretation of the following payment

provision contained in the written subcontract between the parties:

Article XIII Method of Payment

a) Subcontractor is relying upon the financial responsibility of Owner in

performing the Work. It is understood by Subcontractor that payment for the

work is to be made from funds received from Owner by Contractor in respect

to the Work.

The subcontractor argued that the foregoing term simply fixed a reasonable time

for payment by the contractor. Florida’s Third District Court of Appeal rejected that

argument, holding instead that the subject provision plainly and unambiguously made

payment by the owner a condition precedent to payment by the general contractor to the

subcontractor.

For over thirty years, most state courts have held that contractor cannot

indefinitely withhold payment from subcontractors based upon a “pay-when-paid” clause.

Instead, “pay-when-paid” clause requires a contractor to pay its subcontractors within a

“reasonable time” of the completion of satisfactory work. The article on “Contingent

Payment Clauses in the 50 States” by the Foundation of the American Subcontractors

Association (FASA) attempt s to summarize the basic stance of each of the fifty stated

with respect of two types of contingent payment clause, “pay when paid” and “pay if

paid.” The information displayed for all states that have applicable law on this issue

revolved around (a) whether “pay-when-paid” clauses allow a contractor in the state to

only delay payment to its subcontractors for a reasonable time (b) whether a “pay-if-

paid” clause will be enforced in that state if it is unambiguously drafted (c) whether “pay-

110 723 So. 2d 302 (Fla. 3d DCA 1998), reh. den.

47

if-paid” clause will be enforced in that state if it is unambiguously drafted (d) key statutes

and cases that describe the state’s positions on contingent payment clauses (See Appendix

A).

In a nutshell, the summary of the interpretations on the application of “pay when

paid” provisions in the construction sub-contract from the literature review can be

concluded and shown in Table 3.1 as follow:

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Table 3.1: The Application of “Pay When Paid” Provisions in Construction Sub-Contract

No

Case Law

“Pay When Paid”

Suggest Time For Payment

“Pay When Paid” as

Condition Precedent

Judgment

1 Thomas J. Dyer Co. v. Bishop International Engineering Co. 303 F.2d 655, 661 (6th Cir. 1962)

X

• It was the intention of the parties that the subcontractor would be paid by the general contractor for the labor and material put into the project.

• The Sixth Circuit opined that the credit risk inherent in the general contractor’s undertaking could be shifted to the subcontractor, but only where the contract contained express language “clearly showing that to be the intention of the parties.’

• The court interpreted these standard “pay-when-paid” clauses, not as creating an absolute condition precedent to payment to the subcontractor, but rather as affording the general contractor a postponement of payment for a reasonable period of time to allow the general contractor an opportunity to collect funds due from the owner to pay the subcontractors and not to require the subcontractor to wait an indefinite period of time until the general contractor was paid by the owner.

2 Power & Pollution Services, Inc. v. Suburban Power Piping Corp47 Ohio App. 3d 89 (Cuyahoga County 1991)

X • Agreed with the analysis in Dyer • Unless the contract clearly shows that the parties intended

to make payment from the owner a “condition precedent” to payment of the subcontractor, the pay-when-paid clause governs only the timing of payments to the subcontractor but does not allow the general contractor to avoid paying the subcontractor altogether

49

No

Case Law

“Pay When

Paid” Suggest

Time For Payment

“Pay When

Paid” as Condition Precedent

Judgment

3 Seal Tite Corp. v. Ehret, Inc589 F. Supp. 701 (D.N.J. 1984)

X • The parties to a subcontract could shift the risk of the owner’s insolvency to the subcontractor, and make payment to the general contractor an absolute condition precedent to payment to the subcontractor, provided that the subcontract clearly and unequivocally so provides.

4 Mignot v. Parkhill X • Where the contract contains a definite and unambiguous promise to pay for labor and materials performed and furnished, or for other services, equally clear an unambiguous language, expressing the intention that the happening of a contingency over which the promise has no control shall be a condition precedent to payment, must be found in the contract before the positive and absolute agreement to pay will be considered as superseded.

• “until such time as,” combined with the absence of any clear language that expresses the parties’ intention to create a condition precedent, appeared as a stipulation for payment on receipt of a fund “ ‘inserted merely for the purpose of fixing the time at which performance shall become due.’ ” Initially, this provision seems to clearly express an intention to make payment to the subcontractor conditional upon the owner’s payment to the general contractor, but the court required language of a more specific nature. Short of any precise terms, such as “condition precedent,” the contractual

50

No

Case Law

“Pay When

Paid” Suggest

Time For Payment

“Pay When

Paid” as Condition Precedent

Judgment

language could not be construed as anything but merely fixing the time for payment.

5 Berkel & Company Constractors v. Christman Company 210 Mich. App. 416, 533 N.W.2d 838 (1995)

X

• The Michigan Court disagreed, holding that: “The contract clearly provides that all payments made to the subcontractor are to be made only from equivalent payments received by [the general contractor] for work done, “the receipt of such payments by the [general contractor] is being a condition precedent to payments to the subcontractor.”

6 West-Fair Electric Contractors v. Aetna Casualty & Surety Company 87 N.Y. 2d 148, 638 N.Y.S. 2d 394, 661 N.E.2d 967 (1995)

X

• A pay-when-paid provision which merely fixes a time for payment does not indefinitely suspend a subcontractor’s right to payment upon the failure of an owner to pay the general contractor and does not violate public policy.

7 A.J. Wolfe Co. v. Baltimore Contractors Inc., 244 N.E.2d 717, 720 (Mass. 1969),

X

• A contract which provided that “payment will be made on monthly requisitions for progress payments “within 10 days after … [the owners’] payment of such monthly progress payments … [has] been received’ ” by the contractor merely set the time for payment and did not create a condition precedent. The court concludes that this language did not amount to a clear provision “should be viewed only as postponing payment by the general contractor for a reasonable time.”

51

No

Case Law

“Pay When

Paid” Suggest

Time For Payment

“Pay When

Paid” as Condition Precedent

Judgment

8 Southern States Masonry Inc. v. JA Jones Construction Company (1987) 507 So. 2d 198

X

• The court there held that clause could not be interpreted to mean “if” the sub-contractor was to be paid but rather “when” it was to be paid. It interpreted the clauses in that case as relating to the time when a contractor must pay the subcontractor and not to the issue of whether the sub-contractor got paid at all.

9 Harvey Concrete, Inc. v. Agro Construction & Supply Co. 939 P.2d 811 (Ariz. Ct. App. 1997)

X

• Held that the following clause was plain enough to shift the credit risk to the subcontractor:

“Subcontractor agrees as a condition precedent to payment…that the owner shall have first paid the payment…to the contractor, and that payment for wither progress payments or final payment is not due and owing to the subcontractor as provided for herein until the owner has made such payment to the contractor”

• The language that included the term “condition precedent” sufficed to create an enforceable condition. A condition precedent is established when expressions like “exclusively” or “only” demonstrate that payment was to be made from a particular fund and no other.

• Without these key words, one may assume that these provisions would only effect the time of payment and not waive the contractor’s duty to pay for services rendered by the subcontractor. In order to create a condition precedent to the subcontractor’s payment, there must be contractual

52

No

Case Law

“Pay When

Paid” Suggest

Time For Payment

“Pay When

Paid” as Condition Precedent

Judgment

language demonstrating the parties ‘unequivocal intent’ that the subcontractor will only be paid if the contractor is paid

10 Printz Services Corp. v. Main Electric Ltd949 P.2d 77 (Colo. Ct. App. 1997)

X

• The court found that a third – party payment provision that stated the contractor would pay the respective subcontractor “ ‘provided like payment shall have been made by the Owner to Contractor’ ” did relieve the contractor of the obligation to pay a subcontractor absent the contractor’s receipt of full payment from the owner

11 Robert F. Wilson, Inc., v. Post-Tensioned Structures, Inc., 522 So. 2d 70 (Fla. 3d DCA 1988)

X

• The following provision shifted the risk of nonpayment to the subcontractor:“… In the event a controversy occurs between the Owner and the General Contractor concerning the Contract with the Owner or these Change Order(s), then it is expressly agreed had no compensation for these items shall be due the Subcontractor from the Contractor until payment for them is received by the Contactor, regardless of the fact that payments is delayed due to the Contractor negotiating with the Owner..”

12 DEC Electric, Inc., v. Raphael Construction Corporation (1990)

X • Quoting from its earlier reasoning in Peacock Construction Co., Inc. v. Modern Air Conditioning, Inc., held a “pay-when-paid” clause to be condition precedent to payment from the general contractor to the subcontractor. However, the same year the Supreme Court decided OBS v. Pace Construction Corporation and concluded that an ambiguity

53

No

Case Law

“Pay When

Paid” Suggest

Time For Payment

“Pay When

Paid” as Condition Precedent

Judgment

existed between the general conditions to the subcontract and the apparent intent to the subcontract itself, thereby nullifying an attempt to shift the risk of nonpayment.

13 Timbro Development Limited v. Grimsby Diesel Motors Inc

X

• A clause in its purchase orders: “Payments will be made not more than 30 days after the submission date or 10 days after certification or when we have been paid by the owner, whichever is the later”.

• The Ontario Court of Appeal found in 1988 that the clause specified the condition governing the subcontractors’ legal entitlement to payment and not merely the time of payment. The court further found that, under the clause the subcontractors clearly assumed the risks if the owner did not pay the contractor

14 Kor-Ban Inc. v. Pigott Construction Ltd(1993) 11 C.L.R. (2d) 160 (Ont. Gen. Div.)

X

• The subcontractor assumed the risk of non-payment by the owner to the general. The court also held that on the evidence, it was apparent that the subcontractor had been made aware of the pay-when-paid clause in contract

15 Peacock Construction Co. v. Modern Air Conditioning Inc., 353 So. 2d 840 (Fla. 1977)

X

• That nothing prevents parties from shifting the risk of an owner’s nonpayment provided the contract expressly and unambiguously states such intent. The burden of clear expression is on the party seeking to pay only when paid, and any ambiguity will be construed against it as a matter of law.

54

No

Case Law

“Pay When

Paid” Suggest

Time For Payment

“Pay When

Paid” as Condition Precedent

Judgment

16 J.J. Shane v. Aetna Casualty & Surety Company723 So. 2d 302 (Fla. 3d DCA 1998), reh. den.

X

• The subject provision plainly and unambiguously made payment by the owner a condition precedent to payment by the general contractor to the subcontractor.

55

3.6 Reasonable Time of Payment

Often domestic subcontractors would find themselves contracting under heavily

amended bespoke contract with payment provisions that were weighted heavily in favour

of main contractors. “Pay when paid” provisions were legion, and under such

arrangements the payee was usually unaware of the time when payment would be made.

Payment was almost entirely dependent on when the client paid the main contractor. This

also caused significant difficulties for many, particularly subcontractor, in trying to

establish when a legally enforceable debt was due. Debt is an important factor in any

payment arrangement because until the debt is created there is no legally enforceable

means of recovering sums that one party may believed to owed. For subcontractors

operating under “pay-when-paid” provisions, the condition precedent to the debt being

established was the payment to the main contractor. Only then could the subcontractor’s

debt crystallize and action be taken to recover111.

Often, the agreed payment cycle would be replaced with a valuation arrangement

to correspond with the release of payment to the main contractor. Similar problem were

encountered with bespoke contracts and many subcontractors often did not know when

they were going to be paid and how much they would be paid; in other words, they did

not know the timing of the payment or amount of payment that was going to be made 112.

111Pettigrew, R. (2005). Payment Under the Construction Contract Legislation. Published by Thomas Telford. Pg 75-76 112Ibid Pg 76

56

The American Institute of Architects (AIA) A401 and the Associated General

Contractors (AGC) 650 subcontract forms contain pay-when-paid terms113. With “pay

when paid” clause, as long as the cause for the owner’s nonpayment to the general

contractor is not related to the subcontractor immediately following the expiration of a

reasonable time period. The time period is like grace period for the general contractor,

but if the general contractor does not receive payment from the owner through no fault of

the subcontractor, the general contractor will still be liable to the subcontractor 114.

3.6.1 A Mechanism to Determine When Payment is due

A common judicial limitation is to hold that the general contractor is required to

pay the subcontractor within a reasonable time. Some courts have held that the “pay-

when-paid” clause does not allow non-payment for an indefinite period, but rather, that

the subcontractor must be ultimately paid, regardless of whether the general contractor

has been paid. These courts may interpret the payment clause’s “pay-when-paid”

language as merely a timing provision, rather than a condition precedent115.

The “pay-when-paid” indicates the time for payment which the time for payment

is calculated from the date when payment should have been made by the employer,

whether or not payment has in fact been made. This is illustrates by Smith & Smith Glass

Ltd. v. Winstone Architectural Cladding System Ltd. (1991).

113 Hess, S.A. & Bales, J.V. (2007). Design Professional and Construction Manager Law. American Bar Association - Forum on the Construction Industry. Chapter 15 Pg 500 114 Ibid Pg 500 115 Murphey, D.R. (1999). Surety’s Reliance on Pay-When-Paid Clause Rejected. Smith, Currie & Hancock LLP.

57

Atkinson (2007) cited that, a “pay-when-paid” could only be effective so long as

the main contract machinery of payment was capable of being operated. For the clause to

be effective the Contractor impliedly undertaken that it will pursue all means available to

obtain payment or it will not be able to rely on the clause to defeat the subcontractor’s

claim for payment.

Across the country, in Massachusetts, New York, Maryland, North Carolina and

Oklahoma, the courts have construed “pay-when-paid” provisions to mean that the

contractor shall pay his or her subcontractors within a stated number of days or a

reasonable time thereafter116.

Where no duration is set forth in the contract documents, the courts will interpret

that to mean that the contract should last a reasonable time117. A general contractor had

delayed payment to a subcontractor since the owner had not yet paid the general

contractor. The general contractor could not show that the owner’s delay in payment was

due to any purported acts or omissions on the part of the subcontractor. The court found

that the subcontractor was, therefore, entitled to payment of its retained percentage 118.

A variation of a contingent payment clause arose in Lowy and Donnath, Inc.

v.New York119. The court found that an electrical subcontractor was entitled to receive

payment for the labor and materials furnished to the general contractor. The purchase

order form of subcontract between the general contractor and the electrical subcontractor

made the subcontract subject to the contract between the general contractor and the

116 A.J. Wolfe Co. v. Baltimore Contractors, Inc., 355 Mass 361 (1969), Schuler-Haas Elec. Co. v. Aetna Cas. & Sur. Co., 49 A.D.2d 348 (1976), Fishman Const. Co. v. Hansen, 238 Md. 418 (1965), Howard-Green Elec. Co. v. Chaney & James Const. Co., 12N.C.App.63 (1971), Moore v. Continental Cas. Co., 366 F.Supp. 954 (W.D.Okl.1973) 117 Krol, J.J.P (1993). Construction Contract Law. Published by John Wiley and Sons. Pg 34 118Grossman Steel and Aluminum Corp. v. Samson Window Corp., 78 A.D.2d 871, 433 N.Y.S.2d 31 (2nd Dept. 1980), aff d 54 N.Y.2d 653, 442 N.Y.S.2d 769 (1981) 119 98 A.D.2d 42, 469 N.Y.S.2d 760 (1st Dept. 1983), aff’d 62 N.Y.2d 746, 476 N.Y.S.2d 830 (1984).

58

owner, to the extent that the electrical work was to be in strict accordance with the

contract plans and specifications. Absent from the language was any indication that

payment for the electrical work was subject to verification or audit by the public agency

or payment from the owner to the general contractor. In addition, the purchase order did

not contain any provision regarding to timing of payment. Therefore, payment was due

immediately upon completion of the work.

With a “pay-when-paid” clause, as long as the cause for the owner’s nonpayment

to the general contractor is not related to the subcontractor’s work, the general contractor

will remain liable to the subcontractor immediately following the expiration reasonable

time period. The time period is like a grace period for the general contractor, but if the

general contractor does not receive payment from the owner through no fault of the

subcontractor, the general contractor will still be liable to the subcontractor 120

In Galloway Corp. v. S.R. Ballard Constr. Co.121, Stein states that: “Traditionally,

courts have refused to strictly enforce “pay-when-paid” clauses, holding that they merely

grant the contractor a reasonable time to obtain payment from the owner when that

payment is due. When this reasonable period has expired, the contractor is obligated to

pay the subcontractor whether or not the contractor has received payment from the

owner. Recently, however, courts have become more receptive to enforcing “pay-when-

paid” clauses so long as the clause unequivocally provides that receipt of payment by the

contractor is a condition precedent to the contractor’s obligation to pay its subcontractor.”

The most comprehensive analysis seems to be that of the Connecticut Supreme

Court in Blakeslee Arpaia Chapman v. EI Construction, Inc. 239 Conn. 708, 687 A.2d

506 (1997) even though the court did not decide the issue:

120Hess, S.A. & Bales, J.V. (2007). Design Professional and Construction Manager Law. American Bar Association - Forum on the Construction Industry. Chapter 15 Pg 500 121 250 Va 493, 494 S.E.2d 349 (1995) (Virginia Supreme Court)

59

The plaintiff and the amicus American Subcontractors Association advance

several arguments for not enforcing such a clause. These arguments can be

summarized as follows: (1) a “pay-when-paid” clause, which transfer the credit

risk incurred by the general contractor, can only be enforced if the language in

the subcontract is clear and unequivocal and, in this case, the subcontract

language was equivocal;…(2)such a clause does not relieve contractors of their

duty to pay the subcontractor because it conflicts with the contract read in its

entirety or the intent of the parties;…(3) “pay-when-paid” clauses are not

enforceable when the conduct of the contractor is the cause of the failure;…(4)

such a clause merely sets the time for payment, and “should be viewed only as

postponing payment by the general contractor for a reasonable time after

requisition…so as to afford the general contractor an opportunity to obtain funds

from the owner”; and (5) that a “pay-when-paid” clause is a condition precedent

that is contrary to public policy and therefore unenforceable

3.7 Issues Regarding to “Pay When Paid” Provisions

3.7.1 Prevention Doctrine

The Prevention Doctrine provides that a party who prevents performance of a

contract may not complain of such nonperformance. The Prevention Doctrine may have

an effect on a carefully drafted pay-when-paid provision. This is one that attempts to

60

condition and limit a subcontractor’s right to receive payment on whether the general

contractor has received payment from the owner122.

Even a pay-when-paid clause that qualifies as a condition precedent will not be

regarded as an absolute transfer of the risk of owner nonpayment. A pay-when-paid

defense cannot be asserted by a contractor who frustrates or prevents the owner’s

payment by its own material breach. As the beneficiary of a condition payment by the

owner to its duty to pay the subcontractor, the contractor is itself subject to an implied

condition that it not frustrates the fulfillment of that condition. However, the mere fact

that the owner is refusing to pay because of a dispute with the contractor; such a refusal

could be a risk contemplated by the parties to the subcontract123.

Where the general contractors’ own actions or inactions contribute to the non-

occurrence of a condition precedent, the condition precedent to pay out is deemed to

waived or excused. This is known as the “Prevention Doctrine”. As refer to the case of

Moore Brothers Co. v. Brown & Root, Inc. 207 F.3d 717 (2000), the Prevention Doctrine

provides that the general contractor cannot cause the non-payment to occur and then rely

on the came condition as a basis to occur and then rely on the same condition as a basis

not to pay its subcontractor. If the owner fails to pay the general contractor because of the

general contractor’s own fault, the general contractor will not be able to rely on the “pay-

when-paid” clause to withhold the payment to the subcontractor 124.

In the case of Northeast Drilling, Inc. v. Inner Space Services, Inc., the 8th Circuit

Court of Appeals held that a subcontractor could not invoke a pay-when-paid clause after

it prevented fulfillment of a condition precedent. Because the subcontractor failed to

122 Sienicki, J. and Roth, J. (2007). The Prevention Doctrine and Its Effect on ‘Pay-If-Paid’ and ‘Pay-When-Paid’ Clauses. Snell & Wilmer L.L.P. 123 Lybeck, K.L. and Shreves, H.B. (1998). The Law of Payment Bonds. American Bar Association. Pg 265 124 Ahlers J.P. (2008). “Pay When Paid” vs. “Pay If Paid” Clauses: Mystery vs. Myth.

61

submit a change-order request to the contractor after drilling in an expanded area, it

contributed to the contractor’s failure to pay. Thus , the subcontractor was required to pay

the sub-subcontractor because the prevention doctrine applied and rendered the pay-

when-paid clause void.

3.7.2 Summary Judgment

Summary judgment is a decision made on the basis of statements & evidence

presented for the record without a trial. It is used when there is no dispute as to the fact of

the case & one party is entitled to judgment as a matter of law.

The principles applied in a summary judgment proceedings is clearly illustrated in

the case of Alloy Automotive Sdn Bhd v. Perusahaan Ironfield Sdn Bhd [1986] 1 MLJ 382

(SC) where the Supreme Court had stated (at p 390) that:

“Where all the issues are clear, summary judgment should be given. An appellant

ought not to be shut out from defending unless it is very clear that he has no case

in the action. A complete defence need not be shown. The defence setup need only

show that there is a triable issue or question or that for some reason there ought

to be a trial.”

Similar principles were further illustrated in the case of Malayan Insurance (M)

Sdn Bhd v. Asia Hotel Sdn Bhd [1987] 2 MLJ 183 (SC), where the Supreme Court had

held as follows:

62

“… the underlying philosophy in the O 14 provision is to prevent a respondent

clearly entitled to the money from being delayed his judgment where there is no

fairly arguable defence to the claim. The provision should only be applied to

cases where there is no reasonable doubt that the respondent is entitled to

judgment. Order 14 is not intended to shut out an appellant. The jurisdiction

should only be exercised is very clear cases.”

The High Court in Hong Kong Teakwood Works Ltd. v. Shui On Construction Co.

Ltd. [1984] HKLR 23 and The Court of Appeal in Schindler Lifts (Hong Kong) Ltd. v.

Shui On Construction Co. Ltd. [1985] HKLR 118 have considered the meaning of clause

11(b) in the context of an application for summary judgment. The Hong Kong Courts

came to the view that it was arguable that “receipt of payment” in clause 11(b) means

actual receipt of payment which does not embrace set-off for liquidated damages made

under clause 22 of main contract. The Hong Kong Teakwood and Schindler Lifts (Hong

Kong) cases cannot be regarded as authority to support the main contractor’s argument

for not paying the sub-contractor since:

1. The burden of defendants in an application for summary judgment

is only to show an arguable defence, the courts did not decide that

the arguments advanced by the defendants were sustained. They

only held that such arguments were not unsustainable.

2. The parties only argued whether a set-off exercised by the

employer against payment due to the main contractor constituted

receipt of payment by the main contractor. Whether receipt (in any

sense) of payment by the main contractor is a condition precedent

to payment by the main contractor to the sub-contractor has never

been raised as an issue before the Courts in the above-mentioned

cases.

63

3.7.3 Payment Bond Surety

The payment bond is straight forward device basically requiring a third party such

as a bank or an insurance company to guarantee payment in the event of default on the

part of the paying party. The provision of bond by the employer is presently uncommon

in Malaysia other than for bullet payment contracts. The CIDB 2000 Form nevertheless

provides for it as an option125.

Many general contractors are needlessly exposing themselves to increased

liability and legal risks. A general contractor on a public construction project have

completed the works but have yet to be paid in full by the owner. When subcontractors

ask for final payment, the general contractor will point to the subcontract’s “pay-when-

paid” clause. Then the subcontractor does something that the general contractor don’t

expect instead of suing the general contractor, it sues the general contractor payment

bong surety. The issue is whether the surety can enforce the pay-when-paid clause and

tell the subcontractor that its bond claim must wait until the general contractor is paid by

the owner. Most courts considering the issue have held that a surety cannot enforce a

subcontract’s pay-when-paid clause and must reimburse an unpaid subcontractor even

when the general contractor has not been paid by the owner126.

The court decisions by two U.S. Circuit Courts in Moore Brothers Co. v. Brown

& Root Inc.127, and United States ex rel. Walton Technology v. Weststar Engineering

Inc.128, are alarming for general contractors, who have come to rely upon pay-when-paid

clauses to shift some of the risk of an owner’s non-payment to their subcontractors. The

125 Lim Chong Fong. The Malaysian Construction Industry-The Present Dilemmas of the Unpaid Contractors 126 Koprince, S.J. (2008). Is Your Pay-When-Paid Clause Worthless? . The Constructor January/February 2008. McGraw Hill Construction 127 207 F.3d 717 (4th Cir. 2000) 128 290 F.3d 1199 (9th Cir. 2002)

64

appellate court addressed “whether a surety can assert the principal’s defense based on

‘pay-when-paid’ language in the subcontract, where the surety did not expressly

incorporate the ‘pay-when-paid’ language into the contract payment bond. 129” In

rejecting the surety’s attempt to rely upon the contractor’s defense, the Fourth Circuit

reasoned:

There is no indication that the parties intended the phrase “sums justly due” to

incorporate the contingency of payment by the Owners. On the contrary, the very

purpose of secur ing a surety bond contract is to ensure that claimants who

perform work are paid for their work in the event that the principal does not pay.

To suggest that non-payment by the Owner absolutely absolves the surety of its

obligation is nonsensical, for it defeats the very purpose of a payment bond.

Just as in Moore Brothers, because the subcontractors are suing on the payment

bond and not their subcontracts, and because there is no language in the payment bond

that hinges payment by the surety on the contractor’s receipt of payment from the owner,

there is no basis for denying the subcontractors payment under the performance bond. As

the Fourth Circuit aptly noted in Moore Brothers, such a denial would frustrate the very

purpose of the payment bond130.

In Brown & Kerr, Inc. v. St. Paul Fire and Marine Insurance Co.131 the court

opined that as the purpose of the bond is to assure that subcontractors be paid,

subcontractors should not have to wait the determination of an unrelated legal dispute

between the owner and the contractor. Instead of suggesting the surety was not entitled to

assert the pay-when-paid defense under any circumstances, the court should have

considered whether the contractor’s dispute with the owner amounted to frustration of the

payment condition, a recognized bar to its enforcement.

129 Moore Brothers Co. v. Brown & Root Inc. 207 F.3d 723 (4th Cir. 2000) 130 II, R.L. (2005). Nos. 31869 and 31870. Supreme Court of Appeals of West Virginia. Pg 8 131 940 F. Supp. 1245, 1249 (N.D. III. 1990)

65

Several courts have strongly suggested that had pay-when-paid language been

included in the payment bond, rather than merely in the subcontract, the surety would

have been permitted to delay payment until the general contractor had been paid by the

owner132. In the case of Casey Indus. Inc. v. Seaboard Surety Co133., the district court

written that “a surety cannot assert its principal’s defense based on pay-when-paid

language in the subcontract when the pay-when-paid provision is not expressly

incorporated into the payment bond.”

The clear and dangerous trend of cases like Moore Brothers and Walton

Technology is to prohibit payment bond sureties from enforcing standard pay-when-paid

clause. General contractors should aware of the significant liability problem. These cases

may pose and take steps to strengthen their subcontracts and payment bonds before they

are caught on the wrong end of an unenforceable pay-when-paid clause134.

3.7.4 Contractor’s Own Default

It often happens that a main contractor would suffer liquidated damages as a

result of his own default or that of one of a number of his subcontractors. The question

whish arises in such situation is whether the main contractor is entitled to deduct the

liquidated recovered by the owner from the sub-contractors who did not contribute to

delay?

132 Koprince, S.J. (2008). Is Your Pay-When-Paid Clause Worthless? . The Constructor January/February 2008. McGraw Hill Construction 133 2006 WL 2850652,*7 (E.D. Va. 2006) 134 Koprince, S.J. (2008). Is Your Pay-When-Paid Clause Worthless?. The Constructor January/February 2008. McGraw Hill Construction

66

In Durabella Limited v. J. Jarvis & Sons Limited (2001), it was held that the

Housing Grants Construction and Regeneration Act 1966 clearly envisaged that pay-

when-paid clauses which shared the risk of insolvency were not unreasonable. A

contractor cannot rely on a pay-when-paid clause if the reason for non-payment is its own

breach of contract or default. A party cannot take an advantage from its own breach of

contract135.

Hudsons Building and Engineering Contracts 11th Edition holds the view that a

main contractor is not entitled to withhold payment in such a situation for the following

reasons:

1.1 The deduction of, for example, liquidated damages or a sum for defective works

amounts to a cross-claim or set-off which should count as credit given to the main

contractor. In other words the work done by the main contractor and hence all

sub-contractor are still being recognized and accordingly the relevant sub-

contractors should be paid;

2.1 The application of the “business efficacy” and “officious bystander” tests would

favour the view that a sub-contractor had not agreed to withholding of payment

when he did not cause his main contractor to suffer for example, liquidated

damages. But as the parties to contracts can agree to whatever positions they may

wish to take, it is open to the parties to agree otherwise; and

3.1 The “prevention principle” implies that a main contractor should not gain from his

own negative act, i.e. default in sat, completing the works in a timely manner and

thus take advantage of same to deny his sub-contractor from being paid.

135 Atkinson D. (2001). Payment – Pay When Paid Clauses.

67

Subcontractors can always also argue that the Owner’s nonpayment resulted from

unrelated breaches of the general’s contract with the owner. The general rule is that

“where defendant prevents the performance of a condition of a contract, the condition is

excused. 136” In Sassenrath v. Sassenrath137 and AEE-EMF v. Passmore138, if the owner

has refused to pay the general contractor because of the general contractor’s own

breaches, the general contractor has, in essence, prevented the occurrence of the

condition precedent and cannot assert the Owner’s nonpayment as a defense.

The Illinois case in Preload v. Marino Construction139, the court held that a

general contractor could not assert a “pay-when-paid” clause when the general contractor

was responsible for the Owner’s nonpayment, reasoning that “the performance of a

condition precedent is excused if the party for whose benefit the condition is created

prevents the condition from occurring.

3.8 Conclusion

As conclusion, with a few exceptions, courts do not interpret “pay when paid”

provisions as conditions precedent without including explicit and unambiguous language.

Once the courts interpret the provisions as conditions precedent, the written agreement

defeats the subcontractor’s claim against the contractor. A subcontractor will be entitled

to payment if the general contractor causes the nonoccurrence of the condition precedent

to payment or if the general contractor commits fraud or tortuously interferes with the

contract. Condition precedents do not necessarily supersede a subcontractor’s statutory

rights to file mechanic liens and recover against surety bonds. Payment provisions can

have significant financial consequences for any party that has assumed the risk of non- 136 Goodin, P.W. and Dickinson, J.C.. Who Bears the Risks of Owner Non-Payment?. Midwest Construction Law, Contracts and Claims 137 657 S.W. 2d 671, 674 (Mo. Ct. App. 1983) 138 906 S.W. 2d 714 (Mo. Ct. App. 1995) 139 1991 WL 202651 (N.D. I11. 1991)

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payment, and can have significant financial benefits for the party that has shifted the risk

of the non-payment. Parties negotiating a construction contract should scrutinize

conditional payment provisions to determine the effect of such provisions before entering

into the contract.

The Arizona Court of Appeal in Harvey Concrete, Inc. v. Agro Construction &

Supply Co.140, The language that included the term “condition precedent” sufficed to

create an enforceable condition. Furthermore, the court held that a condition precedent is

established when expressions like “exclusively” or “only” demonstrate that payment was

to be made from a particular fund and no other. Without these key words , one may

assume that these provisions would only effect the time of payment and not waive the

contractor’s duty to pay for services rendered by the subcontractor. In order to create a

condition precedent to the subcontractor’s payment, there must be contractual language

demonstrating the parties ‘unequivocal intent’ that the subcontractor will only be paid if

the contractor is paid.

In determining what constitutes a “reasonable time” for payment under such

provisions, courts have (1) looked to other provisions within the contract at issue which

set forth the time periods for performance of analogous act; and (2) have determined, as

matter of law, when a reasonable time has elapsed

140 939 P.2d 811 (Ariz. Ct. App. 1997)

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CHAPTER 4

ANALYSIS ON THE APPLICATION OF “PAY WHEN PAID”

PROVISIONS IN SUB-CONTRACTS

4.1 Introduction

The preceding chapter discussed in detail the topic of the application of “pay when

paid” provisions in construction sub-contract. This chapter is done in order to achieve the

objective of this project report, which to identify whether “pay-when-paid” arrangement

in construction sub-contract waiving the right of the subcontractor to be paid or simply a

timing mechanism. Besides, the ground constitutes the application of “pay when paid”

provisions was discuss in detail to give the readers an insight the circumstances where the

subcontractor entitle to get payment by the main contractor when they have suffering the

risk of non-payment.

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This chapter discusses the judicial interpretation on the application of “pay when

paid” provisions in construction sub-contract. The circumstances behind the application

of “pay when paid” provisions were collected through the documentary analysis of law

journals and law report, e.g. Malayan Law Journal, Hong Kong Law Journal, All England

Report, Construction Law Report, etc. The decided court cases will be analysed and

being categorized under the terms which constitute the “pay-when-paid” arrangement as

condition precedent to the payment by the owner to general contractor and timing

mechanism (time for payment). It is done mainly through in Sub-Contract.

A total number of eleven (11) cases centered the issue of “pay when paid”

provisions in construction sub-contract were studied. Out of the eleven (11) cases chosen,

eight (8) cases gave illustration that “pay when paid” constitutes as timing mechanism

and the remaining constitutes the “pay when paid” provision as condition precedent. The

cases will be discussed in detail in order to give better understanding to the readers to

give a better understanding to the readers and the principle lying behind that drove the

judge to come a judgment that “pay when pay” provisions as timing mechanism or

waiving the subcontractor right to payment (condition precedent).

4.2 The Application of “Pay When Paid” Provision in Sub-Contract

After reading chapter 2 and chapter 3, it is known the application for the

payment provision of “pay when paid” in construction sub-contract which can result as

time for payment within reasonable time and as condition precedent to general contractor

get payment by the owner. “Pay when paid” provisions in sub-contract typically defer the

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time when payment is due from say a main contractor to a sub-contractor until the main

contractor has received payment from the client. The general contractor has made an

unconditional promise to pay with the time payment postponed until happening of a

certain event, or for a reasonable period of time if the owner’s payment does not happen.

Whether the “pay when paid” provisions constituted time for payment or condition

precedent to general contractor get payment by the owner is probably best judged

objectively having regard to such matter as:

a) The intention of the contractual parties (Dyer Interpretation);

b) The contractual language either ambiguous or unambiguous;

c) The subcontractor’s assumption of the risks of non-payment by the owner to

general contractor; and

d) The enforcement of the contractual terms or provisions.

The above indicates the matters that constitute the application of “pay when paid”

provisions from the literature. However, there is a great deal of uncertainty as to the exact

judgment to the matter of interpretation of sub-contract language contain “pay when

paid”. The judgments for the application of the “pay when paid” provisions in the sub-

contract are discussed below with illustration of cases relating to construction sub-

contract across the country.

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4.2.1 “Pay When Paid” Suggest Time of Payment

Case 1

The controlling factor as to whether the “pay when paid” clause was a conditional

or unconditional promise was the intention of the parties. Whether the “pay when

paid” clause is to be construed as a conditional promise to pay, enforceable only

when and if the conditions precedent has taken place or is to be construed as an

unconditional promise to pay with the time of payment being postponed until the

happening of a certain event, or for a reasonable period of time if it develops that

such event does not take place. To construe it as requiring the subcontractor to wait

to be paid for an indefinite period of time until the general contractor has been paid

by the owner, which may never occur, is to give to it an unreasonable construction

which the parties did not intend at the time the subcontractor was entered into.

In the case of Thomas J. Dyer Co. v. Bishop International Engineering Co. 303

F.2d 655, 661 (6th Cir. 1962), The contract between the contractor and the subcontractor

provided in pertinent part:

The total price to be paid to the Subcontractor shall be … ($115,000.00)

…no part of which shall be due until five (5) days after Owner shall have

paid Contractor therefore…

The Sixth Circuit identified the crucial point of the dispute between the parties as

follows:

[W]hether … [the “pay-when-paid” clause] is to be construed as a

conditional promise to pay, enforceable only when and if the conditions

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precedent has taken place,… or … is to be construed as an unconditional

promise to pay with the time of payment being postponed until the

happening of a certain event, or for a reasonable period of time if it

develops that such event does not take place..

After reviewing several earlier opinions in which similar “pay-when-paid” clauses

had been interpreted, the court held that the controlling factor as to whether the “pay-

when-paid” clause was a conditional or unconditional promise was the intention of the

parties. To determine the parties’ intent, the court looked beyond the plain meaning of the

terms of the contract to consider the usual and customary expectations of parties in the

construction industry. Emphasizing that general contractors normally bare the risk of the

owner’s insolvency, the court acknowledged that this normal allocation of risk could be

varied by the terms of the subcontract, but only if unequivocal language was used to

express the parties’ intention to shift such risk.

The Court cited as follows:

“In the case before us, we see no reason why the usual risk of the owner’s

insolvency assumed by the general contractor should be transferred from

the general contractor to the subcontractor. It seems clear to us under the

facts of this case that it was the intention of the parties that the

subcontractor would be paid by the general contractor for the labor and

materials put into the project. We believe that to be the normal

construction of the relationship between the parties. If such was not the

intention of the parties it could have been so expressed in unequivocal

terms dealing with the possible insolvency of the owner.”

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Consequently, despite the rather explicit language of the “pay-when-paid” clause,

the court purported to ascertain the intention of the parties and held that the “pay-when-

paid” clause was properly construed as follows:

A reasonable 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. To construe it as requiring

the subcontractor to wait to be paid for an indefinite period of time until

the general contractor has been paid by the owner, which may never

occur, is to give to it an unreasonable construction which the parties did

not intend at the time the subcontractor was entered into.

While the Dyer case is relied upon by those who seek to enforce conditional

payment provisions where the contracts at issue contain specific “pay-if-paid” or “pay-

when-paid” language, enforcement of such language is still not automatic. Those courts

that have adopted Dyer approach of enforcing conditional payment clauses only when the

contract terms undeniably demonstrate the intent of the parties still “ recognize a general

presumption against the enforcement of the clauses” and require “that the presumption

can be overcome only by the use of clear an unambiguous contract language.”141

141 Mootz, F.Z. (1990). The Enforceability of Pay When Paid Clauses in Construction Contracts, 64 Conn.B.J. 257,265

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CASE 2

The “pay when paid” provision did not detract from the subcontractor’s right to

paid if it had satisfactorily completed the works according to the contractual

requirements. To interpret a pay-when-paid clause, sufficiently clear words must

have been used in order for a court to construe that such a clause imposed payment

to the main contractor as a condition precedent to the subcontractor's right to be

paid, rather than limiting the time for payment.

The Hong Kong Case of Falcon Building Materials Company Limited v. Fine View

Engineering Limited [2008] HKCU 16 the court considered whether a “pay-when-paid”

provision in a subcontract operated as a condition precedent for payment. The defendant

argued that at the time the writ was issued, the plaintiff was not entitled to the amounts

claimed, as the defendant had not been paid; therefore, under the “pay-when-paid”

provision, the amounts were not yet due to the plaintiff. However, the plaintiff

maintained that it was entitled to the sums claimed on the day the writ was issued.

The defendant, Fine View, was the main contractor of a government contract for

the design, supply and installation of automatic doors at a government hospital. The main

contract was administered by the government's Electrical and Mechanical Services

Department, the employer.

The main contractor engaged the plaintiff, Falcon, as its subcontractor. The

relevant part of the subcontract stated as follows:

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"Payment terms:

(a) 20% deposit... on confirmation of order; and (b) 80% to be

settled by [Fine View’s] receipt of final payment from [the

employer] within 45 days of the completion of testing and

commissioning and the acceptance of the works by the [employer].

“This contract shall be executed on a back-to-back basis in accordance

with the relevant clauses within the main contract."

The 20% deposit was duly paid and the works were allegedly completed by the

subcontractor by April 1 2006. Following testing and commissioning on 26 April 2006,

the subcontractor issued an invoice for the remaining 80% of the subcontract sum,

believing it was entitled to be paid, as testing and commissioning had been carried out.

However, it subsequently transpired that there were defects in the works and the

employer delayed payment to the main contractor. The employer paid the main contractor

on 4 January 2007 after deductions for the defects.

Relying on the pay-when-paid provision in clause (b) of the payment terms, the

main contractor did not settle the subcontractor's invoice for the remaining 80% of the

subcontract sum immediately, as the main contractor had not been paid by the employer.

The subcontractor, believing that the pay-when-paid provision did not affect its

entitlement to payment, commenced proceedings on 16 November 2006 against the main

contractor to recover the balance of the subcontract sum. The trial began on 8 October

2007. Between the commencement of proceedings and the trial, the main contractor paid

the subcontractor the balance of the subcontract sum, less HK$73,700, which the main

contractor had deducted for defects. Therefore, the subcontractor claimed only

HK$73,700 at trial.

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A preliminary issue was whether clause (b) amounted to a condition precedent to

the main contractor's liability to pay the balance of the price. In deciding this issue, the

court relied on Wo Hing Engineering Limited v Pekko Engineers Limited142. In Wo Hing

the judge reviewed a number of authorities from Australia, New Zealand and the United

States and identified an underlying principle:

“When having to construe a pay-when-paid clause, sufficiently clear words must

have been used in order for a court to construe that such a clause imposed

payment to the main cont ractor as a condition precedent to the subcontractor's

right to be paid, rather than limiting the time for payment.”

The judge held on the facts that, as the works had been completed in July 1995

and no complaint of unfinished or defective work had been raised, the plaintiff was

entitled to be paid within a reasonable time of the completion of the works, despite the

fact that the defendant had not been paid. The judge in Wo Hing was satisfied that a

reasonable time had elapsed when the writ was issued in May 1996, and that the plaintiff

was therefore entitled to be paid as of the date of the writ. Consequently, the plaintiff was

entitled to costs.

The court in the present case decided the preliminary issue in the subcontractor's

favour and held that clause (b) did not amount to a condition precedent - the

subcontractor's right to be paid did not depend on the main contractor being paid first.

However, the subcontractor ultimately failed in its claim against the main contractor

because of the existence of defects in the works. The court found that the clause "did not

detract from the subcontractor's right to be paid if it had satisfactorily completed the

works according to the contractual requirements". As there were defects in the works, the

court found that the subcontractor had not satisfactorily completed the works according to

142 [1998] HKCU 2341, HCA5561/1996

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the contractual requirements. The employer and the main contractor were thus entitled to

withhold payment and to make a deduction against the final payment to account for the

unrectified defects. Therefore, the subcontractor's claim was dismissed with costs.

This case confirms that a pay-when-paid clause is not a condition precedent to a

subcontractor's right to be paid. Provided that the subcontractor has carried out its work

satisfactorily according to the terms of its subcontract, it is entitled to payment within a

reasonable time of completing its works, notwithstanding a pay-when-paid clause and the

question of whether the main contractor has been paid by the employer.

CASE 3

Provision calling for payments after written acceptance by the architect and full

payment by the owner do not set condition precedent. They constitute absolute

promises to pay, fixing payment by the owner as a reasonable time for making

payment to the subcontractor. Small subcontractors, who must have payment for

their work in order to remain in business, ordinarily would not assume the risk of

the owner’s failure to pay the general contractor. In order to properly shift the risk

to the subcontractor must unambiguously express such intention and burden of

clear expression is on the general contractor

In the case of Peacock Construction Co., Inc. v. Modern Air Conditioning, Inc. ,

353 So.2d 840 (Fla. 1977) , the issues are as follows”

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1. Is payment by the owner to the contractor a condition precedent to payment by the

contractor to the subcontractors?

2. Is the interpretation of a document a question of law or of fact?

Modern Air Conditioning and Overly Manufacturing subcontracted with Peacock to

perform heating/air conditioning and swimming pool work for a condominium

construction project. The written subcontracts provided that Peacock would make final

payment to the subcontractors “within 30 days after completion of the work included in

this subcontract, written acceptance by the Architectural and full payment therefore by

the owner.”

When the subcontractors completed the work, Peacock did not pay then because

the owner had not paid in full. Modern Air Conditioning and Overly Manufacturing

brought separate suits against Peacock for payment. At trial the court rejected Peacock’s

contention that payment by the owner was a condition precedent to paying the

subcontractors and granted summary judgment in favor of Modern Air Conditioning. The

Court of Appeals affirmed and Peacock appealed to the Florida Supreme Court.

Unless expressly agreed, a subcontractor’s payment is not conditioned upon

payment to the contractor by the owner. That intent is most cases is that payment by the

owner to the general contractor is not a condition precedent to the general contractor’s

duty to pay the subcontractors. The interpretation of a document and its terms and

conditions is a question of law.

Provision calling for payments after written acceptance by the architect and full

payment by the owner do not set conditions precedent; they constitute absolute promises

to pay, fixing payment by the owner as a reasonable time for making payment to the

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subcontractor. The Supreme Court without the benefit of any statistical data or supporting

evidence concluded:

A number of courts, with whom we agree, have recognized that contracts

between small subcontractors and general contractors on large

construction projects are such transactions. Cf. Thos. J. Dyer Co. v.

Bishop International Engineering Co.,6 Cir., 303 F.2d 655 (1965). The

reason is that the relationship between the parties is a common one and

usually intent will not differ from transaction to transaction, although it

may be differently expressed.

The risk-shifting provisions are susceptible to only two possible interpretations as

follows:

“If a provision is clear and unambiguous, it is interpreted as setting a

condition precedent to the general contractor’s obligation to pay. If a

provision is ambiguous, it is interpreted as fixing a reasonable time for the

general contractor to pay. In purported risk-shifting provision between a

contractor and subcontractor, the burden of clear expression is the

general contractor. Once a judge decides that a provision is ambiguous

there is nothing for the jury to decide or interpret.”

The court adopted the majority rule that payment by the owner to the general

contractor is not condition precedent to the general contractor’s duty to pay the

subcontractors. Small subcontractors, who must have payment for their work in order to

remain in business, ordinarily would not assume the risk of the owner’s failure to pay the

general contractor.

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It was held that in order to properly shift the risk to the subcontractor, the

subcontractor must unambiguously express such intention and burden of clear expression

is on the general contractor.

CASE 4

Sufficiently clear words will have to be used before a court will be prepared to

construe that such a clause imposes as a condition payment to the main contractor

which had to be fulfilled before the sub-contractor had the right to be paid as

opposed to a clause limiting the time for payment.

Wo Hing Engineering Limited v. Pekko Engineers Limited (unreported, No.A5561)

had the opportunity to decide the legal effect of a “pay-when-paid” clause in a full trial.

The defendant in this case was a subcontractor and the plaintiff was its sub-sub-

contractor. The relevant clause provided that “this contract is based on back to back basis

including payment”. The court had to decide whether on a proper construction of the

above-mentioned term in the contract, payment of the final balance was only due to the

plaintiff from the defendant after the defendant received payment from the main

contractor as contended by the defendant, or when the plaintiff was entitled to be paid

after reasonable time had elapsed from the completion of the works as submitted by the

plaintiff.

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In giving judgment in favour of the plaintiff, Suffiad J. adopted the principle

which can be gleaned from the decisions in United States, Australia and New Zealand,

namely, when having to construe a “pay when paid” clause, sufficiently clear words will

have to be used before a court will be prepared to construe that such a clause imposes as a

condition payment to the main contractor (the sub-contractor in the Wo Hing case) which

had to be fulfilled before the sub-contractor (the sub-sub-contractor in the Wo Hing case)

had the right to be paid as opposed to a clause limiting the time for payment.

Lordship agreed to the following passages in judgment Smith & Smith v. Winstone:

“While I accept that in certain cases it may be possible for persons contracting

with each other in relation to a major building contract to include in their

agreement clear and unambiguous conditions which have to be fulfilled before a

subcontractor has the right to be paid, any such agreement would have to make

clear beyond doubt that the arrangement was to be conditional and not to be

merely governing the time of payment. I believe that the ‘contra proferentem143’

principle would apply to such clause and that he who seeks to rely upon such a

clause to show that there was a condition precedent before liability to pay arose

at all should show that the clause relied upon contain no ambiguity.”

“For myself I believe that unless the condition precedent is spelled out in clear

and precise terms and accepted by both parties, then clauses such as the two

particular ones identified in this proceeding to no more than identify the time at

which certain things are required to be done, and should not be extended into the

“if” category to prevent a subcontractor who has done the work from being paid

merely because the party with whom he contracts has not been paid by someone

higher up the chain.”

143 In general, if there is any genuine ambiguity in a exclusion contract (that is, if a contract provision is subject to at least two varying reasonable interpretations), it will be strictly construed against the party who drafted the contract.

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Based on the above principle, the Lordship held that the payment clause in

question merely provides for the time of payment and that the plaintiff’s right to be paid

is not dependent upon the defendant getting paid first.

CASE 5

Any such agreement would have to make clear beyond doubt that the arrangement

was to be conditional and not to be merely governing the time of payment. “Contra

Proferentum144” principle would apply to such clause and seeks to rely upon a clause

to show that there was a condition precedent before a liability arose at all should

show that the clause relied upon no ambiguity

The Court of Appeal (Putrajaya) case of Antah Schindler Sdn Bhd v. Ssangyong

Engineering & Construction Co. Ltd., [2008] 3 MLJ 204 provides some guidance as to

the Malaysian position on “pay-when-paid” clauses.

The respondent in the Court of Appeal, Ssangyong Engineering (“Ssangyong”),

was the main contractor appointed by the employer (Yetcome Investment) to install lifts

in respect of the Menara Landmark Johor Bahru Project. The appellant, Antah Schindler,

was a subcontractor to Ssangyong.

144 In general, if there is any genuine ambiguity in an exclusion contract (that is, if a contract provision is subject to at least two varying reasonable interpretations), it will be strictly construed against the party who drafted the contract.

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Antah Schindler carried out and completed the work and received some payments

from Ssangyong, leaving an outstanding sum of approximately RM1.2 million based on 4

interim certificates. Antah Schindler sued Ssangyong for the outstanding sum, and

applied for ‘summary judgment 145’.

Antah Schindler’s position was based on Clause 11(b) of the Sub-Contract

Agreement with Ssangyong, which reads as follows:

“Within fourteen (14) days of the receipt by the Contractor of any

certificate or duplicate copy thereof from the Architect the Contractor

shall notify and pay to the Sub-Contractor the total value certified therein

in respect of the Sub Contract Works and in respect of any authorized

variations thereof and in respect of any amounts ascertained under cl 8(c)

hereof less:…”

Ssangyong resisted the application, relying on Clause 27(a) (vii) of the Main Contract:

“The payment in respect of any work, materials or goods comprised in the sub-

contract shall be made within 14 days after receipt by the Contractor of payment

from the Employer against the architect’s certificate under clause 30 of these

Conditions which states as due in amount calculated by including the total value

of such work, materials or goods, and shall when due be subject to the retention

by the Contractor of the sums mentioned in sub-paragraph (viii) of para (a) of

this Condition.”

145 A decision made on the basis of statements & evidence presented for the record without a trial. It is used when there is no dispute as to the fact of the case & one party is entitled to judgment as a matter of law

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Ssangyong’s position was that this clause was incorporated into the Sub-

Contract pursuant to various provisions of the Sub-Contract. The Senior Assistant

Registrar refused the application for summary judgment, holding that there were triable

issues as there was sufficient evidence in the circumstances of the case. Antah Schindler

appealed against the decision to the Judge in Chambers, who found that there was no

dispute in respect of the quantum and thus allowed the appeal and entered summary

judgment against Ssangyong. However, the Judge went on to hold that Ssangyong would

only have to pay Antah Schindler as and when payment was received from the employer.

Antah Schindler appealed to the Court of Appeal against this part of Judge’s decision.

There was no cross appeal from Ssangyong.

The Court of Appeal held that clause 27(a) (viii) of the Main Contractor had

incorporated into the Sub-Contract and that Antah Schindler by the following provisions

of the clause in seeking payment had acquiesced to it.

Having characterized the broad issues as being one of a “pay-when-paid” clause,

the Court then considered the effect of the clause, referring to the New Zealand case of

Smith & Smith Glass Ltd v. Winstone Architectural Cladding System Ltd [1992] 2 NZLR

473, where Master Towle made the following observations.

“While I accept that in certain cases it may be possible for persons contracting

with each other in relation to a major building contract to include in their

agreement clear and unambiguous conditions which have to be fulfilled before a

subcontractor has the right to be paid, any such agreement would have to make

clear beyond doubt that the arrangement was to be conditional and not to be

merely governing the time of payment. I believe that the ‘contra proferentem146’

principle would apply to such clause and that he who seeks to rely upon such a

146 In general, if there is any genuine ambiguity in an exclusion contract (that is, if a contract provision is subject to at least two varying reasonable interpretations), it will be strictly construed against the party who drafted the contract.

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clause to show that there was a condition precedent before liability to pay arose

at all should show that the clause relied upon contain no ambiguity.”

The Court of Appeal held that upon its proper construction, clause 27(a)(viii) did

not restrict a claim by the Sub-Contractor but merely imposed a time limit on the main

contractor to pay its Sub-Contractor. The Court of Appeal went on to allow the appeal,

holding that on the facts of the case there was sufficient evidence that Ssangyong had in

fact been paid.

The apparent adoption of the observations of Master Towle is to be welcomed. It

appears that the Malaysian Courts see no conceptual obstacle to the practice of “pay-

when-paid” and are content to apply the ordinary rules of contractual interpretations to

such clauses. It is understood that an application by Ssangyong for leave to appeal to the

Federal Court has been refused.

CASE 6

The mere fact that terms of a contract are in dispute is not evidence that the

language is not clear and explicit and requires extrinsic evidence to aid in its

construction. If the terms of the parties’ agreement are contained in a clear and

explicit writing, that writing is the sole memorial of the contract and the sole

evidence of the agreement. The court concludes that the phrases “after the

Contractor receives payment from the Owner” and “has received payment from the

Owner” constitute latent ambiguities in the contracts. That is, the phrases, while

appearing perfectly clear at the time the contracts we re formed, because of

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subsequently discovered or developed facts, may reasonably be interpreted in either

of two ways (ambiguous contractual language)

The Circuit Court of the City of Norfolk in Galloway Corporation v. S.B. Ballard

Construction Co., et al., 250 Va. 493, 494 S.E.2d 349 (1995) , the appeal arises from a

contract dispute between a general contractor and several of its subcontractors in a

construction project following the project owner’s default in making payment on its

contract with the general contractor. The issues are as follows:

1. Whether the terms of the subcontractors provide the general contractor an

absolute “pay when paid” defense to its subcontractors’ breach of contract claims

based upon the owner’s failure to pay.

2. Whether the terms of the subcontracts in question shift the risk of the owner’s

default on payment for labor and materials from the general contractor to the

subcontractors.

On 17 August 1988, Galloway Corporation (“Galloway”), a construction

contractor, entered into a contract with Rowe Properties – Bank Street Limited

Partnership (“Rowe”) for the construction of the First American Financial Center, a

fourteen-story commercial office complex in downtown Norfolk. Rowe and Galloway

used a standard, pre-printed American Institute of Architects (AIA) contract with

attachments to form the basis of their agreement.

Within the general conditions of the contract was the following requirement:

“The Contractor shall promptly pay each Subcontractor, upon receipt of

payment from the Owner, out of the amount paid to the Contractor on

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account of such Subcontractor’s Work, the amount to which said

Subcontractor is entitled…”

Galloway immediately commenced work on the construction project and let

subcontracts to numerous suppliers of labor and materials. Galloway also used a standard,

pre-printed AIA form in letting these subcontracts. Paragraph 11.3 contains the following

pertinent language:

“The Contractor shall pay Subcontractor each progress payment within

three working days after the Contractor receives payment from the

Owner. If the Architect does not issue a Certificate of Payment or the

Contractor does not receive payment for any cause which is not the fault

of the Subcontractor, the Contractor shall pay the Subcontractor, on

demand, a progress payment computed as provided in Paragraphs 11.7

and 11.8”

Paragraph 12.1, entitled “Final Payment,” contains the following pertinent language:

“Final payment, constituting the entire unpaid balance of the Subcontract

Sum, shall be made by the Contractor to the Subcontractor when the

Subcontractor’s Work is fully performed in accordance with the

requirements of the Contract Documents, the Architect has issued a

Certificate of Payment covering the Subcontractor’s completed Work and

the Contractor has received payment from the Owner. If, for any cause

which is not the fault of the Subcontractor, a Certificate of Payment is not

issued or the Contractor does not receive timely payment or does not pay

the subcontractor within three working days after receipt of payment from

the Owner, final payment to the Subcontractor shall be made upon

demand.”

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Work on the project continued from August 1988 until May 1990, suffering

severe financial difficulties, stopped making payment to Galloway. On 31 May 1990,

Galloway informed Rowe and the architect that it would stop work on the project and

notified its subcontractors to secure their tools, equipment, and materials on the job site

anticipation of work being stopped. Work actually continued until 17 July 1990, when

Galloway terminated its contract with Rowe. At that time Rowe had failed to make 3

progress payments to Galloway totaling slightly less that $3,000,000.00

On 21 January 1994, the trial court by letter to counsel, stated its finding that

there remained unpaid balances on the contracts and that Galloway did not have an

absolute “pay when paid” defense based on the contracts as written. The trial court found

that the phrases “after the Contractor receives payment from the Owner” and “has

received payment from the Owner” only permitted Galloway to “delay payment, but the

contracts cannot be construed to say that each subcontractor must bear its own loss if

Galloway never got paid on its contract with the owner.”

The mere fact that terms of a contract are in dispute is not evidence that the

language is not clear and explicit and requires extrinsic evidence to aid in its

construction. If the terms of the parties’ agreement are contained in a clear and explicit

writing, that writing is the sole memorial of the contract and the sole evidence of the

agreement.

The court concludes that the phrases “after the Contractor receives payment from

the Owner” and “has received payment from the Owner” constitute latent ambiguities in

the contracts. That is, the phrases, while appearing perfectly clear at the time the

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contracts were formed, because of subsequently discovered or developed facts, may

reasonably be interpreted in either of two ways.

Here, the contract in question could be interpreted to require Galloway to pay a

subcontractor only if it received a payment demanded from Rowe identifiable with the

progress or completion of a subcontract, or merely to provide for a reasonable time to pay

after such demand was made to Rowe. Because this ambiguity was not patently evident

on the face of the contract, the trial court was permitted to look beyond the contract and

determine the intent of the parties using parol and other extrinsic evidence.

When resolving a dispute between the parties to a contract with a latent

ambiguity, the court may first consider, among other things, whether negotiations and

prior dealings of the parties manifested their intent with respect to the ambiguous term. If

the parties both manifested the same intent with respect to the ambiguity, that intent will

be enforced. If, on the other hand, the parties do not manifest the same intent regarding

the ambiguity, there has been no meeting of the minds on that term of the contract and the

intent of one party will no control. It is apparent from the record of this case that

Galloway intent, in each case, that the contract would provide it with an absolute “pay

when paid” defense. This, only if the subcontractor to each contract manifested the same

intent will an absolute “pay when paid” defense. Thus, only if the subcontractor to each

contract manifested the same intent will an absolute “pay when paid” defense be

available to Galloway.

The court holds that in the absence of a clear and unambiguous statement of the

parties’ intent as to the meaning of the time of payment provision in a construction

subcontract, an absolute “pay when paid” defense is available to a general contractor only

if it can establish by parol evidence that the parties mutually intended the contract to

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create such a defense. Supreme Court affirmed ruling of trial court rejecting “pay-when-

paid” defense of general contractor and awarding judgment to subcontractor.

CASE 7

The court declined to construe a “pay-when-paid” clause as a valid condition

precedent to the subcontractor’s receipt of payment because such a construction

would result in a “significant forfeiture” to the subcontractor.

In Brown & Kerr Inc. v. St. Paul Fire & Marine Insurance Co., 940 F.Supp.

1245, 1250 (N.D. lll. 1996), the court declined to construe a “pay-when-paid” clause as a

valid condition precedent to the subcontractor’s receipt of payment because such a

construction would result in a “significant forfeiture” to the subcontractor. The

subcontract at issue Brown & Kerr stated:

“The final payment would be made by the Contractor to the

Subcontractor when… the Contractor has received final payment from the

Customer under Prime Contract.”

When the contractor failed to pay the subcontractor for work completed under the

subcontract, the subcontractor brought an action against the contractor’s surety to receive

payment under the payment bond.

The surety argued that because the contractor was not paid by the owners, the

surety was under no obligation to pay the subcontractor under its bond pursuant to the

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“pay-when-paid” clause in the subcontract. See id. at 1248. The court rejected this

argument, concluding that the “pay-when-paid” clause did not affect the contractor’s

right to payment under the bond or create valid condition precedent to payment under the

subcontract. See id. at 1250. Declining to follow A.A. Conte147 and instead relying on the

dissenting opinion in that case, the court concluded that the “pay-when-paid” clause did

not create a condition precedent, but rather a timing provision requiring the general

contractor to pay the subcontractor within a reasonable time. See id. at 1250.

CASE 8

When the subcontract was read in conjunction with the general contract and its

conditions, a sufficient ambiguity existed which prevented the general contractor

from effectively shifting the risk of the owner’s nonpayment to its subcontractor. To

its dismay, the general contractor remained liable for the final payments owed to its

subcontractor.

In 1990, the Florida Supreme Court in OBS Company, Inc. v. Pace Construction

Company dealt a blow to general contractors who relied on a “pay-when-paid” clause to

avoid having to pay down its contractual chain to subs and suppliers absent payment from

the owner. Pace was a general contractor on a bonded project. Pace subcontracted the

drywall portion of work to OBS under a subcontract agreement that contained the

following language:

“In addition to any other requirements of this subcontract and the

contract documents, final payment, shall not become due unless and until

147 A.A. Conte, Inc. v. Camphell-Lowrie-Lautermilch Corp., 132 lll.App. 3d 325, 477 N.E.2d 30 (1st Dist. 1985)

93

the following conditions precedent to final payment have been satisfied (c)

receipt of final payment for subcontractor’s work by contractor from

owner.”

The above language was the contractor’s sole reason for refusing to make

payment to OBS. The Pace subcontract defined the ‘contract documents’ to include the

owner-general contractor agreement, and it incorporated the terms of the ‘prime contract’

into the subcontract with OBS. The contract between the general contractor and the

subcontractor clearly provided that the subcontractor was to be paid only after the owner

paid the general contractor. The contract between the general contractor and the owner,

however, was a “cost plus” or reimbursement type of contract that required the general

contractor to pay its subcontractors before the owner reimbursed the general contractor.

The owner general conditions also required that before final payment become due, the

general contractor was to submit an affidavit certifying that all subcontractors had been

paid. This inconsistency was construed against the general contractor. The court found

that when the subcontract was read in conjunction with the general contract and its

conditions, a sufficient ambiguity existed which prevented the general contractor from

effectively shifting the risk of the owner’s nonpayment to its subcontractor. To its

dismay, the general contractor remained liable for the final payments owed to its

subcontractor.

It is not surprising or unusual that the prime contract required Pace to pay OBS

notwithstanding the failure of the owner to pay the Pace. This created a clear an

ambiguity that the Florida Supreme Court agreed to examine when it accepted

jurisdiction of OBS v. Pace. In it analysis, the Florida Supreme Court examined an earlier

line of decisions. It already had decided that “pay-when-paid” clauses were going to be

strictly construed with any ambiguity resolved in favor of unpaid subcontractor or

supplier. In order to shift the burden of nonpayment to the subcontractor of supplier, the

subcontract was required to contain a “clear an unequivocal expression” of that fact. The

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decision was based on the ambiguity created by incorporation of the prime contract into

the OBS subcontract. Pace had failed to meet its burden of a clear and unequivocal “pay-

when-paid” clause.

Although this ruling constituted another nail in the coffin of the general

contractor, the true devastation was realized when the Supreme Court went on to look at

Pace’s bond as issued by Transamerica Insurance Co. and Seaboard Surety. The opinion

states that, “the payment bond is a separate agreement, and any ability to proceed against

the general contractor with a subcontract “pay-when-paid” clause does not necessarily

prevent recovery against the sureties under the bond.”

It rejected earlier holding that sureties’ liability was coextensive of that of the

principal. Even with an effective “pay-when-paid” provision, the surety must make

payment to subcontractors and suppliers within a “reasonable time.” Anyone who has

been around the construction site or the courthouse knows that the surety will look to its

principal for reimbursement of any claims it is required to pay. The effect is that a

general contractor on a bonded job who remains unpaid by the owner will be required to

make payment to subcontractors and suppliers even in the presence valid pay-when-paid

clause.

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4.2.2 “Pay When Paid” As Condition Precedent

CASE 1

The clause clearly specifies the condition governing the contractor’s legal

entitlement to payment and not merely the time of payment. Under such clause, the

subcontractor clearly assumes the risk of non-payment by the owner to the

contractor. Since general contractor was not paid, it is not obliged to pay the

subcontractors. In order to properly shift the risk to the subcontractor, the

subcontractor must unambiguously express such intention and burden of clear

expression is on the general contractor

The Ontario Court of Appeal in Timbro Developments Ltd. v. Grimsby Diesel

Motors Inc., (1998). 32 C.L.R. 32 (Ont. C.A.), allowed a general contractor to rely on a

standard from clause providing as follows:

“When used for sub-contract work the following terms will apply:

Payment will made not more than thirty (30) days after the submission

date or ten (10) days after certification or when we have been paid by the

owner, whichever is the later. Holdback will be retained in accordance

with the Mechanic’s Lien Act in effect at the time, and when released by

the owner all payments will be made in Canadian Funds and will be

payable at par in Welland (emphasis added by the Court)”

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In a very short judgment, the Court held that:

The Court is divided on the interpretation of the underlined words which were

added to the standard form used by the Ontario contractors several months before

execution by the subcontractors. The appellant contended that the added clause

was ambiguous but the majority (Blair and Cory JJ.A.) reject this submission. In

their opinion the clause clearly specifies the condition governing the contractor’s

legal entitlement to payment and not merely the time of payment. Under the

clause, the subcontractor clearly assumes the risk of non-payment by the owner to

the contractor. Since Timbro was not paid, it is not obliged to pay the

subcontractors and the appeal must fail.

Finlayson J.A., dissenting, is of the view that the clause relates to the timing of

payments due under the contract and in no sense puts the subcontractors at risk that they

will not be paid if the contractor is not paid. They are not co-adventures or partners in this

construction contract. Having done the work as found by the trial judge, they are entitled

to be paid. There is a privity of contract between them and Timbro and the trial Judge

was correct in awarding judgment in their favour. He would have allowed the appeal and

restored the judgment of the trial Judge. Leave to appeal to the Supreme Court of Canada

was dismissed148.

Timbro was followed by the Ontario General Division in Kor-Ban Inc. v. Pigott

Construction Ltd149. However, Bell J., in that case, also quoted from the 1874 case of

McBrian v. Shanly150 . There, a subcontract had provided for payment to the

subcontractor within ten (10) days after the general contractor was paid by the owner.

148 Id. (1989). 99 N.R. 400 (note) 149 (1993). 11 C.L.R. (2d) 160 (Ont. Gen. Div.) 150 (1984). 24 U.C.C.P. 28 (C.A.)

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However, the jury concluded that the owner had terminated the contract because of the

general contractor’s default. Hagarty C.J. held that:

I think the true intent and meaning of such a contract must be that the best

the defendant [general contractor] can say: “If I duly perform my

contract with the company [the owners], and though I be entitled to the

money from them, if from any cause, not arising from any act or default

of mine, they [the owners] do not pay, you [the subcontractor] cannot

call on me to pay.”

In cases where default of the general contractor caused the non-payment by the

owner, Bell J. concluded, the general contractor should not be allowed to rely on the pay-

when-paid clause. This reasoning was used in Applied Insulation Co. v. Megatech

Contracting Ltd.151, where the defendant general contractor was in default and the

plaintiff subcontractor had in no way contributed to the problems. The general contractor

was not allowed to rely on the clause.

Other provinces’ appeal courts decided not to follow Timbro. In Arnoldin

Construction & Forms Ltd. v. Alta Surety Co.152, the payment clause in a subcontract was

summarized by the Court as follow:

After deduction for a 10% mechanic’s lien holdback and previous

payments the balance of the amount of the requisition as approved by the

contractor “shall be due to the subcontractor on or about one day after

receipt by the Contractor of payment from the owners”. The final payment

under the subcontract is to be made on acceptance of the work “and

151 (1994), 22 C.L.R. (2d) 251 (Ont. Gen. Div.) 152 (1995), 19 C.L.R. (2d) 1 (N.S. C.A.), leave to appeal to the Supreme Court of Canada refused (1995), 22 C.L.R. (2d) 131 (note)

98

within thirty (30) days after payment has been received by the

contractor”.

The Nova Scotia Court of Appeal argued that this was not clear enough language

to impose a standard term on the subcontractor. Hallett J.A. held that:

In my opinion, in order for a general contractor to impose a term on a

subcontractor pursuant to a standard form of a contract, that payment for

its work is conditional on the contractor being paid by the owner the

contract would require mush clearer language than that contained in the

subcontract between [the respondent] and [the appellant]. An intention so

important cannot be buried in obscure language that would not alert the

subcontractor that payment for the subcontract work was conditional on

the owner paying the subcontractor…

Had the respondent intended that nothing would owe or payable to a

subcontractor upon completion of the work unless payment was received from the owner,

the contract ought to have contained clear words to denote such an intention. Appropriate

words would have been that the balance claimed by the subcontractor for the completion

of the work pursuant to terms of the subcontract would only be paid “if” the owner paid

the contractor. The word “if” is defined in the Oxford Dictionary as meaning “on the

condition or suppos ition that.” To impose on a subcontractor a term that payment was

conditional on the contractor receiving payment from the owner would require the clear

language of the nature I have identified.

In Nova Scotia, therefore, it appears that the use of the word “if” will imply a

condition precedent. The Manitoba Court of Appeal, after reviewing both Timbro and

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Arnoldin, preferred the latter. In Winfield Construction Ltd. v. B.A. Robinson Co.153, Scott

C.J.M. held that:

I am also attracted to the reasoning of the Nova Scotia Court of Appeal in

Arnoldin …, in which the Court chose to limit the effect of the decisions in

Timbro and Kor-Ban by concluding that it would require very clear and

specific words before it could be said that a “pay-when-paid” provision

could govern the sub-contractor’s entitlement to payment.

In a 1997 decision, the Prince Edward Island Supreme Court in the case of R&G

Masonry Ltd. v. Maxim Construction Inc.154 chose to follow Arnoldin and Winfield. A

clause in the contract between general contractor and subcontractor stated:

“IV (b) The subcontractor shall make applications for payment together with

supporting Statutory Declarations and/or other documents when required by the

Contract Documents on or before the 25th day of each month to the Contractor for

approval and due processing covering the value of the products delivered at the

site and the work performed by the Subcontractor proportionate to the

Subcontract Price up to the last day of the month, whereupon payment to the

Subcontractor by the Contractor in the amount of 85% shall become due and

payable not more than five (5) days after receipt of the monies by the Contractor

from the Owner. Where the Contractor or the Consultant makes any changes to

the amount of the applications for payment as submitted by the Subcontractor, the

Subcontractor shall be so notified promptly in writing by the Contractor of

changes and given the opportunity to defend his submission without delay.”

153 (1996), 27 C.L.R. (2d) 78 (Man. C.A.) 154 (1997), 36 C.L.R. (2d) 300

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DesRoches J. held that while being aware of jurisprudence tending to support the

contractor’s attempt to rely on this clause, the substantial weight of authority in Canada

and the United States supported the conclusion that in order for a general contractor to be

able to rely on a “pay-when-paid” clause, the language ought to be much clearer than that

contained in Article IV (b). Based on Arnoldin and Winfield, the Court held that:

An intention so important cannot be buried in obscure language which

would not alert the subcontractor that payment was subject to a condition

precedent that the owner pays the contractor.

CASE 2

The subcontract unambiguously required payment from the owner to general

contractor before payment become due to the subcontractor.

The Supreme Court of the State of Florida in DEC Electric, Inc., v. Raphael

Construction Corporation 558 So. 2d 963 (Fla. 4th DCA 1989) deals with the issue of

either must all payment provisions in contracts between contractors and subcontractors or

suppliers that concern a condition or time of payment provision be construed as a matter

of a law?

This suit involves a subcontractor’s claim for money due for work done on a

construction project when the general contractor refused to pay because it had not been

paid by the owner. DEC Electric, Inc. (“DEC”), subcontracted with Raphael Construction

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Corporation (“Raphael Construction”), the general contractor, to perform various

electrical job on a construction project. The owner subsequently shut down the project. It

is undisputed that DEC satisfactorily performed its work and is owed a total of $25, 612

plus interest. Raphael Construction refused to pay DEC, however, because it has not been

paid by the owner. To support its refusal to pay DEC, Raphael Construction relied upon

paragraph 6 of the subcontract, which states:

“… Your payments are made in accordance with our interims draws as we

show you on our sworn statement with your percentage of completion as

we estimate it at the time of our billing to the Owner … No funds will be

owed to the subcontractor unless the General Contractor is paid by the

Owner in accordance to the sworn statement. The subcontractor fully

understands that in event of non payment by the owner to the General

Contractor, the subcontractor has legal recourse against the owner

through the Mechanics Lien Laws or other legal procedures for their

correct monies due.”

The trial court held, as matter of law, that DEC was not entitled to payment from

Raphael Construction because paragraph 6 of the subcontract unambiguously required

payment from the owner to Raphael Construction before payment become due to DEC. In

reaching its decision the district court expressed concern that the trial court decided the

issue as matter of law rather than submitting it to the jury.

Raphael Construction argues that, when the terms of a contract are ambiguous, the

actual intention of the parties becomes a question of fact to be resolved by the jury.

Although this principle of law is correct between contractors and subcontractor, the court

declined to apply it to contracts between contractors and subcontractors in reference to

risk-shifting provisions. In Peacock, the court held that the interpretation of contract

provisions relative to time and conditions of payment between a contractor and

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subcontractor is a question of law and not of fact. The Supreme Court rejected submitting

the issue to the jury because:

“If an issue of contract interpretation concerns the intention of the parties,

that intention may be determined from the written contract, as a matter of

law, when the nature of the transaction lends itself to judicial

interpretation. A number of courts, with whom we agree, have recognized

that contracts between small subcontractors and general contractor on

large construction are such transaction. The reason is that the

relationship between the parties is a common one and usually their intent

will not differ from transaction to transaction, although it may be

differently expressed.”

“The intent in most cases is that payment by the owner to the general

contractor is not a condition precedent to the general contractor’s duty to

pay the subcontractors. This is because small subcontractors, who must

have payment for their work in order to remain in business, will not

ordinarily, assume the risk of the owner’s failure to pay the general

contractor.”

McDonald J. found, as matter of law, that the language was a condition

precedent and that the subcontractor was not entitled to payment from the general

contractor because the general contractor has not been paid by the owner.

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CASE 3

An unambiguous “pay-when-paid” clause may block a subcontractor’s right to

recover in a breach of contract suit against the general contractor. Based on the

unambiguous language in the subcontract, the court strictly enforced plain language

of the agreement, stating that it “may not rewrite a contract to suit one of the

parties but must enforce the term as written.”

In A.A. Conte, Inc. v. Camphell-Lowrie-Lautermilch Corp, the Illinois Appellate

Court held that “pay-when-paid” clauses are enforceable under Illinois law as a valid

form of what is known as a “condition precedent.” A condition precedent is an event that

must occur before one party to a contract is obligated to perform his or her obligations

pursuant to that contract. See Premier Elec. Constr. Co. v. American Nat’l Bank, 658

N.E.2d 877, 885 (lll.App. Ct. 1995). If there is a valid condition precedent in a contract,

the party in whose favor the condition exists is not obligated to perform an action

required by the contract until the condition has been satisfied. See John J. Calnan Co. v.

Talsma Builders, Inc., 395 N.E.2d 1076, 1080 (lll App. Ct. 1979).

In A.A. Conte, the general contractor and the subcontractor entered into a written

agreement which stated that the subcontractor would be paid “if payment … has been

received by [the general contractor] under its general contract [with the owner] .” After

the subcontractor had performed substantial work pursuant to the subcontract, the project

owner became insolvent and failed to pay the general contractor. Because the general

contractor did not receive payment from the owner, the general contractor, in reliance on

the “pay-when-paid” clause, made no payment to the subcontractor. In addition to

asserting a mechanics lien against the project, the subcontractor brought an action against

the general contractor to recover payment for the work performed under the subcontract.

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The general contractor denied that it owed any debt to the payment clause in the

subcontract was a valid condition precedent – the condition being that the contractor had

to receive payment from the owner of the project under the general contract before it was

obligated to pay the subcontractor for its work. The Illinois Appellate Court held that the

payment clause was an enforceable condition precedent and that because the owner had

not paid the contractor, the subcontractor was no entitled to payment from the general

contractor. Id. at 33.

In holding that the payment clause was a valid condition precedent, the court

expressly rejected the subcontractor’s argument that the clause created a limitation only

as to the timing of payment. In other words, the court held that payment clause did not

simply control when the subcontractor was paid by the general contractor – it controlled

the subcontractor’s right to be paid under the subcontractor’s right to be paid under the

subcontract. Based on the unambiguous language in the subcontract, the court strictly

enforced plain language of the agreement, stating that it “may not rewrite a contract to

suit one of the parties but must enforce the term as written.”

The court in A.A. Conte also deemed it significant that the subcontract was

entered into by two business entities experienced in the construction industry and that,

presumably, the parties had entered into many other contracts of a similar nature in the

course of their business. Thus, at least one Illinois court decision supports enforcement of

“pay-when-paid” language in an agreement, despite a harsh result for the subcontractor.

However, other courts have not similarly construed “pay-when-paid” clauses. In

fact, the highest courts of California and New York have held that any clause purporting

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to make payment by the owner to the contractor a true condition precedent to contractor’s

obligation to pay the subcontractor is unenforceable as contrary to public policy155.

The A.A. Conte decision does not necessarily mean that am subcontractor facing a

“pay-when-paid” is left without remedy. The subcontractor still may file a mechanics lien

Section 21 of the Illinois Mechanics Lien Act, 770 ILCS 60/12, expressly provides that

any subcontract provision conditioning payment from a contractor to a subcontractor

upon receipt of payment from the owner is not a defense to subcontractor’s lien claim.

In short, under current Illinois law, an unambiguous “pay-when-paid” clause may

block a subcontractor’s right to recover in a breach of contract suit against the general

contractor. As s result, a general contractor may find the “pay-when-paid” clause an

effective method of avoiding payment to a subcontractor for work when the owner has

not paid the general contractor. A “pay-when-paid” clause does not prevent a

subcontractor from filling a mechanics lien, but if a subcontractor is concerned about

preserving its contract rights, the subcontractor, before signing a subcontract presented by

the general contractor, should review or have its attorney review the subcontract to see if

it includes a “pay-when-paid” clause. If it does, the subcontractor may want to consider

whether it wants to share the risk of owner nonpayment.

155 See Wm. R. Clarke Corp. v. Safeco Ins. Co. of Am., 938 P.2d 372 (Cal. 1997); West-Fair Elec. Contractors v. Aetna Cas. & Sur. Co., 661 N.E.2d 967, 971 (N.Y.1995)

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4.3 Conclusion

The above discussion show eleven (11) judgment for the application to the “pay

when paid” provisions in sub-contact and the principle laying behind that drove the judge

to come a judgment that the “pay when paid” provisions constitute time for payment and

waiving the subcontractor right to payment (condition precedent of payment by the owner

to the main contractor). It shows that the “pay when paid” provisions in construction sub-

contract may constitute as waiving the subcontractor right to be paid and as timing

mechanism. This is because the wording of the contractual language in the sub-contract is

critical. Unambiguously and sufficiently clearly contractual language must have been

used in order for a court to construe such a clause imposed payment to the main

contractor as condition precedent to the subcontractor’s right to be paid, rather than

limiting the time for payment. Once a judge decides that provision is ambiguous there is

nothing for the jury to decide or interpret.

Overall, the findings are found to be parallel with the literature review. It shows

that the risk-shifting provisions are susceptible to only two possible interpretations which

are: if a provision is clear and unambiguous; it is interpreted as setting a condition

precedent to the general contractor’s obligation to pay. If a provision is ambiguous, it is

interpreted as fixing a reasonable time for the general contractor to pay. In purported risk

shifting, provision between a contractor and subcontractor, the burden of clear expression

is to the general contractor.

Whether the “pay when paid” clause is to be construed as a conditional promise to

pay, enforceable only when and if the conditions precedent has taken place or is to be

construed as an unconditional promise to pay with the time of payment being postponed

until the happening of a certain event, or for a reasonable period of time if it develops that

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such event does not take place. To construe it as requiring the subcontractor to wait to be

paid for an indefinite period of time until the general contractor has been paid by the

owner, which may never occur, is to give to it an unreasonable construction which the

parties did not intend at the time the subcontractor was entered into.

Hence, the court suggest that “Contra Proferentum156” principle would apply to

such clause and seeks to rely upon a clause to show that there was a condition precedent

before a liability arose at all should show that the clause relied upon no ambiguity. The

controlling factor as whether the “pay when paid” clause was conditional or

unconditional promise was the intention of the parties.

The court declined to construe a “pay-when-paid” clause as a valid condition

precedent to the subcontractor’s receipt of payment when such a construction would

result in a “significant forfeiture” to the subcontractor and when the subcontract was read

in conjunction with the general contract and its conditions, a sufficient ambiguity existed

which prevented the general contractor from effectively shifting the risk of the owner’s

nonpayment to its subcontractor

As mentioned above, there is only one principle laying behind the drove the judge

to come a judgment the “pay when paid” provisions as timing mechanism or waiving the

subcontractor’s right to payment, which is the contractual language.

The apparent adoption of the observations of Master Towle in the case of Smith &

Smith Glass Ltd v. Winstone Architectural Cladding System Ltd157 is to be welcomed. It

156 In general, if there is any genuine ambiguity in an exclusion contract (that is, if a contract provision is subject to at least two varying reasonable interpretations), it will be strictly construed against the party who drafted the contract. 157[1992] 2 NZLR 473

108

appears that the Malaysian Courts see no conceptual obstacle to the practice of “pay-

when-paid” and are content to apply the ordinary rules of contractual interpretations to

such clauses. Master Towle made the following observations:

“While I accept that in certain cases it may be possible for persons contracting

with each other in relation to a major building contract to include in their

agreement clear and unambiguous conditions which have to be fulfilled before a

subcontractor has the right to be paid, any such agreement would have to make

clear beyond doubt that the arrangement was to be conditional and not to be

merely governing the time of payment. I believe that the ‘contra proferentem158’

principle would apply to such clause and that he who seeks to rely upon such a

clause to show that there was a condition precedent before liability to pay arose

at all should show that the clause relied upon contain no ambiguity.”

.

158 In general, if there is any genuine ambiguity in an exclusion contract (that is, if a contract provision is subject to at least two varying reasonable interpretations), it will be strictly construed against the party who drafted the contract.

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CHAPTER 5

CONCLUSION AND RECOMMENDATIONS

5.1 Introduction

This chapter is the last chapter that summarizes the finding of the research

according to the research objective. It also contains the problems encounter during the

research as well as the recommendations of future researches.

5.2 Summary of Research Finding

Overall, the objective this research had been achieved through documentary

analysis of law journal and law report. In this research, eleven (11) cases were analysis.

From analysis, it is found in this research that there are eight (8) matters lying behind that

drove the judge to come a judgment that “pay when paid” provisions as timing

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mechanism or waiving the subcontractor’s right (condition precedent). The findings are

shown in the Table 5.1. as follow:

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Table 5.1: Judgment on the Application of the ‘Pay When Paid Provisions In Construction Sub-Contracts

No.

Case Law

“Pay When Paid”

Suggest Time of Payment

“Pay When Paid” as

Condition Precedent

Matter/Subject

Judgment

1 Thomas J. Dyer Co. v. Bishop International Engineering Co., 303 F.2d 655, 661 (6th Cir. 1962)

X

The Intention of the Contractual Parties

- The controlling factor as to whether the “pay when paid” clause was a conditional or unconditional promise was the intention of the parties. - To determine the parties’ intent, the court looked beyond the plain meaning of the terms of the contract to consider the usual and customary expectations of parties in the construction industry. - The allocation of risk could be varied by terms of the subcontract but only if unequivocal language was used to express the parties’ intention to shift risk of nonpayment. - It was the intention of the parties that the subcontractor would be paid by the general contractor. If such was not the intention of the parties it could have been so expressed in unequivocal terms dealing with the possible insolvency of the owner. - A reasonable provision designed to postpone payment for a reasonable period of time after the work was completed during

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No.

Case Law

“Pay When Paid”

Suggest Time of Payment

“Pay When Paid” as

Condition Precedent

Matter/Subject

Judgment

which the general contractor would be afforded the opportunity of procuring from the owner the funds necessary to pay the subcontractor. - To construe it as requiring the subcontractor to wait to be paid for an indefinite period of time until the general contractor has been paid by the owner, which may never occur, is to give to it an unreasonable construction which the parties did not intend at the time the subcontractor was entered into. - The intent of the parties still recognize a general presumption against the enforcement of the clause and require that the presumption can be overcome only by the use of clear and unambiguous contract language.

2 Hong Kong Case: Falcon Building Materials Company Limited v. Fine View Engineering Limited [2008] HKCU 16.

X The Subcontractor had Carried out its Work Satisfactory according to Terms of the Subcontract

"Payment terms: … (b) 80% to be settled by [Fine View’s] receipt of final payment from [the employer] within 45 days of the completion of testing and commissioning and the acceptance of the works by the [employer] …”“This contract shall be executed on a back-to-back basis in accordance with the relevant clauses

113

No.

Case Law

“Pay When Paid”

Suggest Time of Payment

“Pay When Paid” as

Condition Precedent

Matter/Subject

Judgment

within the main contract ." - The court found that the clause (b) "did not detract from the subcontractor's right to be paid if it had satisfactorily completed the works according to the contractual requirements" - Provided that the subcontractor has carried out its work satisfactorily according to the terms of its subcontract, it is entitled to payment within a reasonable time of completing its works, notwithstanding a pay-when-paid clause and the question of whether the main contractor has been paid by the employer.

3 The Ontario Court of Appeal: Timbro Development Ltd. v. Grimsby Diesel Motors, Inc. (1998). 32 C.L.R 32 (Ont. C.A)

X Under the Clause the Subcontractor Clearly Assume the Risk of Nonpayment by the Owner to the Contractor

- The Court allowed a general contractor to rely on a standard from clause providing as follows:

“…Payment will made not more than thirty (30) days after the submission date or ten (10) days after certification or when we have been paid by the owner, whichever is the later …”

- Blair and Cory JJ.A opinion: The clause clearly specifies the condition governing the contractor’s legal

114

No.

Case Law

“Pay When Paid”

Suggest Time of Payment

“Pay When Paid” as

Condition Precedent

Matter/Subject

Judgment

As discuss in the Timbro case: Kor-Ban Inc. v. Pigott Construction Ltd(1993). 11 C.L.R. (2d) 160 (Ont. Gen. Div.)

X

Unambiguous Contractual Language Under the Clause the Subcontractor Clearly Assume

entitlement to payment and not merely the time of payment. Under the clause, the subcontractor clearly assumes the risk of non-payment by the owner to the contractor. Since Timbro was not paid, it is not obliged to pay the subcontractors and the appeal must fail.

- The general rule is that interpretation of a document is a question of law rather than of fact. If an issue of contract interpretation concerns the intention of the parties, that intention may be determined from the written contract, as a matter of law, when the nature of the transaction lends itself to judicial interpretation. - It was held that in order to properly shift the risk to the subcontractor, the subcontractor must unambiguously express such intention and burden of clear expression is on the general contractor - - The court also held that on the evidence, it was apparent that the subcontractor had been made aware of the pay-when-paid clause in contract.

115

No.

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Condition Precedent

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Judgment

Applied Insulation Co. v. Megatech Contracting Ltd. (1994), 22 C.L.R. (2d) 251 (Ont. Gen. Div.) Arnoldin Construction & Forms Ltd. v. Alta Surety Co. (1995), 19 C.L.R. (2d) 1 (N.S. C.A.), leave to appeal to the Supreme Court of Canada refused (1995), 22 C.L.R. (2d) 131 (note)

X

X

the Risk of Nonpayment by the Owner to the Contractor The General Contractor Caused the Nonpayment by the Owner Ambiguous Contractual Language

- Hagarty C.J. held that: I think the true intent and meaning of such a contract must be that the best the defendant [general contractor] can say: “If I duly perform my contract with the company [the owners], and though I be entitled to the money from them, if from any cause, not arising from any act or default of mine, they [the owners] do not pay, you [the subcontractor] cannot call on me to pay.”

-Where the defendant general contractor was in default and the plaintiff, subcontractor, had in no way contributed to the problems. The general contractor was not allowed to rely on the clause. -The payment clause in a subcontract was summarized by the Court as follow:

“…Payments the balance of the amount of the requisition as approved by the contractor “shall be due to the subcontractor on or about one day after receipt by the Contractor of payment from

116

No.

Case Law

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Suggest Time of Payment

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Condition Precedent

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Judgment

the owners”. The final payment under the subcontract is to be made on acceptance of the work “and within thirty (30) days after payment has been received by the contractor”. - The Nova Scotia Court of Appeal argued that this was not clear enough language to impose a standard term on the subcontractor. - The respondent intended that nothing would owe or payable to a subcontractor upon completion of the work unless payment was received from the owner, the contract ought to have contained clear words to denote such an intention. - Appropriate words would have been that the balance claimed by the subcontractor for the completion of the work pursuant to terms of the subcontract would only be paid “if” the owner paid the contractor. - An intention so important cannot be buried in obscure language which would not alert the subcontractor that payment was subject to a condition precedent that the owner pays the contractor.

117

No.

Case Law

“Pay When Paid”

Suggest Time of Payment

“Pay When Paid” as

Condition Precedent

Matter/Subject

Judgment

4

Florida Supreme Court Peacock Construction Co., Inc. v. Modern Air Conditioning, Inc. , 353 So.2d 840 (Fla. 1977)

X

Small Subcontractor Ordinarily Would Not Assume the Risk Owner’s Failure to Pay the General Contractor

- Provision calling for payments after written acceptance by the architect and full payment by the owner do not set condition precedent. They constitute absolute promises to pay, fixing payment by the owner as a reasonable time for making payment to the subcontractor. - The Supreme Court conclude:

A number of courts, with whom we agree, have recognized that contracts between small subcontractors and general contractors on large construction projects are such transactions. Cf. Thos. J. Dyer Co. v. Bishop International Engineering Co.,6 Cir., 303 F.2d 655 (1965). The reason is that the relationship between the parties is a common one and usually intent will not differ from transaction to transaction, although it may be differently expressed.

- Small subcontractors, who must have payment for their work in order to remain in business, ordinarily would not assume the risk of the owner’s failure to pay the general

118

No.

Case Law

“Pay When Paid”

Suggest Time of Payment

“Pay When Paid” as

Condition Precedent

Matter/Subject

Judgment

contractor. - In order to properly shift the risk to the subcontractor, the subcontractor must unambiguously express such intention and burden of clear expression is on the general contractor.

5

Wo Hing Engineering Limited v. Pekko Engineers Limited (unreported, No.A5561)

X

Ambiguous Contractual Language

- Suffiad J. cited:

“sufficiently clear words will have to be used before a court will be prepared to construe that such a clause imposes as a condition payment to the main contractor (the sub-contractor in the Wo Hing case) which had to be fulfilled before the sub-contractor (the sub-sub-contractor in the Wo Hing case) had the right to be paid as opposed to a clause limiting the time for payment.”

6

The Court of Appeal (Putrajaya), Malaysia Antah Schindler Sdn Bhd v. Ssangyong Engineering & Construction Co. Ltd., [2008] 3 MLJ 204

X

- The Court considered the effect of the clause, referring to the New Zealand case of Smith & Smith Glass Ltd v. Winstone Architectural Cladding System Ltd [1992] 2 NZLR 473, where Master Towle made the following observations.

119

No.

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Suggest Time of Payment

“Pay When Paid” as

Condition Precedent

Matter/Subject

Judgment

“While I accept that in certain cases it may be possible for persons contracting with each other in relation to a major building contract to include in their agreement clear and unambiguous conditions which have to be fulfilled before a subcontractor has the right to be paid, any such agreement would have to make clear beyond doubt that the arrangement was to be conditional and not to be merely governing the time of payment. I believe that the ‘contra proferentem159’ principle would apply to such clause and that he who seeks to rely upon such a clause to show that there was a condition precedent before liability to pay arose at all should show that the clause relied upon contain no ambiguity.”

Clause 27(a) (vii) of the Main Contract:

“The payment in respect of any work, materials or goods comprised in the sub-contract shall be made within 14 days after receipt by the Contractor of payment from

159 In general, if there is any genuine ambiguity in an exclusion contract (that is, if a contract provision is subject to at least two varying reasonable interpretations), it will be strictly construed against the party who drafted the contract.

120

No.

Case Law

“Pay When Paid”

Suggest Time of Payment

“Pay When Paid” as

Condition Precedent

Matter/Subject

Judgment

the Employer...” - The Court of Appeal held that upon its proper construction, clause 27(a)(viii) did not restrict a claim by the Sub-Contractor but merely imposed a time limit on the main contractor to pay its Sub-Contractor. -

7

The Supreme Court of the State of Florida DEC Electric, Inc., v. Raphael Construction Corporation 558 So. 2d 963 (Fla. 4th DCA 1989)

X

Unambiguous Contractual Language

- Raphael Construction relied upon paragraph 6 of the subcontract, which states:

“… No funds will be owed to the subcontractor unless the General Contractor is paid by the Owner in accordance to the sworn statement. The subcontractor fully understands that in event of non payment by the owner to the General Contractor, …”

- The trial court held, as matter of law, that DEC was not entitled to payment from Raphael Construction because paragraph 6 of the subcontract unambiguously required payment from the owner to Raphael Construction before payment become due to DEC.

121

No.

Case Law

“Pay When Paid”

Suggest Time of Payment

“Pay When Paid” as

Condition Precedent

Matter/Subject

Judgment

8

The Circuit Court of the City of Norfolk John E. Clarkson, Judge Galloway Corporation v. S.B. Ballard Construction Co., et al., 250 Va. 493, 494 S.E.2d 349 (1995)

X

Ambiguous Contractual Language (Latent Ambiguity in the Contracts)

- Paragraph 11.3 of Subcontract contains the following pertinent language:

“The Contractor shall pay Subcontractor each progress payment within three working days after the Contractor receives payment from the Owner…”

- The mere fact that terms of a contract are in dispute is not evidence that the language is not clear and explicit and requires extrinsic evidence to aid in its construction. If the terms of the parties’ agreement are contained in a clear and explicit writing, that writing is the sole memorial of the contract and the sole evidence of the agreement. - The court concludes that the phrases “after the Contractor receives payment from the Owner” and “has received payment from the Owner” constitute latent ambiguities in the contracts. That is, the phrases, while appearing perfectly clear at the time the contracts were formed, because of subsequently discovered or developed facts, may reasonably be interpreted in either of two ways. - The court holds that in the absence of a clear and unambiguous statement of the

122

No.

Case Law

“Pay When Paid”

Suggest Time of Payment

“Pay When Paid” as

Condition Precedent

Matter/Subject

Judgment

parties’ intent as to the meaning of the time of payment provision in a construction subcontract, an absolute “pay when paid” defense is available to a general contractor only if it can establish by parol evidence that the parties mutually intended the contract to create such a defense - - Supreme Court held that the phrase in the subcontract only permitted Galloway to “delay payment, but the contracts cannot be construed to say that each subcontractor must bear its own loss if Galloway never got paid on its contract with the owner.”

9

Illinois Courts A.A. Conte, Inc. v. Camphell-Lowrie-Lautermilch Corp., 132 lll.App. 3d 325, 477 N.E.2d 30 (1st Dist. 1985).

X

Unambiguous Contractual Language

- In A.A. Conte, the general contractor and the subcontractor entered into a written agreement which stated that the subcontractor would be paid “if payment … has been received by [the general contractor] under its general contract [with the owner].” - The Illinois Appellate Court held that the payment clause was an enforceable condition precedent and that because the owner had not paid the contractor, the subcontractor was no entitled to payment from the general

123

No.

Case Law

“Pay When Paid”

Suggest Time of Payment

“Pay When Paid” as

Condition Precedent

Matter/Subject

Judgment

contractor. - The court held that payment clause did not simply control when the subcontractor was paid by the general contractor – it controlled the subcontractor’s right to be paid under the subcontractor’s right to be paid under the subcontract. Based on the unambiguous language in the subcontract, the court strictly enforced plain language of the agreement, stating that it “may not rewrite a contract to suit one of the parties but must enforce the term as written.” - An unambiguous “pay-when-paid” clause may block a subcontractor’s right to recover in a breach of contract suit against the general contractor

10

Brown & Kerr Inc. v. St. Paul Fire & Marine Insurance Co., 940 F.Supp. 1245, 1250 (N.D. lll. 1996)

X

“Pay-When-Paid” Clause Result in “Significant Forfeiture” to the Subcontractor.

- The subcontract at issue Brown & Kerr stated:

“The final payment would be made by the Contractor to the Subcontractor when… the Contractor has received final payment from the Customer under Prime Contract.”

- The court declined to construe a “pay-when-

124

No.

Case Law

“Pay When Paid”

Suggest Time of Payment

“Pay When Paid” as

Condition Precedent

Matter/Subject

Judgment

paid” clause as a valid condition precedent to the subcontractor’s receipt of payment because such a construction would result in a “significant forfeiture” to the subcontractor - The court concluded that the “pay-when-paid” clause did not create a condition precedent, but rather a timing provision requiring the general contractor to pay the subcontractor within a reasonable time.

11

Florida Supreme Court OBS Company, Inc. v. Pace Construction Company

X

Ambiguity Existed When the Subcontract was Read in Conjunction with The General Contract

- Subcontract agreement that contained the following language:

“… final payment, shall not become due unless and until the following conditions precedent to final payment have been satisfied (c) receipt of final payment for subcontractor’s work by contractor from owner.”

- The court found that when the subcontract was read in conjunction with the general contract and its conditions, a sufficient ambiguity existed which prevented the general contractor from effectively shifting the risk of the owner’s nonpayment to its subcontractor. To its dismay, the general

125

No.

Case Law

“Pay When Paid”

Suggest Time of Payment

“Pay When Paid” as

Condition Precedent

Matter/Subject

Judgment

contractor remained liable for the final payments owed to its subcontractor. - The Florida Supreme Court agreed to examine when it accepted jurisdiction of OBS v. Pace. In it analysis, the Florida Supreme Court examined an earlier line of decisions. It already had decided that “pay-when-paid” clauses were going to be strictly construed with any ambiguity resolved in favor of unpaid subcontractor or supplier. In order to shift the burden of nonpayment to the subcontractor of supplier, the subcontract was required to contain a “clear an unequivocal expression” of that fact. The decision was based on the ambiguity created by incorporation of the prime contract into the OBS subcontract. Pace had failed to meet its burden of a clear and unequivocal “pay-when-paid” clause.

126

The summary above shows eleven (11) judgment for the application to the “pay

when paid” provisions in sub-contact and the principle laying behind that drove the judge

to come a judgment that the “pay when paid” provisions constitute time for payment and

waiving the subcontractor right to payment (condition precedent of payment by the owner

to the main contractor). Overall, the findings are found to be parallel with the literature

review which shows that the risk-shifting provisions are susceptible to only two possible

interpretations which are: if a provision is clear and unambiguous; it is interpreted as

setting a condition precedent to the general contractor’s obligation to pay. If a provision

is ambiguous, it is interpreted as fixing a reasonable time for the general contractor to

pay. In purported risk shifting, provision between a contractor and subcontractor, the

burden of clear expression is to the general contractor.

Instead of that, Judges from most of the cases cited that the wording of the

contractual language in the sub-contract is critical. The words may convey the “pay when

paid” as timing mechanism or such condition precedent. Unambiguously and sufficiently

clearly contractual language must have been used in order for a court to construe such a

clause imposed payment to the main contractor as condition precedent to the

subcontractor’s right to be paid, rather than limiting the time for payment. Once a judge

decides that provision is ambiguous there is nothing for the jury to decide or interpret.

In a nutshell there are eight (8) matters laying behind that drove the judge to come

a judgment that “pay when paid” provisions as timing mechanism or waiving the

subcontractor right to payment (condition precedent). The matters are as follows:

1. Contractual language (ambiguous or unambiguous);

2. The intention of the contractual parties;

3. Under the clause, the subcontractor assumption of the risk of nonpayment by

the owner to the contractor;

127

4. Compliance to the terms of the sub-contract, e.g. the subcontractor had carried

out its work satisfactorily according to terms of the sub-contract;

5. The general contractor caused the nonpayment by the employer;

6. Small subcontractor ordinarily would not assume the risk of the owner’s

failure to pay the general contractor;

7. “Pay when paid” clause result in significant forfeiture to the subcontractor;

and

8. Ambiguity existed when the sub-contract was read in conjunction with the

general contract.

Hence, the court suggest that “Contra Proferentum 160” principle would apply to

such clause and seeks to rely upon a clause to show that there was a condition precedent

before a liability arose at all should show that the clause relied upon no ambiguity. The

controlling factor as whether the “pay when paid” clause was conditional or

unconditional promise was the intention of the parties.

Any such agreement would have to make clear beyond doubt that the arrangement

was to be conditional and not to be merely governing the time of payment. Therefore,

failure of the contractor to express his intention unambiguously in the provision will lead

the contractor to make payment to the subcontractor in the event of nonpayment or

insolvency of the owner.

160 In general, if there is any genuine ambiguity in an exclusion contract (that is, if a contract provision is subject to at least two varying reasonable interpretations), it will be strictly construed against the party who drafted the contract.

128

5.3 Problem Encountered during Research

The major problem in writing up this project report is the insufficiently of time.

There is only 8 weeks’ time provided for this research. Everything needs to be done in

very fast manner, especially during the data collection process. Besides, it is lack of time

to refer more sources of literature review from others university.

5.4 Conclusion

As a conclusion for all, the court requires language of a more specific nature of

“pay when paid” provisions in construction sub-contract. Short of any precise terms, such

as “condition precedent”, the contractual language could not be construed as anything but

merely fixing the time for payment. The subcontractor may take the legal action to

challenge the enforceability of the clause to seek immediate payment when they have

suffering the risk of non-payment due to the performance problems unrelated to their own

work.

129

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APPENDIX A