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FMG Law Blog Line

Pay-When-Paid Clauses: A Cautionary Tale

Posted on: March 28th, 2018

By: Jake Carroll

With the recent surge of construction projects in Georgia, the memories of owner and developer bankruptcies following the 2008 financial crisis may have grown dim. Nevertheless, material suppliers and subcontractors must remember that when the pace slows down, their contracts could leave them without remedy or recourse to seek payment.

One of the most common issues in construction disputes is whether a general contractor is obligated to pay its subcontractor before the general contractor has received payment from the owner for the work. Most construction subcontracts address this problem and attempt to make the owner’s payment to the general contractor a condition precedent to the general contractor’s obligation to pay the subcontractor. Typically, these clauses are known as “pay when paid” clauses because they condition the general contractor’s obligation to pay the subcontractor upon receipt of payment by the owner.

Georgia appears to adhere to the rule that if the contract makes payments from the owner a condition precedent to the general contractor’s obligation to pay, then the general contractor’s obligation never arises if the owner becomes insolvent and never makes a payment. See Vratsinas Constr. Co. v. Triad Drywall, LLC, 739 S.E.2d 493 (Ga. Ct. App. 2013). Thus, if an owner fails to pay a general contractor due to the owner’s bankruptcy, the subcontractor also remains unpaid. What’s more, the provisions of the automatic stay in Bankruptcy cases may prevent the subcontractor from claiming or enforcing its rights under Georgia’s mechanic lien statutes—depending on the specific circumstances of the Project. See 11 U.S.C. 362. When combined, these circumstances leave the unpaid subcontractor with limited legal remedies and could lead the subcontractor to consider its own option for relief under the Bankruptcy code.

In order to avoid these potential payment issues, all parties in the construction process should carefully review their contracts for “pay when paid” clauses during the contract negotiation and drafting phase of the Project. And despite subcontractors’ limited bargaining power in modifying the terms of its subcontract, full awareness of the contract terms should allow the subcontractor to mitigate risk on its Projects. For advice on specific language or for questions regarding general construction contract terms and conditions, contact Jake Carroll at [email protected] or any member of the FMG Construction Practice Group.

 

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