Who Bears Risk of Non-Payment Between General and Sub-Contractor?

November 13, 2014

A recent decision by the Supreme Court of Ohio highlights the importance of having clear terms in contracts between general contractors and subcontractors, especially in regard to payment provisions.

In Transtar Elec., Inc. v. A.E.M. Elec. Servs. Corp., a general contractor hired a subcontractor to provide electrical services for the installation of a pool at a hotel.  The contract between the general and the subcontractor had a payment provision that read, in part,

RECEIPT OF PAYMENT BY CONTRACTOR FROM THE OWNER FOR WORK PERFORMED BY SUBCONTRACTOR IS A CONDITION PRECEDENT TO PAYMENT BY CONTRACTOR TO SUBCONTRACTOR FOR THAT WORK. 

The owner failed to pay the general contractor who, in turn, refused to pay the subcontractor. The subcontractor sued the general contractor for nonpayment. 

The case turned on whether the contract’s payment provision was a “pay-when-paid” provision or a “pay-if-paid” provision. A pay-when-paid provision is an unconditional promise by a general contractor to pay a subcontractor. Thus, under a pay-when-paid provision, a general contractor bears the risk of the owner’s nonpayment. In contrast, a pay-if-paid provision requires a general contractor to pay a subcontractor only if the owner pays the general contractor. Under a pay-if-paid provision, the risk of nonpayment by the owner shifts from the general contractor to the subcontractor. To be enforceable, a pay-if-paid provision must be sufficiently clear in showing the parties’ intent to shift the risk of nonpayment to the subcontractor. 

The Court held that the contract’s payment provision was a pay-if-paid provision, reasoning that the parties’ use of the words “a condition precedent” was sufficiently clear evidence of their intent to shift the risk of the owner’s nonpayment to the subcontractor. 

The key takeaway here is that when contractors and subcontractors enter into a contract, the parties should take care to (1) clearly establish who bears the risk of the owner’s nonpayment, and (2) draft a contract that clearly states the parties’ intent in that regard.  A trip to the Ohio Supreme Court is an expensive way to determine an issue that could have easily been resolved at the outset of the matter.

 

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