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Watch Out for Onerous Contract Provisions; They Don’t Benefit Anybody

Glass, business, report.

Contracts for construction projects, and among construction participants, can be lengthy and complicated.

Because the contract underlies the relationship between the parties, it can provide insight into not only the work to be performed and its cost, but also the fairness of the parties, the allocation of risk and relative bargaining power. Nobody wants to lose money, and to the extent the contract can provide protection and guidance, it can be a good vehicle to limit that risk. However, the temptation to leverage parties into contracts with over-extended requirements in a quest to shift all financial risk can sometimes cause parties to lose focus on fairness and collaboration. While such provisions are not ultimately to anyone’s benefit, they still appear in construction contracts. Here are some to look out for.

Onerous Contract Provisions

The following contract clauses, to variable extents, may signal reluctance to playing fair. While a contract that contains some of these clauses can be fair, and their mere inclusion doesn’t impugn the character of the contracting party, the more of these one sees, the less it appears the project will be run with a spirit of collaboration. Certain clauses are viewed with disfavor by the parties with less leverage, and can start the project on the wrong foot:

  • pay-when- paid;
  • pay-if-paid;
  • no lien;
  • strict claim notice provisions;
  • no damage for delay;
  • strict waiver requirements; and
  • subordination of lien.

Some of these clauses have been disallowed by statutes or court decisions, or have at least been weakened, but some still work as intended. However, these clauses’ appearance in a contract can signal that a party is attempting to shift risk and insulate itself at all costseven fairness. A brief examination of a couple of these clauses, with examples, will provide some information on why they should be avoided, and what they can look like in the contract itself.

Pay-If-Paid/Pay-When-Paid Clauses

Pay-if-paid clauses were specifically designed to shift the risk of non-payment from the payor to the payee. In order for a pay-if-paid clause to force the courts into enforcing it as a controlling condition precedent to payment (i.e., the contractor must pay the subcontractor if and only if it first receives payment) the clause must be extremely specific, and (depending on the state) likely must contain some particular language.

While these clauses are generally viewed unfavorably by courts, they may still be enforceable under certain circumstances. In order for a pay-if-paid clause to have a chance of being enforceable, it must be precise and clear in both wording and desired effect. This usually means that an enforceable pay-if-paid clause would use language such as:

The contractor’s receipt of payment from the property owner is specifically agreed to be a condition precedent to the contractor’s obligation to pay the subcontractor, and the subcontractor specifically and expressly assumes the risk of the property owner’s nonpayment.

Specific contractual language is mandatory to state that it is understood by both parties that the risk should be shifted. While some states specifically disallow risk-shifting pay-if-paid clauses, when phrases like “condition precedent,” “risk-shifting” or “assumes the risk” are used in conjunction with payment provisions, it would behoove companies to be wary.

Similarly, but to a lesser extent, pay-when-paid clauses are generally interpreted as a timing mechanism rather than a risk-shifting clause. This means that contractual language stating a contractor will pay a subcontractor when payment is received from the property owner is usually not interpreted to mean payment can be avoided indefinitely, and even if the general contractor is never paid, he/she must pay the sub within some “reasonable” time.

It’s worth noting, however, that this type of clause can still delay payment. Since the timing of payments can be nearly as important as the payment itself, companies should take care to examine such clauses. Examples of such clauses include:

Progress payments to the subcontractor shall be made no later than seven (7) days after receipt by the contractor of payment from the owner. If payment from the owner is not received the contractor will make payment to the subcontractor within a reasonable time.

or

Payment will be made not more than thirty (30) days after the submission date or ten (10) days after the certification or when we have been paid by the owner, whichever is later.

Lien Subordination Clauses

While no lien clauses are generally disallowed because attempts to extinguish lien rights preemptively are against strongly held public policy, there are other avenues for contracting parties to render liens ineffective. One of these tricks is a lien subordination clause.

These clauses relate to lien priority, and a lien’s priority is what may ultimately determine who gets paid. While lien enforcement or foreclosure proceedings are not frequent, they do occur, and being at the end of the payment line can mean not getting paideven if a valid lien was filed.

Subordination of a mechanics lien moves a lien from its place of higher priority and places it behind another interest in the property. Often times, these subordination clauses are contained within lending agreements, so that the lenders can claim priority for their deed of trust over mechanics lien claims that may have otherwise had priority. The interest that was originally lower on the priority ladder now has the first bite at the apple, and the mechanics lien claimant can be left out of payment altogether. This can work as a back-door no-lien clause to some extent. If the party who would file a mechanics lien is allowed to effectively allow every other claim to have priority, the benefits of the lien are greatly reduced, if not eliminated.

Accordingly, construction companies should carefully examine their contracts. While it’s just a good business practice to do so, it also may help ensure they are not left holding the bag when time for payment comes along.

One Reply
  1. I’ve worked for large mechanical contractors for almost ten years. I’ve found that trying to get some of these items removed from the agreement can be nearly impossible.
    In regards to lien subordination clauses, there is another issue to consider. Failure to sign could result in the lender not providing funding for the project. If the project isn’t funded, then the project doesn’t proceed and you don’t do the work. Or, the owner/GC/lender then choose a different contractor to perform your scope, and you still don’t do the work. Agreeing to sign the lien subordination clause could be a negotiation tool to reduce some risk by negotiating a lower (or no) retention, or by providing a retention bond instead of retention, or a higher fee for the added risk.
    Another issue with paid if paid or paid when paid agreements, even when it’s interpreted or argued for payment to be made in a reasonable amount of time is that if the general contractor doesn’t have the funds to pay, you still don’t get paid.
    Something I’ve looked at over the last several years, but yet to purchase, to try to protect against these non-payment issues is credit insurance. This is where you buy insurance for your receivables on the project and if the owner/GC/lender don’t pay for any other reason than a dispute, you can still get paid in full for your work performed. The insurance company then pursues payment from the responsible party. Has anyone had experience with credit insurance? Any success or failure stories they could share?
    Roger Shively
    Contracts & Risk Management Manager
    University Mechanical Contractors, Inc.
    Mukilteo, WA

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