Maryland Enforces Pay-if-Paid Clause Against Subcontractor on a Virginia Project

In the recent decision of Young Electrical Contractors, Inc. v. Dustin Construction, Inc., the Maryland Court of Special Appeals, applying Virginia law, affirmed a circuit court ruling that a pay-if-paid clause can vitiate a subcontractor’s claims for nonpayment.  Because the contract conditioned the subcontractor’s right to receive payment upon payment from the owner, the prime contractor had no liability for unpaid delay and acceleration claims.

The case arose out of the renovation and construction of George Mason University’s Student Union in Virginia.  The owner, George Mason University, entered into a prime contract with Dustin Construction, Inc. (“Dustin”), which in turn subcontracted the electrical scope of work to Young Electrical Contractors, Inc. (“Young”).  Due to a number of delays on the Project, Young was unable to meet the agreed-upon date for substantial completion, and as a result, experienced a number of cost overruns, which Young sought to recover from Dustin via several change orders.  Dustin passed through a portion of Young’s change orders to the owner, which were denied, resulting in Dustin’s denial of payment to Young under the subcontract’s pay-if-paid clause.  Young then sued Dustin for breach of the subcontract for that non-payment.

At issue in the case was the subcontract’s pay-if-paid clause, which included the term that payment by the owner was a “condition precedent” to payment to the subcontractor:

It is specifically understood and agreed that the Contractor’s obligation to pay all or any portion of the Subcontract Sum to Subcontractor, whether as a progress payment, retainage, or final payment, is contingent as a condition precedent, upon the Contractor’s receipt of payment from the Owner of all amounts due Contractor on account of the portion of the Work for which the Subcontractor is seeking payment.

As a result of those terms, both the trial court and appeals court in Maryland determined that since the owner denied payment of the change orders to Dustin, Dustin had no obligation to pay Young on its claims.  Had those magic words “condition precedent” been absent from the subcontract, the general contractor would not have been able to avoid liability to the subcontractor.  However, by accepting the pay-if -paid clause, Young could not hold Dustin responsible for unapproved delay and acceleration claims.  The Maryland Court of Special Appeals not only applied Virginia law on this issue, but noted it was consistent with Maryland law as well.  If the contract expressly and unambiguously conditions owner payment on the contractor’s obligation to pay its subcontractors, that clause will be enforced in both jurisdictions.

This case highlights the particular care that must be taken by subcontractors to protect their payment rights when negotiating subcontracts.  N.B.  The court consistently used the term “pay-when-paid” to describe the subcontract clause in question.  However, the more common description of “condition precedent” clauses is that they are pay-if-paid clauses.  In some jurisdictions, pay-when-paid clauses give the contractor a reasonable period of time to collect from the project owner, but does not shift the risk of owner nonpayment to the subcontractor. Instead, pay-when-paid clauses simply address the time in which the general contractor must pay and are more favorable to subcontractors.  An example of a pay-when-paid is: “No payment shall be due until five (5) days after the owner shall have paid the contractor.” 

The ultimate take-away is that the inclusion of the term “condition precedent” shifts the risk of owner nonpayment to the subcontractor and will be enforced as an unfavorable pay-if-paid provision.  Similar terms that will have the same effect include “if,” “provided that,” and “subject to.”  Due to the devastating effect that those terms can have, BrigliaMcLaughlin frequently counsels subcontractors on their contractual obligations and liabilities, and has successfully negotiated more favorable contract terms for its clients.  To learn more about BrigliaMcLaughlin’s construction risk management practice, click here.