Should Subcontractors Share the Risk of Owner Nonpayment?

Is it fair for subcontractors to bear the risk of owner nonpayment for their work? Many prime contractors would argue that it is. The subcontractor is being asked to share the risk. If the project owner hasn’t paid the prime for the sub’s work, why should the prime be required to pay the sub, in effect financing the owner’s project?

Subcontractors would respond that the prime contractor elected to do business with the project owner and had the opportunity to evaluate the credit-worthiness of the owner. The sub contracted only with the prime and should be paid by the prime for work performed. The subcontractor has no control over the business relationship between the project owner and the prime contractor.

Some states have limited, by statute or case law, the enforceability of subcontract pay-if-paid clauses. But in the majority of jurisdictions, the clauses are enforceable if clearly and unambiguously worded. A recent federal appellate decision, applying Virginia law, illustrated how difficult it can be to avoid the effect of these clauses.

I invite your opinion on this topic. Is it reasonable for prime contractors to expect their subcontractors to share the risk of project owner nonpayment?

Featured in next week's Construction Claims Advisor:

• Contractor Denied Compensation for Storm Impact on Labor and Materials

• Subcontracting Did Not Lead to Insurance Exclusion

• Owner Could Sue Architect Only Under Contract

Comments

[Bruce Jervis, Editor, Construction Claims Advisor]

I have three observations in response to the comments.
There is no question that trades who perform in the latter stages of a project are at greater risk from a pay-if-paid clause.
Disclosure of owner creditworthiness to subcontractors would be ideal, but is unlikely to become the norm.
The interrelationship between pay-if-paid clauses and subcontractor lien rights is an interesting one. In some jurisdictions, these clauses cannot be used to negate lien rights. But in many states, if there is no payment right under the subcontract, there can be no mechanic's lien.

[Gary]

no sub should have to accept a "pay when paid" clause. If general contractors had any integrity left at all, we subs wouldn't have to argue about it because they wouldn't exist. if the GC is unable to guarantee payment he has no business contracting with the sub in the first place. I have seen this 'ripoff' clause misused many times. subs should say, "we will accept your 'pay when paid' clause, but its only good for 90 days and oh, by the way, that's going to cost you an additional 15% on the contract." I bet that clause would disappear pretty darn quick then. Subs need to unite and put the pukes out of business that will say they question the financial stability of a sub that has a problem with that clause. Don't let the GC talk down to you! He is the one admitting he isn't sure he can pay his bill! You are just being responsible to your employees and your families by refusing to sign a contract that says you may not get paid. All you GC's that think your subs should be your backup plan to save you when you mismanage a job and the owner doesn't pay you- go ahead and go out of business! we don't need you around. And to the arrogance that asks how would subs exist without the GC 'conduit'? -- oh please!! get rid of the GC and the sub will do just fine! there are hundreds of reasons the owner may not pay the general contractor. most of them have to do with the GC's performance. why should we subs guarantee the performance of those we do not control. generals should place their efforts in securing the construction funds in a force account to guarantee their subs payment instead of wasting time trying to get a subcontractor to sign an immoral contract.

[aaron]

As a specialty contractor in the security sector, we are also one of the last on site when working as a sub. All my proposals clearly state, this agreement is between my company and the company/individual hiring us and nothing will hold up payment once our SOW is complete. So far this has kept us paid. However, many times we act as the prime and have to bring on subs. In every case, I have always paid every subs invoice in full once work is complete regardless if I have been paid or not. Why, because I treat people the way I want to be treated. Some call this the Golden Rule.

[Mike]

I've been in the millwork industry over thirty years and I think I've seen and heard it all. If I could go back and make a different career choice I would, because construction, although a noble profession, is full of pitfalls - much more so than most businesses. We've had a lot of good experiences over the years, and a few really bad ones. The bad ones can kill a whole careeer, steal a lifetime of savings, and ruin a good business. We are still here, even through this economy, but my business has been stiffed for hundreds of thousands of dollars on single projects. We've hired lawyers who've changed their billing from a fee basis to a contingency due to the fact that they agreed, after getting into the meat and potatoes of our claim, that we were being taken advantage of and knew we could not afford the six figures of legal fees over the two and a half years it took to get the case into court. The contractor said it was about pay when paid, but it turned out that the contractor negotiated settlements and payouts with the bigger subs (mechanical, steel) and let the guys who could not afford to fight flap in the breeze. (this was addressed in a previous post by someone else) This sounds like sour grapes and it is, but the system of payment in the indstry is the problem. This GC took a project for 2/3 of the value, got all the money it was going to get from the owner, and didn't pay the subs who could not afford to fight. We were the only one to get them to the courthouse, thanks to principled attorneys. That's not speculation. I was told that personally by one of the superintendants at the courthouse. Now, that's one story about an incompetent, unscrupulous general contractor, but it's illustrative of the problem that subs face and there needs to be protection in the law from people who lie, cheat and steal. There is just about everywhere else, and having done some lobbying for this type of thing I've found that the GC lobby is much stronger than the sub's lobby. On the flip side, I have been an owner's rep and treated the payment process very seriously when approving contractor draws. The contractor received payment on or before the 10th of the month following billing, retainage amounts were reduced to 5% after completion and approval of the individual sub's work, and once proof of downstream payments was received all retainage was released to each sub individually during the progress of the project. Guess which project was fully manned, had excellent workmanship, no arguments or even heated discussions, and was ahead of schedule in a busy market. I used that opportunity to prove a point, and prove it I did.
Subs - know your customer, set your terms, and walk away if you don't get them. We learned this the hard way and we are slower today than we otherwise would be for doing just that, walking away from any project that will not schedule payments to our satisfaction. I've discussed this with my banker and he tells me that the less risk I take, even in a slow market, the better the board of directors at the bank views my business. By the way, for the project I went on about above, the court directed us to settle out of court. It seems that even though you have a case, you might not get to present it without a judge willing to invest the time to hear the evidence. The end result to my business was far less than satisfying, and a sub going up against a GC with deeper pockets has little chance of being treated fairly. My attorney called it "gaming the legal system for profit". Seller beware. I end this by saying thanks and kudos to all the contractors who treat their subs fairly. That does happen more often than not.

[karen in Chicago]

To say a Sub shouldn't sign a pay when paid contract is not realistic. Every contract we see has this clause, usually along with some really onerous liability, too. Anything but a direct contract with a homeowner or a very small business will have a PWP.
Our only protection is to lein, Oh wait, the contract says we can't do that either.

[Frank]

What all you GC's seem to forget is that you dont have any real our-of-pocket costs. What real costs do you have? maybe some rentals on forklifts or something, and then the onsite foreman time and expected profit? Big deal. You try getting tens of thousands of dollars in bills from your suppliers and then not get paid from the GC and see how you like it. Also most all vendors and suplliers want personal guarantees from the business owner to grant credit to the business. So why in the world should i put my family and home at risk because so many of all you GC's nowadays are scum. I've heard GC's who brag about how many people they put out of business.Being a sub in todays commercial construction market sucks, if i had any sense i would have gone to college and gotten a real job.
Another problem that happens way to much is the architects and engineers are terrible, they get worse by the year. What does an architect know about anything outside liek sitework, dirtwork or utilities? NOTHING, and they never involve the civil engineer for hiw own work. A & E's have way to much to say sometimes on the job and they have WAY to much input about GC's or subs payments and chaneg orders. "oh well you should have included that in the bid, the owner shouldnt have to pay for that" SOUND familiar? Oh sure, you as the A/E dont care about anybody else getting paid you got all your money up front already. Not only that you A/E drag for feet for months or years getting the proper plans and permits and when it finally gets to construction you put all of us under the gun because the owner wants it done NOW. To work in the commercial construction market today sucks. I like the actual work and what i do, but just trying to get paid and always be ont he defense against not getting screwed from the GC's gets old. It seems liek every price or change order or bid yo always want lower, or back up and justification about the cost. The prices are what they are, if i give you a good price for the bid, then change orders are a bit higher? well DUH! i have to make some money somewhere, and dont worry you will be diligence in your efforts to screw me later, make me do work thats not in contract, or hold my retainage for a year and hope i go away to make up for it, and by the way we bid the job over a year ago, prices have gone up and fuel costs have gone up, so get off my back about prices, you have no idea what the H*!! you are talking about.

[Paris Tabor]

One would assume we are talking about a GC At Risk...hence they have assume the position in the food chain.
As a design professional or tradesman, we have not enrolled to be a "at risk" participant...hence we can choice to not participate or we can be compensated appropriately with a appropriate contingency line item.
The GC "At Risk" is delivering a product as is Ford, GE, Lockheed, etc. I have not seen Ford, GE, Lockheed, etc. turn to their subcontractors/suppliers and tell them they will be paid when they get paid.
The GC "At Risk" should not expect the subs/suppliers to assume their risk and role.

[PatriciaCONNER33]

I opine that to receive the business loans from creditors you must have a good motivation. However, once I've received a collateral loan, because I was willing to buy a bike.