'Paid If Paid' Clauses – Who Is Left Holding The Bag When A Project Owner Fails To Pay?

If the owner of a half completed construction project declares bankruptcy or otherwise defaults in making payments, is it the general contractor or a subcontractor(s) that bears the risk of non-payment? The answer may hinge on whether the subcontract between the general contractor and subcontractor includes a "paid when paid" clause or a "paid if paid" clause.

"Paid When Paid" Clauses versus "Paid If Paid" Clauses

A "paid when paid" clause is a clause that essentially provides the general contractor agrees to pay the subcontractor after receipt of payment by the owner for the subcontractor's work. If the owner fails to pay the general contractor then there is an express or an implied agreement for the general contractor to pay the subcontractor within a reasonable amount of time. However, a "paid if paid" clause provides that the general contractor's receipt of payment from the owner for the subcontractor's work is a condition precedent to the general contractor's obligation to make payment to the subcontractor. Thus, under a "paid if paid" clause, the general contractor has no obligation to make payment to a subcontractor unless a corresponding payment is made by the owner. In addition to a "paid when paid" clause or a "paid if paid" clause included in the subcontract between a general contractor and its subcontractor, these payment clauses may also be included in further downstream contracts such as subcontracts between a subcontractor and its sub-subcontractor.

Enforceability of "Paid If Paid" Clauses in Indiana

A fairly recent Seventh Circuit Court of Appeals decision highlights the importance of conducting a thorough review and careful negotiation of subcontracts including as to any "paid if paid" clauses. In BMD Contractors v. Fidelity and Deposit Company of Maryland, 679 F.3d 643 (7th Cir. 2012) (applying Indiana law), a project owner declared bankruptcy resulting in corresponding flow-down payments not being made to the general contractor, subcontractors and sub-subcontractors. An unpaid sub-subcontractor filed suit against the surety that provided a payment bond for one of the subcontractors. The subcontract between the sub-subcontractor and subcontractor included a clause that stated "It is expressly agreed that Owner's acceptance of subcontractor's work and payment to the contractor for the subcontractor's work are conditions precedent to the subcontractor's right to payments by the contractor." The sub-subcontractor argued that...