The Ohio Sixth Appellate District Court of Appeals Rejects Purported Pay-if-Paid Provision

Reprinted from the Winter 2013 BrickerConstructionLaw.com Newsletter
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When a contractor enters into a contract with a subcontractor, the contractor may attempt to shift certain risks to the subcontractor through provisions within the subcontract. One risk contractors often attempt to shift to subcontractors is the risk of owner nonpayment. The intent of such a provision, commonly called a “pay-if-paid” provision, is to shift the risk directly to the subcontractor if the owner does not pay for the services.

A “pay-if-paid” provision provides that the contractor is only obligated to pay the subcontractor upon receipt of payment from the owner. Although different language is used to accomplish this shift of risk, contracts often include language making payment a “condition precedent” to payment by the contractor. A “pay-if-paid” provision may significantly affect a subcontractor’s right to bring a claim against the contractor for nonpayment.

Alternatively, a “pay-when-paid” provision does not pass all of this risk on to the subcontractor. A “pay-when-paid” provision deals with the timing of payment. It provides that the subcontractor will be paid within a specified time of receiving payment or within a reasonable time of requesting payment.
Absent a “pay-if-paid” or “pay-when-paid” provision, the risk of owner nonpayment is solely a risk the contractor assumes. This concept is based on the premise that the contractor is in the best position to assess the owner’s ability to pay and to minimize that risk.

In Transtar Electric, Inc. v. A.E.M. Electric Services Corporation, Sixth Appellate District Court of Appeals No. L-12-1100, December 14, 2012, the Sixth Appellate District Court of Appeals recently held that a provision in a subcontract did not contain adequate language to show that the contractor and subcontractor intended to shift the risk of owner nonpayment to the subcontractor.

In Transtar, a contractor and its subcontractor entered into a subcontract containing the following language:

The Contractor shall pay to the Subcontractor the amount due [for work performed] only upon the satisfaction of all four of the following conditions: (i) the Subcontractor has completed all of the Work covered by the payment in a timely and workmanlike manner, * * * (ii) the Owner has approved the Work , * * * (iii) the Subcontractor proves to the Contractor’s sole satisfaction that the Project is free and clear from all liens * * * and (iv) the Contractor has received payment from the Owner for the Work performed by Subcontractor. RECEIPT OF PAYMENT BY CONTRACTOR FROM OWNER FOR WORK PERFORMED BY SUBCONTRACTOR IS A CONDITION PRECEDENT TO PAYMENT BY CONTRACTOR TO SUBCONTRACTOR FOR THAT WORK. (Emphasis sic.)

The contractor argued that this contract language was a “pay-if-paid” provision. After performing work on the project, the subcontractor invoiced the contractor for its services. The contractor, however, only paid a portion of the subcontractor’s invoice because the contractor had not received full payment from the owner. The contractor did not dispute that the subcontractor performed the work or the amount of the invoice. The contractor, however, relied on the contract’s provision that payment from the owner was a “condition precedent” to payment by the contractor to support its position that it was not contractually obligated to pay the full amount.

The subcontractor, however, argued that the alleged “pay-if-paid” provision was actually a “pay-when-paid” provision that did not relieve the contractor from its obligation to pay.
The big issue before the court was to determine the meaning of the contract and, therefore, the intent of the parties in using the provision at issue. In making its decision, the court determined whether the language used was clear and unambiguous. Any ambiguity in the language will result in the provision being interpreted as a “pay-when-paid” provision.

The court, finding that the provision at issue was in fact a “pay-when-paid” provision, relied not only on other state courts’ general disfavor of “pay-if-paid” provisions, but also on Ohio case law requiring unequivocal terms dealing with the possible insolvency of the owner instead of general language providing that payment will be received after provided by the owner.

The court stated that the use of words “condition precedent,” while helpful, was not enough on its own to create a “pay-if-paid” provision because the words in this contract were not sufficiently defined to “impart that both parties understand that the provision alters a fundamental custom between a general contractor and a subcontractor.” Because the court did not consider the language used in this contract to be enough to clearly and unambiguously show the intent of the parties to transfer the risk of owner nonpayment to the subcontractor, the court determined that it could only be a “pay-when-paid” provision requiring that the contractor pay its subcontractor within a reasonable time.

The court found fault with a recent case from the Tenth Appellate District Court of Appeals, Evans, Mechwart, Hambleton & Tilton, Inc. v. Triad Architects, Inc., 196 Ohio App.3d 784, which held that a subcontract similar to the Transtar subcontract was sufficiently unambiguous to qualify as “pay-if-paid.” The Supreme Court of Ohio may need to have the final say on the matter to ensure uniformity in the law across the entire state.