Construction subcontracts frequently contain a “pay if paid” or a “pay when paid” provision. According to the terms of a “pay if paid” provision, the general contractor is not required to pay the subcontractor unless the project owner pays the general contractor. Under a “pay when paid” clause, the general contractor is not required to pay the subcontractor until it is paid the project owner. In California, regardless of which provision is in the contract, a subcontractor will be paid for its work. However, depending on the type of provision, payment may be received later than sooner.
“Pay if paid” provisions were examined by the California Supreme Court in the case of Wm. R. Clarke Corp. v. Safeco Ins. Co. (1997) 15 Cal.4th 882. In that case, the Court addressed the issue of whether “pay if paid” clauses were valid and enforceable. After analyzing the underlying policy of mechanic’s liens, the Court held that “pay if paid” provisions are invalid and unenforceable because they conflict with California public policy. The Court reasoned that when an owner fails to pay the general contractor, “pay if paid” clauses result in an impermissible indirect waiver or forfeiture of the subcontractors’ constitutionally protected mechanic’s lien rights. Consequently, in California, “pay if paid” provisions do not relieve the general contractor or its bond surety from the contractual obligation to pay subcontractors for work performed on the project.
Twenty-five years before the Wm. R. Clarke decision, in the case of Yamanishi v. Bailey & Collishaw, Inc. (1972) 29 Cal. App.3d 457, the California Appellate Court focused on the validity of “pay when paid” provisions. Although the Yamanishi Court held that “pay when paid” clauses were valid and enforceable, it also held that the general contractor may only avoid payment to a subcontractor for a reasonable period of time. The Yamanishi Court concluded that the “pay when paid” provision, which stated that the subcontractor would be paid when the general contractor was paid by the owner, determined when payment would be made rather than completely barring payment if the owner failed to pay the general contractor. What constitutes a “reasonable” amount of time is a question of fact and depends largely upon the specific language of the payment clause.
Therefore, despite the presence of a “pay if paid” or “pay when paid” clause in a contract, a subcontractor is entitled to payment for all work performed on a project. However, when a subcontractor is entitled to payment is dictated by the type of clause and, in the case of the “pay when paid” provision, the specific language of the clause. Accordingly, before entering into a contract, a subcontractor should carefully examine all payment provisions. Failure to do so may result in cash flow problems.