1 PAY IF PAID CLAUSES A Presentation by: And Brought to You by:

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PAY IF PAID CLAUSESA Presentation by:

And

Brought to You by:

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PRESENTER BIOGRAPHYJohn Morris, Esq. practices law with the New Jersey law firm of McElroy, Deutsch Mulvaney and Carpenter, LLC. Mr. Morris is admitted to the bars of New York, Pennsylvania and New Jersey and United States District Courts of New Jersey and the Southern and Eastern Districts of New York. He practices in the area of construction, contract/surety, professional-liability defense and commercial litigation. Most of these cases , but not all are concentrated in the engineering, procurement and construction industries. He co-authored The Surety’s Environmental Risk, a Monograph published by the American Bar Association in 1996, which analyzes the risks associated with underwriting contract surety bonds for response-action contractors performing environmental remedial work at projects listed on the National Priorities List.

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James Rudnik, Esq. began his surety career in Minnesota as a surety exclusive agent in 1976. After law school he practiced law representing sureties and contractors until he joined the surety and fidelity claim department at the St. Paul Fire and Marine Insurance Company. He was the claim manager for Allstate Reinsurance which he notes was “like a post graduate course in surety company finance and management”. He planned and built the surety claim department for the then fledgling Liberty Mutual Surety. For the past ten years he has been a surety claims consultant where his clients include surety companies and reinsurers. He has previously been the claims instructor for the William J. Angell Surety School. Mr. Rudnik is admitted to the bars of Minnesota and Illinois. His surety agency business, Rudnik Surety, Inc., is now owned by his brother, David Rudnik.

PRESENTER BIOGRAPHY

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PAY IF PAID CLAUSESHISTORICAL PERSPECTIVEIDENTIFICATION OF PAY IF PAID

CLAUSESDISTINGUISHING FROM PAY WHEN

PAID CLAUSESENFORCEABILITYSHIELD FOR PAYMENT BOND

SURETIESLATEST DEVELOPMENTSPRACTICE TIPS AND CONCLUSION

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HISTORICAL PERSPECTIVE

A. Origination of Pay When Paid Clauses

B. Purpose of Pay When Paid ClausesC. Case Law DevelopmentD. Legislation Proscribing ClausesE. Development of and Need for Pay If

Paid Clauses

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IDENTIFICATION OF PAY IF PAID CLAUSES

A. Requisite Language1. For Example: “Contractor’s Receipt of Payment

is a Condition Precedent….”2. But Not: “Contractor Shall Pay Subcontractor

within Seven Days of Payment by Owner….”

B. Risk/Burden ShiftingC. Inability to Absorb Owner Non-PaymentD. Condition Precedent – Express LanguageE. Cases Holding Unenforceable when

Clauses Infringe on Statutory Lien Rights

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“Contractor's receipt of payment from the owner is a condition precedent to contractor's obligation to make payment to the subcontractor; the subcontractor expressly assumes the risk of the owner's nonpayment and the subcontract price includes this risk.”

“The obligation of contractor to make payment under this agreement, whether a progress or final payment, or for extra or change orders or delays to the work, is subject to the express condition precedent of payment therefore by the owner.

TYPICAL PAY IF PAID CLAUSES

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 “It is agreed that as a condition precedent to any payment by Contractor to Subcontractor hereunder, the Contractor must first receive payment from the Owner for the work of Subcontractor for which payment is sought.  Subcontractor specifically agrees that it is relying on the Owner's credit for payment.  Subcontractor specifically accepts the risk of non‑payment by Owner.” 

TYPICAL PAY IF PAID CLAUSES

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DISTINGUISHING FROM PAY WHEN PAID CLAUSES

A. Purpose of DifferentiatingB. Timing MechanismC. Common TrapsD. State Law and Public Policy

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TYPICAL PAY WHEN PAID CLAUSES

“Contractor shall pay Subcontractor within seven days of Contractor's receipt of payment from the Owner.”

"The total price paid to Subcontractor shall be the Contract Price, no part of which shall be paid until 5 days after payment is received from Owner."

"The Contractor shall pay the Subcontractor each progress payment and final payment . . . within three working days after he receives payment from the Owner . . . ."

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ENFORCEABILITY & SHIELD FOR SURETIES

A. Miller Act – Federal CasesB. State Law

1. Cases Holding Surety May Not Assert Clause as Defense

2. Cases Holding Surety May Assert Principal’s Defense Based on Clause

C. Contradictory Language Between Bond and Subcontract Forms

D. Owner Approval Triggering Timing of Payment

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FIXTURE SPECIALISTS, INC. V. GLOBAL CONSTRUCTION, LLC, 2009 WL 904031 (D.N.J. 2009)

FACTS:Subcontractor sued a general contractor

and its surety for unpaid amounts on a private construction project in New Jersey.

General contractor and its surety, relying on conditional payment provision in subcontract, refused to pay the subcontractor because general contractor had not been fully paid by the owner.

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Subcontractor moved for summary judgment on two grounds: (1) that a conditional payment provision in its subcontract was not enforceable under New Jersey law; and, (2) that the payment bond surety could not, in any event, rely on the same conditional payment provision as a defense.

FIXTURE SPECIALISTS, INC. V. GLOBAL CONSTRUCTION, LLC, 2009 WL 904031 (D.N.J. 2009)

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CONDITIONAL PAYMENT PROVISION AT ISSUE IN

FIXTURE“Subcontractor agrees that Contractor

shall never be obligated to pay Subcontractor under any circumstances, unless and until funds are in hand received by Contractor in full...This is a condition precedent to any obligation of Contractor, and shall not be construed as a time of payment clause... “

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POSITION OF GENERAL CONTRACTOR AND SURETYFull payment by the owner is an express

condition precedent to any obligation of general contractor’s duty to pay subcontractor based on conditional payment provision in subcontract.

Surety entitled to assert all defenses of its bond principal and, therefore, permitted to refuse to pay subcontractor under payment bond based on conditional payment provision.

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POSITION OF SUBCONTRACTOR

No express intention of the parties to transfer the risk of collection to subcontractor.

Conditional payment provision in subcontract simply permits general contractor a reasonable time to pay subcontractor.

Conditional payment provision violates provisions of construction lien law.

Surety may not rely on the conditional payment provision as a defense to subcontractor’s claim when language is not incorporated into payment bond.

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COURT’S DECISION IN FIXTURE

1. Conditional payment provision created a valid condition precedent to the general contractor’s liability to the subcontractor.

“It is not the use of ‘when’ or ‘if’ that is dispositive of the enforceability of the clause, but whether there is clear evidence of an intent by both parties to shift the risk of collection.”

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“[T]he express language employed in the payment clause in Section 5.3 is clear-the parties intended to shift any and all circumstances of Owner's nonpayment to [subcontractor]. Undoubtedly, the all-encompassing nature of the phrases ‘never be obligated to pay’ and ‘under any circumstances’ clearly and unambiguously expressed that [subcontractor] has agreed to assume the risk of the Owner's nonpayment.

COURT’S DECISION IN FIXTURE

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2. The subcontract’s conditional payment provision did not violate the applicable lien law.

The conditional payment provision did not prevent subcontractor from filing a lien to preserve lien rights as lien foreclosure would be stayed until all the preconditions to payment are met under NJ law.

Subcontractor could have filed a lien to attempt to receive payment and it would not have been in bad faith notwithstanding conditional payment clause.

COURT’S DECISION IN FIXTURE

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3. Surety entitled to rely on conditional payment provision as defense to subcontractor’s claim under payment bond.Based on fundamental concepts of

suretyship, and distinctions between suretyship and insurance under NJ law, the Fixture court concluded that a surety’s liability is triggered only when the bond principal’s debt matures.

COURT’S DECISION IN FIXTURE

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The Fixture court, therefore, found that it “logically follows” that if the general contractor in that case had not been paid by the owner, then the general contractor has not defaulted on a debt owed to the subcontractor.

Consequently, the court in Fixture concluded that the surety in that case was entitled to pursue its defense that it is not obligated on the payment bond until the principal becomes obligated on the debt.

COURT’S DECISION IN FIXTURE

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PRACTICE TIPS AND CONCLUSION

Extra Work IssuesDisputed Work IssuesLiquidation AgreementsAdvice from Broker/Agent

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Advice from Broker/Agent• Know the Difference between “when” and

“if”• Can the clause be changed?

-Probably Not-• Advise client to seek legal advice on the

impact to Mechanics Lien Rights

PRACTICE TIPS AND CONCLUSION

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Advice from Broker/Agent• What to do if there is a claim

PRACTICE TIPS AND CONCLUSION

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If you do not have the opportunity to have your question addressed during the Seminar, you may contact the presenters directly:

James Rudnik – [email protected] Morris – [email protected]

YOUR QUESTIONS?