Pay-When-Paid Clauses

When an owner refuses to pay its prime contractor, does the prime contractor in turn still have to pay its trade contractor? Many prime contractors anticipate this risk and attempt to shift it to the trade contractor with contracts that incorporate pay-when-paid clauses, clauses that provide the trade contractor will be paid only if and when the prime contractor is paid. What do courts think of these clauses?

The issue with true pay-when-paid clauses is that they are effectively a condition precedent in a contract. Condition precedents are not in themselves unusual or unreasonable. For example, a general contractor may include a clause that unless appropriate insurance documentation or bonds are submitted, there is no obligation to pay. What is unusual, and arguably unreasonable about a pay when paid clause, is that unlike other conditions precedent that generally depend on the conduct of the trade contractor, pay-when-paid clauses are activated by a non-paying owner, a situation trade contractors have no control over. For this reason, courts have been hesitant to penalize trade contractors by enforcing this type of clause.

The most recent decision to look at this issue is from the Yukon where the Yukon Supreme Court in Cardinal Contracting Ltd. v. Seko Construction (Vancouver) Ltd. considered the following clause that the general contractor, Seko Construction, argued was a pay when paid clause:

Payments shall be made monthly on progress estimates as approved by the Contractor covering 90% of the value of the Work completed by the Subcontractor to the end of the previous month: such payments to be made 7 days after the Contractor receives payment for such Work from the Owner.

Counsel for the Cardinal, the trade contractor, argued that the above clause simply addressed the timing of payments during the performance of the contract and relied in argument on the Nova Scotia Court of Appeal’s decision in Arnoldin Construction & Forms Ltd. v. Alta Surety Co. where the clause at issue read:

… The balance of the amount of the requisition as approved by the Contractor shall be due to the Subcontractor on or about one day after receipt by the Contractor of payment from the owners.

In that case, the Nova Scotia Court of Appeal ruled that the clause was a not a pay when paid clause. The Nova Scotia Court stated that to be a condition precedent the wording would require much clearer language than the “obscure” language of the contract used in the case before it.

Counsel for Seko Construction, on the other hand, relied on the Ontario Court of Appeal in Timbro Developments Ltd. v. Grimsby Diesel Motors Inc. (which the Nova Scotia Court of Appeal had declined to follow) where the Ontario Court found on the basis of the following wording that the payment clause at issue was a pay when paid clause:

…When used for sub-contract work the following terms will apply: Payments will be made not more than thirty (30) days after the submission date or ten (10) days after certification or when we have been paid by the owner, whichever is the later.

The Yukon court chose to follow the Nova Scotia Court of Appeal and ruled in favour of Cardinal, finding that the words in the contract before it were not as “clear and precise” as the clause before the Ontario Court in Timbro. It held therefore that the payment clause was a timing clause rather than a “pay when paid” clause and since the court could find no clear wording in the subcontract before it that the payment was conditional on the owner paying Seko Construction it ordered that the outstanding contract balance should be paid to Cardinal regardless of whether the owner had paid Seko Construction.

The Yukon decision follows the more recent trend in the case law on this issue which suggests that only the most explicit and clearly drafted pay when paid clauses will be enforced by the Courts.

If you are a trade contractor, you should look closely at the payment clauses in proposed contracts to determine whether the general contractor is attempting to shift the risk of non-payment on you and, if so, whether you are prepared to take that risk in the circumstances of that project. If you are a general contractor who is using such clauses, you should be aware that their use is being questioned by the Courts, and their enforceability will in all likelihood depend on whether the contract has explicitly transferred this risk to the trade contractor.

This article was co-authored by Norm Streu (LMS Reinforcing Steel Group) and was originally published in Business in Vancouver. To read the original article, click here.