It is the sign of the times, contractors routinely try to avoid solely bearing the burden of non payment. Today, a “paid-if-paid” clause is a standard subcontract provision. “Pay-if-paid” clauses are enforceable in a majority of states so long as the conditions are clearly and unambiguously expressed. The burden of clear expression falls squarely on the contractor. However, it may not be enough just to craft a seemingly enforceable “paid-if-paid” provision. A contractor wishing to use a “paid-if-paid” provision should carefully review the other contract provisions to ensure consistency. A general rule of contract interpretation is that a contract must be read as a whole and each provision given its full meaning. Therefore all payment clauses, including those that are incorporated by reference, must be in harmony. A recent Florida case illustrates how an incorporation by reference clause, which incorporates the terms of the prime contract into the subcontract, can negate an otherwise enforceable “pay if paid” provision.
In International Engineering Services, Inc. v. Scherer Construction & Engineering of Central Florida, LLC, 74 So.3d 531 (Fla. 5th DCA 2011), International Engineering Services, Inc. (“IES”) entered into a subcontract agreement with Scherer Construction & Engineering of Central Florida, LLC (“Scherer”) for structural steel work. IES performed all the work under the subcontract but did not receive payment from Scherer. IES filed suit for breach of the subcontract and Scherer asserted a single affirmative defense: that the subcontract contained a pay-if-paid clause, which provided that payment by the owner was a condition precedent to Scherer’s obligation to pay IES.
The “Pay-if-Paid” Provision
The subcontract contained two payment provisions found in Article 6 and Article 7. The relevant part of Article 6 read:
Subcontractor agrees that all progress payments and final payment to Subcontractor are contingent upon and subject to Owner’s acceptance of Subcontractor’s work and upon Contractor’s receipt of payment from Owner. Subcontractor agrees to accept the risk of non-payment if Contractor is not paid progress payments and/or final payment from Owner, for any reason. Subcontractor further agrees that Owner’s payment to Contractor of all progress payments and final payment for any work performed by Subcontractor, other Subcontractors and Contractor shall be an express condition precedent to any obligation of Contractor to make any progress payment, retainages, or final payment to Subcontractor, and Subcontractor hereby waives all right to commence litigation or arbitration until payment is made to Contractor.
Article 7 provided:
Final Payment shall be due when the work described in this Subcontract is fully completed and performed in accordance with the Contract Documents, is satisfactory to the Owner and Architect and Final Payment has been made by the Owner to Contractor.
The court held that Article 6 was a clear expression that the parties intended for IES to assume the risk of nonpayment. The court also found that if read in isolation, Article 7 would be ambiguous and unenforceable. However, the court ruled: “when Article 6 and 7 are read together, it is apparent that the parties expressly and unambiguously intended to shift the risk of nonpayment to IES for progress payments and final payments.”
Prime Contract Incorporation Creates an Ambiguity
The court’s inquiry did not stop at the two subcontract payment clauses. The court also looked at Article 2, an incorporation by reference clause that provided:
The “Contract Documents” for this Subcontract consist of this Agreement, the terms, conditions or instructions contained in the transmittal letter from the Contractor to the Subcontractor delivering this subcontract for execution by the Subcontractor, any exhibits attached hereto, the Agreement between the Owner and Contractor dated (prime contract), the conditions of the Architect, all approved drawings and architectural plans and specifications, all modifications issued prior to execution of the Agreement between the Owner and Contractor, and all modifications issued subsequent thereto.
The prime contract contained the following provision relating to payment by the Owner to Scherer:
Neither final payment nor any remaining retained percentage shall become due until the Contractor submits to the Architect (1) an affidavit that payrolls, bills for materials and equipment, and other indebtedness connected with the Work for which the Owner or the Owner’s property might be responsible or encumbered (less amounts withheld by Owner) have been paid or otherwise satisfied.
The prime contract provided that the owner was not obligated to pay Scherer until Scherer paid all of its subcontractors. The court found the “pay-if-paid” provision ambiguous because the prime contract was incorporated by reference into the subcontract, requiring Scherer to pay IES before the owner paid Scherer. The prime contract’s payment provision conflicted with the subcontract’s “pay if paid” clause; therefore the “pay if paid” clause was unenforceable.
This case illustrates the importance of thoroughly reviewing all the terms of the contract for consistency. If a general contractor incorporates a prime contract into a subcontract by reference, it should read the terms of the prime contract thoroughly. Incorporation by reference or other type of flow down clauses are routinely used in construction; therefore careful attention must be paid when drafting such provision as to avoid the unintended consequences illustrated in this case.