On July 17, 2014, the Supreme Court of Ohio reaffirmed the enforceability of “pay-if-paid” provisions in construction contracts. These provisions condition payment from the general contractor to its subcontractor on the receipt of payment from the owner. Transtar Elec., Inc. v. A.E.M. Elec. Servs. Corp., 2014-Ohio-3095. In doing so, the Court also approved specific language that should be used when drafting these provisions.
Pay-if-paid provisions are different from “pay-when-paid” provisions, which are unconditional promises to pay a subcontractor within a specific period of time after receiving payment from the owner (e.g., contractor shall pay subcontractor within seven days of contractor’s receipt of payment from the owner). Under a pay-when-paid provision, if the owner never pays, a general contractor still must pay its subcontractor within a “reasonable period of time.” See e.g., Evans, Mechwart, Hambleton & Tilton, Inc. v. Triad Architects, Ltd., 965 N.E.2d 1007, 2011-Ohio-4979, ¶ 10 (10th Dist.).
But under a pay-if-paid provision, the general contractor never has to pay the subcontractor if the owner does not pay. Transtar, 2014-Ohio-3095 at ¶¶ 11-12. Pay-if-paid provisions are therefore disfavored under Ohio law. Thus, in order to be enforceable, they “must clearly and unambiguously condition payment to the subcontractor on receipt of payment from the owner.” Evans, 2011-Ohio-4979 at ¶¶ 12. The pay-if-paid provision in Transtar stated in pertinent part:
The Contractor shall pay to the Subcontractor the amount due under subparagraph (a) above only upon the satisfaction of all four of the following conditions: * * * (iv) the Contractor has received payment from the Owner for the Work performed by the Subcontractor. RECEIPT OF PAYMENT BY CONTRACTOR FROM THE OWNER FOR WORK PERFORMED BY SUBCONTRACTOR IS A CONDITION PRECEDENT TO PAYMENT BY CONTRACTOR TO SUBCONTRACTOR FOR THAT WORK.
At issue was whether the bolded and capitalized language, particularly the term “condition precedent”, clearly evidenced the parties’ intent to transfer the risk of nonpayment to the subcontractor. The Supreme Court of Ohio held that the provision, including the term “condition precedent”, was clear and enforceable. Thus, any contractor who wishes to pass the risk of nonpayment on to its subcontractors would be wise to incorporate the above language into any contract made under Ohio law. Although not specifically addressed by the Court, it would also be wise to include language ensuring that the contractor’s surety is also able to enforce this provision. For example: “All the Contractor’s rights and obligations set forth in this section inure to the benefit of its surety.” In sum, due to courts’ hostility toward pay-if-paid provisions, careful care should be taken when drafting them.