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.