Key Notes:

  • Court enforces pay-if-paid provision.
  • Court allows unjust enrichment claim against owner.
  • Decision is of significance to parties engaged in construction projects in Kentucky.

On December 14, 2017, in a decision of significant import to contractors and subcontractors who perform work in Kentucky, the Kentucky Supreme Court recognized the validity of and enforced a pay-if-paid provision in a contract between a construction manager and a subcontractor.

In Superior Steel v. The Ascent at Roebling’s Bridge, the subcontractor entered into a contract with the construction manager for the steel fabrication and erection scope of work on a high-rise condominium project in Covington, Kentucky. The subcontract contained a pay-if-paid provision, which stated “[r]eceipt of payment by the Contractor from the Owner for the Subcontract Work is a condition precedent to payment by the Contractor to the Subcontractor. The Subcontractor hereby acknowledges that it relies on the credit of the Owner, not the Contractor for payment of Subcontract Work.”

In the course of the project, the steel subcontractor performed work outside the scope of its subcontract with the construction manager. The owner refused to pay the construction manager for the extra work, and, therefore, the construction manager did not pay the steel subcontractor. The steel subcontractor filed a lawsuit against the construction manager and the owner asserting claims for, among other things, breach of contract and unjust enrichment. The construction manager asserted a claim against the owner for indemnification.

The case proceeded through a 15-day jury trial, at the conclusion of which the jury decided that the steel subcontractor had performed extra work for which it was entitled to compensation. As a result of the jury’s verdict, the trial court entered judgment against the construction manager for breach of the subcontract and against the owner on an unjust enrichment theory. The trial court then determined that the owner was required to indemnify the construction manager for all amounts the construction manager was required to pay under the subcontract. All parties appealed.

The Court of Appeals reversed the trial court’s judgment and remanded for a new trial. In so doing, the Court of Appeals vacated the breach of contract award against the construction manager on the ground that the jury should have been instructed on the “pay-if-paid” provision in the subcontract. According to the appeals court, “[t]he jury should have been instructed to determine if [the construction manager’s] obligation to pay [the subcontractor] ever arose, and thus if [the construction manager] was in breach, or if [the construction manager] was not obligated to pay [the subcontractor] until it first received payment from [the owner], and thus it did not breach the contract.”

Although pay-if-paid provisions had not been previously addressed by Kentucky’s Supreme Court, it agreed with the Court of Appeals, finding that the pay-if-paid provision in the subcontract clearly and “unequivocally allocates the risk of nonpayment” by the owner to the subcontractor and that the construction manager was relieved of any obligation to pay until it received payment from the owner. While the court noted the subcontractor’s public policy arguments against application of the clause, it concluded that Kentucky respects the freedom of contract, and any prohibition on pay-if-paid clauses would have to come from the legislature. Thus, the court concluded that the pay-if-paid provision precluded a breach of contract finding against the construction manager.

In a related, noteworthy turn, the court also relied on the pay-if-paid provision to reinstate the unjust enrichment verdict against the owner, concluding that although the equitable remedy of unjust enrichment does not exist when there is a contractual remedy, the existence of the pay-if-paid clause in the subcontract blocked the subcontractor from pursuing a contract remedy. As such, the subcontractor was permitted to pursue its claim for unjust enrichment against the owner, and that portion of the trial court’s judgment was reinstated.

This decision is of significance to parties engaged in construction projects in Kentucky. Contractors and subcontractors should be aware that courts will enforce clear and unambiguous pay-if-paid provisions. Thus, in contracts with those terms, the risk of non-payment by the owner will fall to the parties who fall lower in the chain of contracts.