“Pay If Paid” Provisions in Subcontracts Are Very Much Alive and Enforceable – So Says Michigan’s Second Highest Court

A July 2013 Michigan Court of Appeals decision upholds the enforcement of pay-if-paid provisions in subcontracts, provided the provisions have the “magic” language. In Walbridge Aldinger Company v. Angelo Iafrate Construction, Moorehead Electric Company, et al, the State of Michigan’s second highest court held that when a pay-if-paid clause explicitly indicates that a general contractor’s receipt of payment from the owner is a condition precedent to its obligation to pay the subcontractor, the provision is enforceable, and prevents the subcontractor from collecting monies owed.

Walbridge’s  subcontract with its subcontractor, Moorehead Electric, contained the following provision:

“PAYMENTS: Subcontractor acknowledges that it has considered the Owner’s solvency and Owner’s ability to perform the terms of its contract with Contractor before entering into this Subcontract. Subcontractor acknowledges that it relies on the credit and ability to pay of the Owner, and not the Contractor, for payment for work performed hereunder. Subcontractor is entering into this subcontract with the full understanding that Subcontractor is accepting the risk that the Owner may be unable to perform the terms of its contract with Contractor. Subcontractor agrees that as a condition precedent to contractor’s obligation to make any payment to Subcontractor, the Contractor must receive payment from the Owner. Upon written request by Subcontractor, Contractor will provide Subcontractor access to all information in Contractor’s possession, if any, regarding the Owner’s solvency and ability to perform the terms of Owner’s contract with Contractor.

“In the event that the Contractor does not receive all or any part of the payment from the Owner in respect of Subcontractor’s Work, whether because of a claimed defect or deficiency in the Subcontractor’s Work or for any other reason, the Contractor shall not be liable to the Subcontractor for any sums in respect thereto. In the event the Contractor shall incur any cost or expense of any nature in preparing for the prosecution of, and prosecuting any claim against the Owner, whether by means or negotiations, arbitration or legal action, arising out of the Owner’s refusal to pay the Contractor for Work done by the Subcontractor, Contractor shall be entitled to deduct such costs and expenses form the amount due Subcontractor.”

The Court dismissed all of Moorehead’s arguments. The Court said the language of the subcontract (receipt of payment being a condition precedent) clearly and explicitly shifted the risk that the owner would not pay to the subcontractor. The Court also rejected the idea that the pay-if-paid provision was not enforceable because Walbridge fraudulently induced Moorehead to enter into the agreement by misrepresenting the project owner’s identity. The Court pointed to the contract’s specific language that “upon written request by the Subcontractor, Contractor will provide Subcontractor access to all information in Contractor’s possession regarding the Owner’s solvency and ability to perform the terms of Owner’s contract with Contractor.” Since Moorehead had at its disposal the means to establish the true identity of the owner and its solvency, there was no fraud. Moorehead’s claims were dismissed on a motion, without the necessity of a trial.

The take-away from this case is that subcontractors that sign pay-if-paid subcontracts containing the explicit “condition precedent” language must know that courts will enforce them, even though they may appear onerous, unfair, and unreasonable.

When contracting with generals contractors, there are ways subcontractors can negotiate to reduce their risk, in spite of the enforceability of pay-if-paid provisions. You may also consider using this same provision in your subcontracts. If you are interested or need additional information, please feel free to contact me.