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The Dotted Line: Virginia bans ‘pay-if-paid’ contract language

This feature is a part of “The Dotted Line” series, which takes an in-depth look at the complex legal landscape of the construction industry. To view the entire series, click here.

Construction subcontractors in Virginia can now breathe a little easier when it comes to getting paid for their work.  

In April, Virginia Gov. Glenn Youngkin signed into law SB550, which prohibits the use of “pay-if-paid” clauses in construction contracts. In doing so, Virginia joined a handful of states that have some type of statutory ban on a common, but also controversial, legal term of art in construction contracts.

Pay-if-paid clauses shift the risk of getting paid for completed work on a project from the prime contractor down to its subs, attorneys say. In other words, if the wheels come off a job and the money stops flowing at the top, pay-if-paid clauses let the prime off the hook for any money owed to subs lower on the chain.

Shoshana Rothman

Courtesy of Smith, Currie & Hancock LLP

 

“If for some reason the owner doesn’t pay the general contractor and you’re a subcontractor, you may never see payment, even if it’s completely unrelated to your work,” said Shoshana Rothman, a partner in the Tysons, Virginia, office of construction law firm Smith, Currie & Hancock LLP.

While that may not seem fair for subcontractors who have no control over the dealings between a prime and the owner, “in many jurisdictions, it’s absolutely enforceable,” said Judah Lifschitz, principal and co-president of Washington, D.C.-based law firm Shapiro, Lifschitz & Schram, P.C. “If you’re not in this industry, pay-if-paid might seem a little bit shocking, even draconian,” he said.

For that reason, Lifschitz says subs usually try to avoid pay-if-paid clauses in contracts. But they may feel compelled to accept them in situations where they don’t have leverage, or during periods when work is scarce.    

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Judah Lifschitz

Courtesy of Shapiro, Lifschitz & Schram, P.C.

 

“Most sophisticated subcontractors know better, and they wouldn’t sign a subcontract with a pay-if-paid clause,” Lifschitz said. “But when economic times are tough and people need the work, some subcontractors will sign what they need to sign to survive.”

What SB550 does                           

Virginia’s new law tries to alleviate that situation for subs on both public and private contracts, and puts the onus of payment back on the shoulders of prime contractors, regardless of whether they’re paid by a project owner.

“SB 550 prohibits the inclusion of pay-if-paid terms in any public or private construction contract,” said Phillip L. Sampson Jr., a partner at Houston-based law firm Bracewell LLP. “The Virginia legislature took the step that only a few other U.S. states to date have taken to protect subcontractors from the potential unfairness and inequities resulting from pay-if-paid subcontracts.”

SB550 requires primes to pay subs within 60 days from receiving an invoice, or seven days after receiving payment from the owner, whichever is earlier. Interest penalties apply for late remittance.

Just six other states have laws on the books that explicitly make pay-if-paid clauses unenforceable by statute, according to a survey by law firm Woods Aitken:

  • California.
  • Delaware (for private contracts).
  • New York.
  • North Carolina.
  • South Carolina.
  • Wisconsin.

When SB550 goes into effect Jan. 1, 2023, Virginia will become the seventh state to have such a statute. The prohibition will apply to contracts from that date forward, according to Rothman.

Protection beyond liens

Nine other states — Illinois, Indiana, Kansas, Maryland, Massachusetts, Montana, Nevada, Ohio and Utah — have language on the books or legal precedent that make pay-if-paid clauses unenforceable under certain conditions, according to the Woods Aitken survey.

In most of these jurisdictions, pay-if-paid clauses become void when they undermine a sub’s right to file a mechanic’s lien against a private project for non-payment. (On public projects, subs can usually make a payment bond claim.)

Liens, which put a claim on physical property by a third party, have long been used in construction by subs to get paid. They’re effective because subsequent financing — for example, a construction loan converting to a long-term mortgage after a job is done — is often subject to an asset being free of any third-party claims.

In other words, subs can still remedy nonpayment for a job by pursuing the owner of a private project directly via a lien. Indeed, pay-if-paid supporters highlight the lien option as a reason why laws like Virginia’s are unnecessary.

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Phillip L. Sampson, Jr.

Courtesy of Bracewell LLP

 

“Most states have strong lien and fund trapping statutes that help protect subcontractors’ right to payment within a reasonable time,” Sampson said. “Proponents of pay-if-paid provisions — contractors — routinely point to those types of statutes as providing adequate protection for subcontractors.”   

At the same time, the lien process is often complex, onerous and time consuming. Texas overhauled its lien laws recently, for example, to help make them more streamlined. What SB550 and laws like it provide, attorneys say, is another avenue for subs to get paid the money they are rightly owed.

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