Consider the following hypothetical situation that has played itself out countless times in recent years: A general contractor enters into a construction contract to build a large commercial building, such as a hotel. The general contractor then engages various subcontractors to assist with portions of the building. The general contractor completes the project with the assistance of its subcontractors, but the owner runs out of money and fails to pay the general contractor for all its work.
Is the general contractor responsible for paying its subcontractors in full, despite not receiving payment in full from the owner?
Under the laws of Missouri and most states, the answer is generally yes.
General contractors that hire subcontractors must pay those subcontractors for their work – even if the general contractor does not receive payment from the project owner.
The theory behind such a rule is that subcontractors cannot protect themselves from nonpayment because the general contractor has all of the contact with the owner.
In the wordingGeneral contractors in Missouri can potentially prevent this result – and the financial disaster that could come with it – through the use of a properly worded “pay-if-paid” clause in their subcontract agreements.
A pay-if-paid clause is one that shifts the risk of nonpayment by making the general contractor’s payment to the subcontractor contingent on the general contractor first receiving payment from the owner for the subcontractor’s work.
Enforcing the clauseSome states have passed laws making pay-if-paid clauses unenforceable, but Missouri is not one of them.
Even though Missouri law disfavors pay-if-paid clauses, Missouri courts will enforce the clause so long as they are correctly written.
A recent Missouri case – Environmental Energy Partners v. Siemens – confirmed this point in denying a subcontractor’s lawsuit against a general contractor for payment. In the case, an HVAC subcontractor working on a large project in Joplin was denied payment for work it performed because its subcontract stated that it would not be paid unless the contractor first received payment from the owner.
The devil is truly in the details on this point, and one word can make a difference. Whether a pay-if-paid clause will be enforced by a Missouri court may depend on a single term or phrase in the clause.
For example, a provision stating that a subcontractor will not be paid “until the contractor receives payment from the owner” will probably not be enforced to shift the risk of nonpayment.
However, a provision stating that the subcontractor will not be paid “unless the contractor receives payment” may be enforced. Stating that payment from the owner is a “condition precedent” to paying the subcontractor may strengthen the clause.
Other provisions in the subcontract that protect a subcontractor’s right to file a mechanic’s lien and provide the subcontractor with financial disclosures about the owner’s ability to pay might also impact the analysis.
Construction projects do, unfortunately, sometimes end badly. This has been especially true in recent economic times.
General contractors might consider shifting the financial risk of a nonpaying owner through the use of a properly worded pay-if-paid clause in their subcontract agreements.
By the same token, subcontractors should be aware that the inclusion of a pay-if-paid clause may bar their right to receive payment.
Although a pay-if-paid clause may seem insignificant at the beginning of a project, anyone in the construction industry knows that owners do sometimes run out of money or refuse to pay. General contractors and subcontractors should be aware that the inclusion and wording of a pay-if-paid clause in their agreements may ultimately determine who bears the financial burden of this situation.
Jason C. Smith is a business litigation attorney with Husch Blackwell practicing in the real estate, development and construction unit. He can be contacted at jason.smith@huschblackwell.com.
