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Overview

"Pay-When-Paid" and "Pay-If-Paid" clauses are common, contingent payment provisions included in construction contracts.  As compared to traditional contract terms, which require payment to a subcontractor within a period of time after performance of the work, these clauses make a contractor's obligation to pay its subcontractors conditional on payment by the owner.  In other words, these provisions protect a contractor by postponing its payment obligations to a subcontractor until it receives payment from the owner. 

In Article 409 (Vol. 15, No. 13) of this newsletter, we analyzed the decision of the United States Court of Appeals for the Fourth Circuit decision in Moore Bros. Co. v. Brown & Root, Inc. and Highlands Ins. Co., 207 F.3d 717 (4th Cir. 2000).  In Moore Bros., the court held that a surety could not invoke a "Pay-If-Paid" clause in a subcontract as a defense to its liability on a payment bond.  As noted in that article, the decision in Moore Bros. illustrated that parties to a construction project need to pay careful attention to the language in the contract and bond documents to ensure that the parties' intent with regard to risk shifting is accurately reflected.  The article also recommended that parties to a contract review applicable law to determine the effectiveness (and enforceability) of these provisions.

A recent decision issued by Florida's Fourth District Court of Appeal examined a similar issue in the context of a "Pay-When-Paid" clause.  Everett Painting Co. v. Padula &Wadsworth Constr., Inc., 856 So. 2d. 1059, (Fla. 4th DCA 2003).  In evaluating this issue under Florida law, the court illustrated the same lessons learned in Moore Bros. That is, the decision underscored the importance of ensuring that the contract and bond documents accurately reflect the parties' intentions and of knowing the applicable law in a given jurisdiction.

Factual Background

In December 1997, Everett Painting entered into a written subcontract with Padilla & Wadsworth ("P&W") to perform painting services at "Driftwood Middle School".  This project qualified as a "public project" under Florida Statute §255.05 and, under the terms of the statute, P&W was required to obtain both a payment bond and a performance bond on the project.  P&W obtained the bond from Travelers Insurance Company (the Surety). 

The subcontract between Everett Painting and P&W contained a "Pay-When-Paid" clause, which provided "that final payment from the owner is a condition precedent to Contractor's obligation to make final payment to Everett Painting."  After completing the project, Everett Painting requested final payment due under the contract.  When P&W refused payment, Everett Painting filed suit against the contractor and the Surety seeking payment in the amount of $11,471.50.

The trial court entered a summary judgment in favor of P&W and the Surety.  According to the court, the "Pay-When-Paid" clause in the subcontract barred Everett Painting's claim because at the time the suit was filed the contractor had not yet received final payment from the owner.  Everett Painting appealed the trial court's decision to the Florida's Fourth District Court of Appeal. 

Decision on Appeal

The Florida Fourth District Court of Appeal affirmed the trial court's decision with respect to Everett Painting's claim against P&W, but reversed the ruling with respect to the  Surety.  In reaching its decision, the appellate court specifically addressed whether the "Pay-When-Paid" clause of the subcontract precluded Everett Painting from recovering on its payment bond claim. 

As a threshold matter, the appellate court reviewed the language of the subcontract to determine the applicability of the "Pay-When-Paid" clause.  Finding the clause clear and unambiguous, the court held that the provision was binding on the parties to the subcontract.  In other words, the court determined that "final payment from the owner [was] a condition precedent to Contractor's obligation to make final payment to Everett Painting."  Because P&W had not yet received final payment from the owner, Everett Painting was not entitled to payment from the contractor.  Accordingly, the appellate court affirmed trial court's ruling in favor of the contractor on the claim under the subcontract.

However, the "Pay-When-Paid" provision did not bar Everett Painting's claim against the Surety on the payment bond.  That is, the appellate court recognized that "[a] payment bond is a separate agreement from the contract and an inability to proceed against the Contractor does not necessarily prevent recovery on the bond."  Accordingly, the court concluded that the trial court should have allowed Everett Painting to pursue its claim against the Surety. 

As an aside, the appellate court noted that Section 713.245 of the Florida Statutes allows a surety to limit its liability by including conditional payment language in certain payment bonds.  These "conditional payment bonds" are allowable only if the contractor and subcontractor include a similar limitation in the subcontract.  In order to create a "conditional payment bond", the surety must include specific language as prescribed by the statute. Specifically, Section 713.245 states that the front page of the bond must contain the following statement in at least 10-point type:

This bond only covers claims of subcontractors, sub subcontractors, suppliers, and laborers to the extent the contractor has been paid for the labor, services, or materials provided by such persons.  This bond does not preclude you from serving a notice to owner oR filing a claim of lien on this project.

Because the bond agreement was not submitted into the record, the court could not determine whether the Surety included this necessary language showing its intention of creating a "conditional payment bond."  Nevertheless, even if the bond did contain the requisite language prescribed by Section 713.245, the surety did not have the ability to limit its liability on the public project, which gave rise to this action.  The payment bond on this school project was issued pursuant to Section 255.05, which does authorize to use of a conditional payment bond on public projects.  On the contrary, this provision "seeks to protect subcontractors and suppliers by providing them with an alternative remedy to mechanics liens on public projects." 

As a practical matter, the successful defense to the claim on the subcontract may provide the general contractor limited or no economic protection.  Since it is likely that the general contractor provided the payment bond surety a broad form indemnity, any recovery on the bond will eventually become the subject of an indemnity claim by the surety. 

Comment

The court's holding in Everett Painting demonstrates the importance of carefully reviewing and understanding the significance of certain provisions in the contract and bond documents.  Specifically, clauses such as "Pay-When-Paid" and "Pay-If-Paid" can alter the terms of payment for a given project, and expose a party to substantial risk of non-payment. To avoid such unintended consequences, members of the construction industry should carefully review all documents and ensure that the agreements accurately reflect the parties' respective intentions.  In

addition, a party will be well served to review the applicable law to be certain that the terms of the agreements are effective and enforceable and that any procedural requirement is satisfied. 

Ramsey Kazem

404/582-8065

rkazem@smithcurrie.com

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