PAY-WHEN-PAID AND THE PREVENTION OF PERFORMANCE DOCTRINE

Posted on February 23, 2014June 26, 2024 by Edward Garber

The pay-when-paid doctrine is a standard provision in subcontracts to shift the risk of the owner’s nonpayment to the subcontractor. The owner’s payment to the contractor is a condition precedent to the contractor’s payment to the subcontractor. However, if there is a payment bond in place, a surety in Florida cannot rely on this contractual defense to defeat a subcontractor’s claim. (Notably, in other jurisdictions, a surety can rely on this defense.) The pay-when-paid doctrine has been discussed numerous times in the following articles: https://floridaconstru.wpengine.com/pay-when-paid-provisions-and-payment-bonds/ and https://floridaconstru.wpengine.com/subcontractors-and-unjust-enrichment-claims/ and https://floridaconstru.wpengine.com/careful-drafting-of-pay-when-paid-provisions/.

Sometimes, there is not a payment bond in place and the subcontractor is forced to assert a direct claim against the contractor. Or, perhaps, the subcontractor may not have properly preserved its lien / bond rights and its best recourse is to assert a claim against the contractor. In this situation, the contractor will be able to rely on the pay-when-paid provision in its subcontract assuming it can prove that it was not paid for the subcontractor’s work that is the subject of the dispute. This defense, however, may not be absolute. There is a legal doctrine known as the “prevention of performance” doctrine.

Florida law provides:

“Under the doctrine of prevention of performance, one who prevents the happening of a condition precedent upon which his liability is made to depend, cannot avail himself of his own wrong and thereby be relieved of his responsibility to perform under the contract.” Florida Ins. Guar. Ass’n v. Somerset Homeowners Ass’n, Inc., 83 So.3d 850, 852, n.1 (Fla. 4th DCA 2011) (internal quotation omitted).

This doctrine really has not been analyzed in the context of a pay-when-paid defense under Florida case law. Yet, now and again, a case outside of Florida addresses interesting points that are worthy of discussion.

In Moore Brothers Co. v. Brown & Root, Inc., 207 F.3d 717 (4th Cir. 2000), the Fourth Circuit (interpreting Virginia law) analyzed the prevention of performance doctrine in the context of a contractor raising the pay-when-paid defense. In this case, the contractor entered into a contract to build a private toll road in Virginia. (The contractor was also an equity partner in the ownership group.) During the drafting of the prime contract, several design issues were referenced that would result in additional payment to the contractor. One of those issues was changing the thickness of the pavement subbase material. There was strong uncertainly over the initial pavement design and it was anticipated that the thickness of the pavement subbase material would change. The construction lenders wanted to contain construction costs and insisted on certainty in determining the costs. The lenders did not want to authorize a prime contract that did not provide this certainty and the draft prime contract with examples of additional costs the lenders may have to fund did not sit well with them. To appease the lenders, the owner and the contractor agreed to remove examples of design changes or issues that would result in increased construction costs. The owner and contractor further assured the lenders that they did not anticipate substantial changes in the work (such as a change in the pavement subbase thickness). Of course, what the contractor and owner assured the lenders was not really what they believed because they anticipated a design change regarding the thickness of the pavement subbase material. Thus, the owner and contractor entered into a side agreement that was not shared with the lenders concerning the design changes / issues that would result in increased costs to the contractor.

The contractor then hired subcontractors to perform scopes of work relative to the road construction. The subcontracts contained pay-when-paid provisions. The contractor did not advise the subcontractors that design changes such as a potential change in the thickness of the pavement subbase material were hidden from the lenders and that such a change would likely not be funded by the lenders. The contractor did not seem as concerned with this because it had pay-when-paid language shifting the risk of nonpayment to the subcontractors (although the contractor did have a payment bond in place). Naturally, there was a design change that changed the thickness of the pavement subbase material and this work was performed by the subcontractors. A payment dispute originated in arbitration involving the owner, contractor, and subcontractors regarding this additional work. The arbitrator ruled that the owner must pay the contractor for this additional work and the contractor, after receiving payment, must pay the subcontractors. The owner did not pay so the contractor never paid the subcontractors contending that the pay-when-paid language does not contractually require it to pay.

Since the arbitration award was never paid, the subcontractors filed suit in federal district court which was appealed to the Fourth Circuit. Among other issues discussed in the case, the Fourth Circuit analyzed whether the contractor was required to pay the subcontractors for the additional work associated with the pavement subbase thickness in light of the pay-when-paid provision. The Fourth Circuit found that the trial court correctly applied the prevention of performance doctrine to hold the contractor responsible for the payment of the additional work. The Fourth Circuit agreed that the contractor could not rely on the pay-when-paid language in the subcontract because it was responsible for the non-payment or non-occurrence of the condition precedent (i.e., owner’s payment). Specifically, the contractor knew that the additional work would most likely need to be performed which is why this design change was called out in the draft prime agreement. However, because of lender issues, it removed this language from the final prime contract and assured the lenders that additional work was not anticipated. It then contemporaneously entered into a side agreement with the owner that was not shared with the lenders regarding the same anticipated additional work (that it assured the lenders it was not anticipating). The Fourth Circuit held:

“The prevention [of performance] doctrine does not require proof that the condition would have occurred ‘but for’ the wrongful conduct of the promisor; instead it only requires that the conduct have ‘contributed materially’ to the non-occurrence of the condition.” Moore Brothers, 207 F.3d at 725.

It is easy to see how the facts in this case as presented by the Fourth Circuit warrant the application of the “prevent of performance” doctrine. It is uncertain from this case what the lenders would have done if construction costs were increased to specifically cover the highly anticipated design change to the pavement subbase thickness or why this change was not funded through any contingency funds / line item in the loan (perhaps there was none because the lenders insisted on certainty with the costs). It is also uncertain what the lenders would have done (or what they did) regarding the submission of these additional work costs since the parties could not dispute that the work was additional contractual work. And, it is uncertain why the contractor did not obtain bids for the additional work from the subcontractors before hiring them and try to negotiate perhaps a more palatable cost knowing this additional work was likely going to occur. Even though the contractor appeared to try to appease the lenders so this project could move forward, it knew funding for the additional work would be a huge concern and it was not up front with its subcontractors regarding this potential lack of funding. Had it been up front with the subcontractors, perhaps this risk could have been specifically accounted for in the subcontract through specific language or better pricing that could have been presented to the lenders.

Notwithstanding, in the event a contractor raises a pay-when-paid defense, a subcontractor may be able to rebut this defense by arguing the “prevention of performance” doctrine, that being that the contractor caused the very non-occurrence of the payment and, therefore, should not be entitled to rely on this defense. Although this argument seems like a tough hurdle for the subcontractor since not all facts will be as egregious as the facts in this case, the contractor should still take steps to eliminate this argument by showing that it took steps to obtain payment from the owner. Subcontractors, on the other hand, that may not have bond / lien rights or want to pursue substantial claims for additional work against the contractor, may want to rely on this argument in furtherance of trying to get around the expected pay-when-paid defense.

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.

PAY-WHEN-PAID PROVISIONS AND PAYMENT BONDS

Posted on October 12, 2013October 12, 2013 by Edward Garber

Pay-when-paid (also known as pay-if-paid) provisions are customary in subcontract agreements. These provisions provide that the contractor must be paid by the owner for the subcontractor’s work as an express condition precedent to the contractor’s payment to the subcontractor. Thus, if the contractor does not get paid by the owner, the subcontractor does not get paid by the contractor. This is a must-include provision to contractors as it shifts the risk of the owner’s nonpayment to the subcontractor.

However, on public projects and even many large-scale private projects, the contractor is required to obtain a payment bond that guarantees the contractor’s payment to subcontractors. Importantly, the pay-when-paid language does not protect a payment bond surety; it is not a defense to a payment bond surety. See OBS Co., Inc. v. Pace Construction Corp., 558 So.2d 404 (Fla. 1990) (finding that pay-when-paid language in subcontract does not prevent subcontractor from suing payment bond); see also Everett Painting Co. v. Padula& Wadsworth Const., Inc., 856 So.2d 1059, 1061 (Fla. 4th DCA 2003) (“However, this [pay-when-paid] contract provision is not a defense that is available to Surety.”).

From a subcontractor’s perspective, it is important on the front-end to know whether a payment bond is in place and, if so, what steps need to be taken to preserve a payment bond claim in the event of nonpayment. If there is any concern as to whether the general contractor was paid by the owner, it may be advisable to pursue the payment bond directly (instead of the contractor) unless there are reasons not too such as issues with the subcontractor’s compliance with statutory conditions precedent to sue on the bond. (Also, if there are concerns with the venue provision in the subcontract, pursuing a claim against the bond may create an argument to sue in a venue outside of the venue provision in the subcontract.)

From the general contractor’s perspective, if there is a payment bond in place, it needs to appreciate that the pay-when-paid defense will not apply to its surety. One thought is to include a provision in the subcontract that references that the subcontractor understands that the surety is an intended-third party beneficiary of pay-when-paid language and can utilize the pay-when-paid defense in the event the general contractor is not paid for the subcontractor’s work. There is, however, a strong argument that this language would not be enforceable based on caselaw set forth above that does not allow a surety to benefit from the pay-when-paid defense. The leading Florida Supreme Court case, OBS Co. (cited above), that finds that a surety cannot benefit from this pay-when-paid defense, states:

“The payment bond is a separate agreement, and any inability to proceed against the general contractor does not necessarily prevent recovery against the sureties under the bond. In this case recovery under the payment bond is in no way conditioned on the owner making final payment to Pace [general contractor]. Nor does the bond incorporate the payment terms of the subcontract.”

Based on that bolded language, it is an uphill battle to create an argument that the surety can be protected by the pay-when-paid defense because the payment bond does not incorporate each and every subcontract and such language would merely turn the bond into a conditional payment bond, i.e., a bond conditioned on the owner’s payment to the contractor. Including language in the subcontract that says the surety is an intended third-party beneficiary of the pay-when-paid language is definitely a tough sell, but it has little downside, as the worst that happens is that the pay-when-paid defense does not apply to claims against the surety no matter what, which is likely the case.

Notably, it is advisable for the general contractor to include language in subcontracts that provides to the extent the pay-when-paid provision conflicts with language in the prime contract, the pay-when-paid language shall govern. The reason being is to avoid any argument that the pay-when-paid language is ambiguous because it conflicts with language in the prime contract (that is incorporated into the subcontract) which would not have a pay-when-paid provision.

For motion information on pay-when-paid provisions, please see: https://floridaconstru.wpengine.com/careful-drafting-of-pay-when-paid-provisions/

THE REALITY WHEN THE CONSTRUCTION LENDER FORECLOSES

Posted on August 15, 2013August 15, 2013 by Edward Garber

Sometimes, projects go bad and the developer’s (owner) lender forecloses on the real property, whether at some point during construction or after. When this happens, there are often unpaid contractors which may be named in the lender’s lawsuit so that their inferior interests to the property are foreclosed. Hopefully, the general contractor has a pay-when-paid provision in its subccontracts so that it is not responsible to pay subcontractors until it receives payment from the developer for the subcontractor’s work. While both the general contractor and subcontractors have lien rights (if the rights were preserved under Florida’s Lien Law), when the developer’s lender forecloses it more often than not means that the general contractor and its subcontractor’s liens are worthless since there will not be a surplus of funds after a foreclosure sale.

The recent case of CMH Homes, Inc. v. LSFC Company, LLC, 38 Fla. L. Weekly D1712a (Fla. 1st DCA 2013), illustrates a creative argument a general contractor tried to argue when the construction lender moved to foreclose on the construction loan and named the general contractor to foreclose its inferior interest to the property. In this case, a developer took out loans to finance a residential development. The lender recorded a mortgage.

Thereafter, the developer entered into a contract with a contractor. The contract provided that the contractor would construct a model home and would be paid for the model home when the model home was sold, but the model home could not be sold until other homes in the development were first built. (Also, in the contract, the contractor agreed that the developer possessed title to the lot in which the model home was built free and clear of all encumbrances except for the developer’s lender’s mortgage.)

The notes the developer executed and the mortgage were assigned to a new entity. The new entity filed a lawsuit to foreclose the mortgage and named the contractor as a defendant (in order to foreclose any interest the contractor may have relating to the real property). In defense, the contractor argued an unjust enrichment theory, that being it would be inequitable for the lender / new entity to take ownership of the model home without paying the reasonable value for the model home. The trial court rejected the contractor’s unjust enrichment defense. The First District Court of Appeal affirmed the trial court maintaining that the contractor conferred no benefit upon the new entity (or original lender) because the decision to loan money to the developer was made prior to the construction of the model home and prior to the developer defaulting on the loan. (Besides, the contractor contractually agreed that its interests in the real property the model home was built was inferior to the security interest of the lender’s mortgage.)

CAREFUL DRAFTING OF PAY-WHEN-PAID PROVISIONS

Posted on November 27, 2011November 27, 2011 by Edward Garber

The pay-when-paid provision is an important aspect of a contractor’s subcontract. Under this provision, the risk of an owner’s nonpayment to a contractor for a subcontractor’s scope of work is shifted to the subcontractor. In other words, a contractor is not responsible for paying the subcontractor unless the contractor was specifically paid by the owner for the subcontractor’s work–the owner’s payment to the contractor serves as an express condition precedent to the contractor’s payment to a subcontractor. However, for pay-when-paid provisions to be enforceable, they need to be clearly drafted so that it is unequivocal that the owner’s payment to the contractor for a subcontractor’s work serves as the express condition precedent to the contractor’s payment to the subcontractor.

Subcontractors oftentimes look for arguments to circumvent the pay-when-provision. If the contractor has a payment bond, then the subcontractor does not need to look to the contractor for payment, even if the owner has not paid the contractor for the subcontractor’s work. When there is a payment bond, the subcontractor can sue the bond and the surety that issued the bond cannot raise the pay-when-paid provision as a defense. See OBS Co. v. Pace Construction Corp., 558 So.2d 404 (Fla. 1990).

However, if there is no payment bond, or the subcontractor, for whatever reason, did not properly preserve its rights to pursue a payment bond claim, the recent case of International Engineering Services, Inc. v. Scherer Construction & Engineering of Central Florida, LLC, 2011 WL 5109306 (5th DCA 2011), provides another argument that a subcontractor can raise in an effort to escape the harsh effect of a pay-when-paid provision. In this case, the subcontract incorporated by reference the contractor’s prime contract with the owner. The prime contract provided:

“Neither final payment nor any remaining retained percentage shall become due until the Contractor submits to the Architect (1) an affidavit that payrolls, bills for materials and equipment, and other indebtedness connected with the Work for which the Owner or the Owner’s property might be responsible or encumbered (less amounts withheld by Owner) have been paid or otherwise satisfied.”

The subcontractor successfully argued that this provision in the prime contract, which was incorporated into its subcontract, created an ambiguity with the pay-when-paid provision. The reason being is that this provision maintained that the owner was not responsible for paying the contractor until the contractor paid its subcontractors. Well, this conflicts with a pay-when-paid provision which says a contractor is not responsible for paying a subcontractor until an owner has paid the contractor. By the subcontractor arguing that this provision in the prime contract conflicts and creates an ambiguity with the pay-when-paid provision, the Fifth District held that the pay-when-paid provision was unenforceable because it was ambiguous. Thus, the contractor was responsible for paying the subcontractor!

The outcome of this case is important for both contractors and subcontractors. For contractors, it is important to ensure that language in the prime contract does not conflict with language in the subcontract, particularly the pay-when-paid provision. Typically, all subcontracts incorporate by reference the prime contract. One thing a contractor can do is to include a provision in the subcontract that says something to the effect: “If anything in the subcontract conflicts or creates an ambiguity with anything in the prime contract, the terms of the subcontract shall govern. This includes anything that conflicts with the pay-when-paid provision included in this subcontract and subcontractor therefore understands that owner’s payment to contractor for subcontractor’s scope of work is an express condition precedent to contractor’s payment to subcontractor.”

For subcontractors, it is important to request a copy of the owner’s prime contract with the contractor since it is incorporated into the subcontract. By looking for a provision in the prime contract that may conflict with the pay-when-paid provision in the subcontract–a provision similar to the one referenced above that requires the contractor to pay its subcontractors before the owner is obligated to pay the contractor final payment–can allow the subcontractor to argue that the pay-when-paid provision should be deemed unenforceable thereby making the contractor liable to the subcontractor for payment even if the contractor was not paid by the owner.