Pay When Paid Clauses

By on Nov 30, 2011

 
Construction work is being done at a faster pace and often with smaller profit margins. Getting paid for all of the work your company does, and everything your company supplies, is increasingly important in this environment. Working with an owner (if a contractor or subcontractor, with a General Contractor) that has a good payment record and solid credit history can help. A subcontractor will want to avoid contracts that allow a contractor to avoid payment with a pay when paid clause. General Contractors will want to see these clauses to help share the risk of non-payment by an owner. This article provides an overview of how the courts in Ontario deal with “Pay when paid” clauses and what type of wording to watch for at the time of signing the contract. Each case, however, is determined on its own unique facts. As such, this information is general in nature and should not to be relied on as legal advice.
 

What is a Pay When Paid Clause?

 
It is becoming more and more common for contractors to include a clause in their contracts with subcontractors that allows them to wait to pay for work done until not only after they are paid for the work themselves, but also only if and when they are paid by the owner for the work. These clauses can apply to the work in the contract and to extras and changes as well. Courts are reluctant to allow contractors to rely on these clauses to allow a contractor to avoid payment to a subcontractor and require very strict and clear wording to do so. In the case of Timbro Developments Ltd. v. Grimsby Motors Inc. [1988] O.J. No. 448 (O.C.A.) wording that was considered by the Ontario Court of Appeal to be sufficiently clear in Ontario to allow a contractor to avoid paying a subcontractor for work done was as follows:

When used for sub-contract work the following terms will apply: Payments will be made not more than thirty (30) days after the submission date or ten (10) days after certification or when we have been paid by the owner, whichever is the later.

 

What are the potential problems with a Pay When Paid Clause?

 
The risk of non-payment is, in that way being passed on from the contractor to the subcontractor. Unfortunately, this can mean that if the contractor is particularly disorganized or the job is just going poorly because of any of a number of unforeseen or difficult to manage circumstances, the contractor has little incentive to pursue the owner for payment for extra work or changes in the work as a result of the poor organization and/or unforeseen circumstances.

This has been considered by the courts to produce an unfair result. In one case, for example, where a surety attempted to deny payment on the basis that payment was not owed for extras because the extras had not been paid for by the owners, the court found an obligation on the part of the contractor to pursue payment in order to rely on a “pay when paid” clause in the contract. The court in Harris Steel Ltd. (c.o.b. Harris Rebar) v. Seaboard Surety Co. of Canada [2003] O.J. No. 1739 had this to say:

[The General Contractor] had a duty to act promptly to assure that payment for all Extras completed by [the subcontractor] as a consequence of initial CCOs would be processed to payment or, at the very least that it provide a reasonable and justifiable explanation for its own failure initially to obtain a CO and later, an architect’s certificate. Processing to payment includes the necessity of [the General Contractor] obtaining certification and COs.

That being said, the subcontractor in that case had done extra work that was considered to be essential to the project in what were described as exigent circumstances and still had to make a claim under the Labour and Material Payment Bond in order to get paid and pursue the matter in court against the surety who refused to pay on the basis that no Change Order had been signed prior to the work having been done.

Although the subcontractor did win in court and the contractor was ordered to pay for the extras, this argument continues to be used by General Contractors and sureties. As such, as a subcontractor, it is best to avoid pay when paid clauses when you can and to get something in writing from the General Contractor before proceeding with extra work. For General Contractors, it is risky to avoid processing change orders and to rely on a pay when paid clause to avoid paying your subs.

The article posted here is for general information. We hope you find it useful. For advice specific to your circumstances you should consult a lawyer. We would be pleased to speak with you if you have questions about our services or need the assistance of a lawyer.