This continues our blog post series on protecting payment in the construction industry. In this post, we ask the question, “Can a Pay If Paid clause bar a Minnesota lien or bond claim?” Despite the contract language, the answer might be: no.
Contingent payment language is common in contracts between prime contractors and subcontractors. The answer to our question, therefore, primarily affects the potential defenses of a prime contractor against a subcontractor asserting its lien or bond claim.
On private construction the answer is also important to owners. If the contractor’s Pay If Paid clause does not bar the lien, then the owner’s project is at risk and in Minnesota that could mean paying twice for the subcontractor’s work. Keep in mind, however, that the owner is already no-pay or slow-pay with that contractor to activate the Pay If Paid issue.
There are two main types of contingent payment clauses in construction contracts. The most common is called Pay When Paid. This clause affects the time for a subcontractor to be paid. It shifts the risk of owner slow payment to the subcontractor. Once the prime gets paid it will owe payment to the subcontractor. Even if the contractor has not been paid it will still owe payment to the subcontractor within a “reasonable time.” Since the clause affects the timing of payment but not the right to payment, it does not bar a timely lien claim.
The other contingent payment clause is called Pay If Paid. This clause is intended to affect the right to payment and shift the whole risk of owner non-payment to subcontractors. This is essentially a gambling clause for the subcontractor. It is much less common than the Pay When Paid but its impact on a subcontractor can be existential. If the subcontractor has no right to payment, it would seem to undermine the right to a lien or bond claim. Practice Pointer: Any subcontractor must read its contract carefully for contingent payment language and strike a Pay If Paid clause or offer a Pay When Paid alternative.
Minnesota case law supports the reasonable enforcement of Pay When Paid clauses. The reported cases have not yet shown just how the Minnesota courts would respond to a serious attempt to enforce a Pay If Paid clause. The Minnesota Court of Appeals has said that conditions precedent, such as contingent payment, are generally disfavored. Any Pay If Paid clause would have to make owner payment an explicit and unambiguous condition precedent to the obligation to pay the subcontractor. See Mrozik Const v Lovering Assoc. 461 N.W. 2d 49 (Minn. App. 1990).
The obvious unfairness of Pay If Paid from the perspective of the subcontractor is compounded by the fact that the prime contractor deals directly with the owner and is in the best position to assess the owner’s credit and financing before it takes the project and hires the subcontractor. The popular AIA A201 2017 General Conditions, for example, expressly provide that the prime contractor can request evidence that the owner has financing for the project and does not have to start work until the owner furnishes that information.
A number of states have responded by outlawing the Pay If Paid clause by statute. Wisconsin is one, South Carolina and Delaware are two more.
California, New York and Nevada courts handled the issue in a different way. Each barred the enforcement of Pay If Paid on the basis of public policy and that the clause amounts to a waiver in advance of the right to a lien claim. Each of those states had statutes which protected subcontractors against being compelled to waive lien rights in advance.
Interestingly, Minnesota has a similar statute barring waiver in advance of lien rights which would seem to open the door to making the same argument against enforcing a Pay If Paid clause in the state. Practice Pointer: The subcontractor faced with the Pay If Paid defense to its lien claim should look to the cases in California, New York and Nevada and Minn. Stat 337.10 to push back against the clause.
A Pay If Paid clause in a subcontract on public work in Minnesota is less likely to be a concern. The owner is a public entity. On bonded private construction, however, the Pay if Paid issue may threaten the ability to make a bond claim. The traditional legal obligation of a surety is co-extensive with its principal. If the bonded contractor could assert a Pay If Paid defense, the surety can assert that same defense arguing that if the contractor did not have to pay then the surety does not have to pay either.
In private construction the payment bond is, essentially, intended to be in lieu of mechanic liens. In a state like Wisconsin where the Pay If Paid clause is outlawed by statute, the surety cannot rely on it as a defense. In Minnesota, the answer is less clear because a payment bond surety can be sued on the bond directly. If the bonded prime contractor is not an indispensable party to the bond claim query, what effect does that have on the surety’s ability to base its defense on a clause it plucks from its principal’s contract? Conditions precedent are generally disfavored by the courts. The first challenge would be language of the clause presenting an explicit condition precedent. Then, if the court could accept the analogy to the statutory bar against waiver of lien in advance, the surety may similarly be barred from relying upon the Pay If Paid clause.
No one wants to be the test case that decides whether Minnesota’s statute barring lien waiver in advance can be used to prevent the enforcement of a Pay if Paid clause. Where the question presents an existential risk to some subcontractors, the battle will be joined and the subcontractor may find that it has some ammunition of its own to protect its right to payment.