By: Thomas H. Welby Published: September 2010

High Court K.O.'S Pay-If-Paid Clause

On December 7, 1995, the New York Court of Appeals, the highest Court in this State, handed-down a decision which changes the body of construction law and impacts the process of subcontracting. All CIC members, whether they are general contractors, subcontractors or suppliers, will be affected by the Court's ruling.

In this landmark case entitled West-Fair Electric and L.J. Coppola, Inc. v. Aetna Casualty & Surety and Gilbane Building Company, the High Court held that:

"... a pay-when-paid provision which forces the subcontractor to assume the risk that the owner will fail to pay the general contractor is void and unenforceable as contrary to public policy set forth in the Lien Law Section 34. By contrast, a pay-when-paid provision which merely fixes a time for payment does not indefinitely suspend a subcontractor's right to payment upon the failure of an owner to pay the general contractor and does not violate public policy as stated in the Lien Law."

In essence, in the normal course of a construction project, slight delays in payment from an owner to a general contractor would permit a corresponding slight delay from the general contractor to the subcontractor or supplier, if the subcontract or purchase order contained a simple pay-when-paid clause. If, however, the subcontract or purchase order contained a clause stating that the general contractor's obligation to pay the subcontractor was subject to the "condition precedent" of payment from the owner to the general contractor, a pay-if-paid clause, such a term will henceforth be legally void and unenforceable because its enforcement would run afoul of the public policy of the State of New York to protect subcontractors and suppliers. In so ruling, the Court of Appeals has overturned earlier decisions by New York's intermediate appellate courts.

The lawsuit developed as a result of the financial failure of a project known as the Westchester Pavilion, a new mall resulting from the gut-rehab of the former Alexanders store in White Plains, New York. The owner/developer was Fischer-Reese; the general contractor/construction manager was Gilbane Building Company of Rhode Island and the architect/engineer was the Planned Expansion Group of White Plains. Several Construction Industry Council members were subcontractors to Gilbane on this project.

The cost of construction, approximately $23,000,000.00, greatly overran the original budget by approximately 62%. As a result, towards the end of the project, subcontractors and suppliers were owed millions of dollars which the owner could not pay. Mechanic's liens were filed and bond claims were asserted.

Several of the subcontractors, including West-Fair Electric Contractors, Inc. and L.J. Coppola, Inc., were represented by Michael E. Greenblatt and Thomas H. Welby of CIC Associate Member Welby & Brady, LLP (formerly Welby & Welby), who commenced a mechanic's lien foreclosure action against the property in State Supreme Court, Westchester County, and simultaneously, commenced a breach of contract and bond claim lawsuit in U.S. District Court. Gilbane and Aetna moved for summary judgment to dismiss the subcontractors' lawsuit on the basis that the subcontract contained the following language: "It is specifically understood and agreed that the payment to the trade contractor is dependent, as a condition precedent, upon the construction manager receiving contract payments, including retainage from the owner..." West-Fair and Coppola cross-moved for summary judgment stating that the subcontractors had fully performed their work and that the operative language was not intended to shift credit risk to the subcontractors, particularly where their general contractor has posted a labor and material payment bond.

Hon. Charles L. Brieant held for the subcontractors stating that the position urged by Gilbane and Aetna violated the public policy of the State of New York, as stated in Section 34 of the Lien Law, which renders void and unenforceable, any contract provision which purports to waive a subcontractor's right to file and/or enforce a mechanic's lien.

The general contractor and the surety then appealed to the U.S. Court of Appeals for the Second Circuit. That Court determined that the central issue in the case turned on a matter of New York law on which New York's highest court had never been called upon to decide. Therefore, the Second Circuit certified two questions of law to the New York Court of Appeals, which subsequently found for the subcontractors in the twelve page Decision and Opinion handed-down last week. The High Court's Decision was unanimous.

The Court's decision is both logical and fair in that it calls upon general contractors to be responsible for the financial risks that they, rather than the subcontractors and suppliers, stand in a better position to evaluate and manage. Needless to say, the Court's lengthy Opinion, although resolving the central issue, leaves many questions unanswered. The full impact of this new law on general contractors, subcontractors and suppliers in both the private and public sectors will be the subject of considerable debate in the future.

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