Question. What is the difference between a liquidating agreement and a “pay when paid” clause?
Answer. Subcontracts often contain provisions that govern different aspects of payment from the general contractor (GC) to its subcontractor (sub). Two of the most common, and perhaps most controversial, of these clauses are the “pay-when-paid” clause and the “liquidating agreement”.
Pay-when-paid clauses provide that the GC will make payment to the sub when payment has been made by the owner to the GC. In New York, pay-when-paid clauses have been the subject of much litigation because of their potential effect on the sub’s lien rights. In the case of West Fair Elec. Contractors v. Aetna Cas. & Sur. Co., 87 N.Y.2d 148, 159, 661 N.E.2d 967, 972 (1995), the New York Court of Appeals held that a pay-if-paid clause which made payment from an owner to its GC a necessary occurrence before payment became due and owing to the sub was unenforceable because it would effectively destroy the lien rights that the sub has against the owner if the owner became unable to pay the GC. Thus, a pay-when-paid clause is only enforceable if it merely delineates a reasonable time for payment, and does not make payment to the GC a condition precedent to the sub’s right to payment.
A liquidating agreement provides that if a sub is owed money for completed work, the GC is responsible to pay the sum owed, but only to the extent that the GC recovers money, if any, for the subcontractor’s work through settlement or disposition of a claim against the owner. The liquidating agreement is so named because it liquidates the liability of the GC to the sub, whatever that amount may be, to the amount recoverable from other parties. In New York, a liquidating agreement is enforceable if it includes: (1) an imposition of liability on the GC for its subs damages, (2) a liquidation of that liability to the amount recovered by the GC from the at-fault party and (3) a provision for pass through of the recovery to the sub. See, N. Moore St. Developers, LLC v Meltzer/Mandl Architects, P.C., 23 A.D.3d 27, 31, 799 N.Y.S.2d 485, 489 (1st Dept. 2005). A properly drafted liquidating agreement imposes an enforceable condition precedent to the GC making payment to its sub. The agreement also binds the GC to act in good faith and take all reasonable steps to secure a recovery from the owner, the absence of which renders it liable, in full, for the subs damages.
While a pay-when-paid clause is enforceable if it simply sets a time for payment, it may not operate as a condition precedent to payment because to do so may constitute a waiver of the subs ultimate right to payment in violation of New York’s lien law. In contrast, a liquidating agreement assumes the sub’s ultimate right to payment from the GC but also sets the amount owed to the sub equal to any amount recoverable on the sub’s behalf in a claim by the GC against the owner. Since the latter agreement secures the subs right to payment, the condition precedent to payment that it imposes is enforceable. The duty of good faith and fair dealing also operates to protect a sub from a GC taking advantage of the liquidating agreement by not diligently pursuing its claim against the owner.
Still not clear on the difference? It’s a subtle one. Liquidating agreements are used for “pass through” claims. A “pass-through” claim is where the subcontractor has asserted a claim related to some action or inaction on the part of the Owner. The subcontractor cannot assert the claim directly against the Owner because it doesn’t have a contract with the Owner. The Liquidating Agreement bridges that gap. The “pay-when-paid” clause is simply a timing mechanism for direct claims of the subcontractor against the contractor.