Woes in Different Area Codes - Enforceability of Pay-If-Paid Provisions

Welby, Brady & Greenblatt LLP represents contractors working throughout the Northeast United States; from the New York, New Jersey and Connecticut tristate area, to Pennsylvania, Massachusetts and beyond. Nonetheless, our clients’ “bread and butter” expectedly revolves around projects in the states of New York and New Jersey. If you were to create a composite WBG client, they would likely be a successful contractor with multiple projects in both states, operating as either General Contractor or Subcontractor depending on the size of the project.

In light of the prevalence of our clients’ involvement in New York/New Jersey, we keep a close eye on any legal developments that affect the construction industry in one or both states. A recent decision by New Jersey’s Appellate Division concerning a subcontractor’s right to payment has created a chasm in how contracts will be enforced in New Jersey when juxtaposed to statutory and caselaw authority in New York, and dual-state contractors must beware when signing on to New Jersey Projects.

On a daily basis, our firm drafts and/or negotiates contracts on behalf of prospective subcontractors. Quite often, the upstream general contractor attempts to include a “Pay-if-Paid” provision in the subcontract, which essentially transfers the risk of a project owner’s non-payment from the general contractor to the subcontractor by making the owner’s payment a condition precedent to the subcontractor’s entitlement to compensation for services rendered. This is quite easy to deal with when negotiating a subcontract in New York; under New York’s General Obligation Law §5-322.1, Pay-if-Paid provisions are unenforceable as contrary to public policy due to their infringement on lien rights, even if agreed to by both parties. As such, in New York these contract clauses revert to simple timing mechanisms for payment as opposed to their intended purpose of restricting the general contractor’s ultimate obligation to pay the subcontractor.

In contrast, the New Jersey courts are taking a diametrically different approach to Pay-if-Paid contract clauses. In JPC Merger Sub, LLC v. Tricon Enterprises (286 A.3d 1186 [2022]), the Appellate Division held that a Pay-if-Paid provision is fully enforceable so long as the parties’ contract specified a clear and unambiguous intent and agreement by the parties to shift the risk of non-payment by the project owner.

Tricon Enterprises (“Tricon”) was hired by the County of Union (“Owner”) to serve as general contractor on a large public improvement project. Tricon then hired JPC Merger Sub, LLC (“JPC”) as a subcontractor/vendor for the furnishing of materials on the project. The JPC-Tricon subcontract (the “Subcontract”) included an ironclad Pay-if-Paid provision:

“Vendor understands and agrees that Tricon’s obligation to make any payment to Vendor is subject to, and shall not exist unless and until, Tricon’s receipt of payment on account of Vendor’s work from the Owner…, the occurrence and satisfaction of which shall be a condition precedent to Tricon’s duty to remit payment.”

During the course of the project, JPC furnished structural steel beams for installation on the project, which were subsequently not accepted by Owner and never installed on the project. Due to the non-use of the materials, Owner did not pay Tricon for the beams, and Tricon in turn refused to pay JPC pursuant to the Subcontract’s Pay-if-Paid clause.

In its decision, New Jersey’s Appellate Division specifically referenced the fact that – unlike New York – the State does not have a statute or published caselaw governing the enforceability of such contract provisions. Moreover, the Court’s decision specifically stated that the prohibition against the use of Pay-if-Paid provisions as conditions precedent in construction contracts should come from the legislature rather than the courts, and that absent statutory authority such provisions are “neither unfair, unconscionable, nor against public policy” so long as the contract on its face contains clear and unequivocal language that unambiguously sets forth the parties intentions when the contract was executed.

The New Jersey decision is clearly problematic for subcontractors. In fact, the decision wholly changes how we approach contract negotiations for New Jersey projects. Rather than advise the clients of the provision’s true impacts and recommend its removal due to potential delays in payment (which is the approach in New York contracts), we now tell clients that the Pay-if-Paid clause in a New Jersey contract must be removed unless the client desperately wants to work on a specific project and is willing to eat the risk of non-payment. And make no mistake, the risk is substantial; if the receivable is large enough and the subcontractor is left holding the bag, their profit margin may be erased in the best case, and company-crippling losses may be sustained in the worst case.

This cautionary tale neatly illustrates the importance of retaining counsel before negotiating and executing a contract for a New Jersey project, and allowing your legal team to fight against a general contractor’s inclusion of a Pay-if-Paid provision before non-payment issues ever have a chance to arise. As discussed above, a subcontractor can do everything right on a given project and still have no legal recourse when making a justified claim for payment. As is always the case, a contractor’s best litigation defense remains “pre-litigation”; if you have any questions regarding what you are ultimately agreeing to, it is always wise to have skilled construction counsel review your contract before signing.

If you would like more information regarding this topic please contact Andreas M. Koudellou at akoudellou@wbgllp.com or call (914) 607-6487