Pay if Paid vs Pay When Paid:
Know the Difference

In 2023, the South Carolina Court of Appeals handed down an important decision which focuses on pay when paid and pay if paid clauses in contracts. The Court’s opinion highlights the importance of understanding the distinctions between these two clauses and the differences that exist from state to state regarding their enforceability.

The Case Notes

In J&H Grading & Paving, Inc. v Clayton Construction Company, Inc., 441 S.C. 272 (2023), Clayton Construction Company, Inc. (“Clayton”) was the general contractor for the construction of a new car dealership. Clayton subcontracted with J&H Grading & Paving, Inc. (“J&H”) for site work. The contract between Clayton and J&H contained the following language.

Final payment of the balance due shall be made to [J&H] no later than seven (7) days after receipt by [Clayton] of final payment from Owner [for J&H’s] work. 

J&H submitted its final payment application to Clayton on April 26, 2017. On August 1, 2017, Clayton responded saying that it had not been paid by the owner and, as such, could not issue its final payment to J&H until Clayton had received payment. Clayton did not dispute the amount of J&H’s final payment application and there was no dispute that J&H had not performed the work. Clayton also had no reason to withhold any monies from J&H for other reasons related to J&H’s work under the subcontract.

J&H filed a certificate of mechanics’ lien on the property on February 27, 2018. Clayton responded by referring to the pay when paid provision in the contract, stating that it did not owe J&H because Clayton still had not been paid by the owner.

J&H filed a lawsuit against Clayton and the owner for foreclosure of the mechanics’ lien among other things. A year later, J&H, Clayton, and the owner entered into a settlement agreement in which the owner agreed to release the remaining amounts owed to J&H directly to J&H as payment for the subcontract. J&H released its claims against the owner but reserved the right to claim attorney’s fees and interest against Clayton.

A trial was held on the discrete issue of whether J&H was entitled to attorney’s fees. J&H argued Clayton had conditioned its final payment on payment from the owner, which was expressly prohibited under South Carolina law which provides:

Notwithstanding any other provision of law, performance by a construction subcontractor in accordance with the provisions of its contract entitles the subcontractor to payment from the party with whom it contracts. The payment by the owner to the contractor…is not…a condition precedent for payment to the construction subcontractor. Any agreement to the contrary is not enforceable.

The trial court found in favor of J&H and concluded it was entitled to attorney’s fees. Clayton appealed.

The appellate court determined that South Carolina law expressly prohibits a general contractor from conditioning payment to a subcontractor upon payment to the general contractor by an owner and that any agreement to do so is contrary to South Carolina law and unenforceable.

The Foundation

Before we get to the key takeaways of this case and the rationale behind the court’s decision, it is important to understand what pay when paid and pay if paid clauses mean in a contract and the distinctions between the two. Simply put, a pay when paid clause addresses timing for when a subcontractor will be paid by a contractor. The following is an example of a pay when paid clause:

The Subcontractor shall be paid within ten (10) business days after receipt of payment from the Owner by the General Contractor for Subcontract work.

A pay if paid clause on the other hand is all about shifting the risk of nonpayment by the owner to the subcontractor. Here is an example of a pay if paid clause.

Contractor’s receipt of payment from the Owner is a condition precedent to Contractor’s obligation to issue payment to the Subcontractor. The Subcontractor fully understands that it bears the risk of non-payment by the Owner.

The law regarding pay when paid and pay if paid clauses differs from state to state. Whereas some states deem pay if paid clauses enforceable, about a dozen states, including the State of South Carolina, restrict the use of pay if paid clauses in subcontracts. Some states such as Colorado require that if a pay if paid clause is in a contract, it must contain specific language such as the contractor’s receipt of payment from the owner is a condition precedent to the subcontractor getting paid, and language that expressly states that the subcontractor assumes the risk of nonpayment if the contractor does not receive payment from the owner. The laws on the books in about 24 states say that a subcontractor can still file a lien on a project for monies owed even though their subcontract contains a pay if paid clause.

Most of the states recognize pay when paid provisions. However, if a contractor has not been paid by an owner, having a pay when paid provision in the contractor’s contract with a subcontractor does not allow a contractor not to pay a subcontractor indefinitely. The law in the case of pay when paid contracts applies the legal standard of reasonableness to the period of time in which a contractor has not been paid by an owner which can be uncertain and frustrating. The decision in J&H Grading & Paving, Inc. added yet another wrinkle in this patchwork of laws on payment provisions in subcontracts.

The Takeaway

In J&H Grading & Paving, Inc., the Court relied on the state’s Prompt Pay Act which requires payment to a subcontractor within 90 days. The Court used this period of time as the absolute outer limit that a subcontractor must be paid under a pay when paid clause even if the contractor has not received payment from the owner. The Court then determined that the contractor’s lack of payment to the subcontractor beyond 90 days was unreasonable and that the pay when paid language in the subcontract was effectively rendered pay if paid. The Court reiterated that in the State of South Carolina, a general contractor is prohibited from conditioning payment to a subcontractor upon payment to the general contractor (i.e., pay if paid) and that any agreement to do so is unenforceable.

Even though there was no dispute regarding the amount owed to J&H or that J&H had satisfactorily performed the work, the decision in J&H Grading & Paving, Inc. affirms that a contractor can still withhold payment to a subcontractor for the subcontractor’s failure to comply with the terms of the contract (e.g., they caused delays, performed defective work, or liens were filed by their sub-tier subcontractors because the subcontractor failed to pay them and had received payment from the contractor for the sub-tier subcontractors’ work).

Conclusion

With improvements to Dennis Group’s standard Subcontractor Agreement that will roll out over the course of the next month, an eventual designated resource on the Legal team, and new procedures in place to guarantee the enforceability of the payment language in the contracts we enter into with subcontractors and vendors on our projects in various states, Dennis Group will be poised to avoid traps for the unwary such as this one involving a general contractor, subcontractor and a pay when paid provision in a subcontract for a South Carolina project.