Scary Contract Terms 101: Paid When Paid
Every day, I read over contracts.
That’s…just one of those things you do when you’re a lawyer in the construction industry. That and send emails. It’s like, the world’s lamest reward for paying attention in college.
Suffice to say, at this point, I have read over more contracts than the average person will in a lifetime.
I’ve seen big contracts, small contracts, contracts that cover every possible contingency, contracts that have been copy-and-pasted from other irrelevant contracts, contracts that leave out literally all of the vital information, contracts that look like they might have been written by a first grader, contracts that actually were written by a first grader, contracts that devote 60 pages to OSHA contingency plans for volcanic activity in Nebraska, and contracts that actually make sense. (The latter being the rarest of all contract varieties.)
One contract term that comes up pretty regularly, and sends a chill down the spine of every seasoned lender, is ‘Paid-When-Paid’.
Paid-When-Paid is exactly what the name implies: It means that until the owner on a project releases payment to the GC, the GC doesn’t have to pay any subs or suppliers.
Unfortunately, this clause can be found in most standard AIA contracts, and if you do much commercial construction, you’ll eventually bump into it.
As to what this means for you, the subcontractor, I’ve got good news and bad news: The good news is, eventually, the GC has to pay you. The bad news is, that payment may take some time.
Unlike Paid-When-Paid’s ugly stepsister, Paid-When-Paid does nothing to shift the risk of eventual payment. If the project owner skips town without paying the GC a dime, the GC is still going to be legally liable for paying suppliers and subcontractors.
The risk that this clause does shift, however, is that of slow payment.
If the GC’s contract with the owner says that the first draw for the project will be paid in July, and July comes and goes without a check from the owner, the GC has no obligation to pay any of the people who’ve already provided labor and materials on the job. The same applies if August and September pass by, equally devoid of payment.
Eventually, the courts will tell the GC they have to pay up, but depending on what your jurisdiction considers a ‘reasonable’ amount of time, payment for that work may not come for many months after the work has been completed. From a cash flow perspective, this is devastating to subcontractors–after all, by this time, you’ve likely sunk tens of thousands of dollars into supplies and labor, and yet you have nothing coming into pay those bills.
And, on top of that, you’ve essentially gone six months without a paycheck.
Unfortunately, there is no easy way around this clause–it’s endemic to the industry, and if you take on many projects, you’re going to encounter it from time to time. The best thing that you can do is be aware of the dangers: Look for this clause before entering into a contract. Think about who the project owner is. Take the risk into account when setting your bid price. Watch your cash flow so that you have a cushion in the event of slow payment. Keep an eye on lien rights. And, if worse comes to worse, don’t be afraid to talk to somebody who knows what they’re doing on this stuff. As far as scary contract clauses go, this risk is easier to mitigate that some, but doing so requires planning ahead and being aware of the dangers to your cash flow.