The Dotted Line: Virginia bans ‘pay-if-paid’ contract language

This feature is part of “The Dotted Line” series, which takes an in-depth look at the complex legal landscape of the construction industry. To see the whole series, click here.

Construction contractors in Virginia can now breathe a little easier when it comes to getting paid for their work.

In April, Virginia Governor Glenn Youngkin signed into law SB550, which prohibits the use of “pay-if-paid” clauses in construction contracts. In doing so, Virginia has joined a handful of states that have some sort of legal ban on a common, but also controversial, legal term in construction contracts.

Pay-if-paid clauses shift the risk of being paid for work completed on a project from the prime contractor to its subcontractors, the lawyers say. In other words, if the wheels come off a job and the money stops flowing to the top, pay-on-pay clauses allow first to fend for any money owed to lower subs in the chain .

Shoshana Rothman

Courtesy of Smith, Currie & Hancock LLP

“If for some reason the owner doesn’t pay the general contractor and you’re a subcontractor, you may never see the payment, even if it’s unrelated to your job,” said Shoshana. Rothmanpartner of TysonVirginia, office of construction law firm Smith, Currie & Hancock LLP.

While that might not seem fair to subcontractors who have no control over the relationship between a prime contractor and owner, “in many jurisdictions it’s absolutely enforceable,” Judah said. Lifschitzdirector and co-chairman of the Shapiro law firm based in Washington, DC, Lifschitz & SchramPC “If you’re not in this industry, pay-to-pay might seem a bit shocking, even draconian,” he said.

For this reason, Lifschitz says contractors typically try to avoid pay-on-pay clauses in contracts. But they may feel compelled to accept them in situations where they have no influence or during times when work is scarce.

Juda Lifschitz

Courtesy of Shapiro, Lifschitz & Schram, CP

“Most sophisticated subcontractors know better, and they wouldn’t sign a subcontract with a pay-if-paid clause,” Lifschitz said. “But when economic times are tough and people need work, some contractors will sign what they need to sign to survive.”

What the SB550 does

Virginia’s new law attempts to alleviate this situation for subcontractors on public and private contracts and puts the burden of payment on the shoulders of prime contractors, whether or not they are paid by a project owner.

“SB 550 prohibits the inclusion of pay-as-you-go terms in any public or private construction contract,” said Phillip L. Sampson Jr., partner at Houston-based law firm Bracewell LLP. “The Virginia Legislature has taken the step that only a few other U.S. states have taken to date to protect contractors from potential unfairness and inequity resulting from pay-if-paid subcontracts.”

SB550 requires premiums to pay subcontractors within 60 days of receiving an invoice, or seven days after receiving payment from the owner, whichever comes first. Interest penalties apply in the event of late payment.

According an investigation by the law firm Woods Aitken:

  • California.
  • Delaware (for private contracts).
  • New York.
  • North Carolina.
  • Caroline from the south.
  • Wisconsin.

When SB550 takes effect on January 1, 2023, Virginia will become the seventh state to have such status. The ban will apply to contracts from that date, according to Rothman.

Protection beyond privileges

Nine other states – Illinois, Indiana, Kansas, Maryland, Massachusetts, Montana, Nevada, Ohio and Utah – have language on the books or legal precedent that makes the terms of pay-if-paid unenforceable under certain conditions, according to Woods Aitken investigation.

In most of these jurisdictions, pay-if-paid clauses become void when they impair a subcontractor’s right to file a mechanic’s lien against a private project for non-payment. (On public projects, subcontractors can usually apply for a payment bond.)

Liens, which claim physical ownership by a third party, have long been used in construction by submarines to be paid for. They are effective because subsequent financing – for example, a building loan converted into a long-term mortgage after completion of a job – is often subject to an asset free of third-party claims.

In other words, subcontractors can always remedy non-payment for a job by directly suing the owner of a private project through a lien. Indeed, pay-if-paid proponents point to the lien option as the reason why laws like Virginia’s are unnecessary.

Phillip L. Sampson, Jr.

Courtesy of Bracewell LLP

“Most states have strong lien and fund entrapment laws that help protect contractors’ right to timely payment,” Sampson said. “Proponents of pay-if-paid provisions — contractors — regularly point out that these kinds of laws provide adequate protection for subcontractors.”

At the same time, the lien process is often complex, expensive and time-consuming. Texas has revised its lien laws recently, for example, to help streamline them. What SB550 and similar laws provide, lawyers say, is another way for submarines to get paid the money they are rightfully owed.

“A lien is always good bargaining chip for a subcontractor who hasn’t been paid on a private project,” Rothman said. “But with this law in place now, it adds an extra level of protection. Now, the general contractor is required to issue payment regardless of any upstream disputes between the owner and the general contractor.

Implications beyond Virginia

Although the new law only applies in Virginia, lawyers say it’s possible other states will follow suit. One reason for this is Virginia’s historical view of contract law, where legally agreed upon contracts generally supersede other provisions.

“It’s a big change for us here in Virginia because the terms of a contract are historically king,” Rothman said.

That said, any new payout changes if paid would likely come on a case-by-case basis.

“It’s not the COVID of construction contract law, where it’s just going to be contagious across state lines,” Lifschitz said. “I think it will be a state-by-state situation.”

The Dotted Line Series is brought to you by AIA Contract Documents®, a recognized leader in design and construction contracts. To learn more about their 200+ contracts and to access free resources, visit their website here. AIA Contract Documents has no influence on the coverage of Construction Dive in the articles, and the content does not reflect the views or opinions of the American Institute of Architects, AIA Contract Documents or its employees.

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