Litigation

Steptoe & Johnson PLLC: Subcontractors Beware - Ohio Supreme Court Upholds ‘Pay-If-Paid’ Provisions

By Eric J. Hulett and Matthew A. Brandt

The Ohio Supreme Court recently changed the landscape in construction law when it held that a payment provision in a subcontract which included the term “condition precedent” was sufficient to transfer the risk of the owner’s non-payment from the general contractor to the subcontractor.  At issue was whether or not the general contractor Transtar could pass on to the subcontractor A.E.M. the risk of non-payment by the owner by including the following clause in the subcontract:       

"Receipt of payment by contractor from the owner for work performed by subcontractor is a condition precedent to payment by contractor to subcontractor for that work. (emphasis added).

In Transtar Electric, Inc. v. A.E.M. Electric Services Corp,[1] the Ohio Supreme Court held that payment provisions in subcontracts must include clear language transferring the risk of non-payment from contractor to subcontractor [enhanced opinion available to lexis.com subscribers]. The Supreme Court’s holding overturns Ohio’s Sixth District Court of Appeals’ decision that held that the use of the term “condition precedent” alone is insufficient to place the subcontractor on notice of the risk of non-payment.  The Appeals Court reasoned that transferring liability from the general contractor to the subcontractor is bad policy, as the general contractor is in the better position to evaluate the owner’s financial health and collect payment.  Thus, the court held that a subcontract must meet a heightened standard to transfer the risk of non-payment from the general contractor to the subcontractor.  The Court found that the above-quoted language did not manifest the intent to shift the risk of non-payment because it was “not specific enough to show that both parties understood and agreed that the risk of the owner’s non-payment would be borne by the subcontractor instead of the general contractor.”

In rejecting the approach taken by the Court of Appeals, the Supreme Court first noted the two types of contractual provisions that establish how a subcontractor is paid: “pay-if-paid” and “pay-when-paid” provisions.  The “pay-when-paid” provision is an unconditional promise to pay that is not dependent on or modified by the owner’s nonpayment, whereas the “pay-if-paid” is a conditional promise that is enforceable only if the condition precedent has occurred.  The Supreme Court found that the clause contained in the subcontract at issue was clearly a “pay-if-paid” clause.  The Supreme Court reasoned that use of “condition precedent” in the clause establishes a condition that must be performed before the general contractor’s obligation to pay the subcontract becomes effective, and that if the condition (i.e. the owner’s non-payment) is not fulfilled, the general contractor is excused from paying the subcontractor.

Additionally, the Supreme Court held that the use of the term “condition precedent” negates the need for additional language that demonstrates the parties’ intent to transfer the risk of non-payment from general contractor to subcontractor.  The Court found that including additional specific assumption of risk language would reinforce that intent; however, the inclusion of such additional language would be redundant and unnecessary in the instant case.

The Supreme Court’s holding offers contractors and subcontractors some guidance on what language to consider when entering into contractors.  General contractors doing business in Ohio should consult with their attorneys to prepare “pay-if-paid” provisions that will meet the standards set forth by the Supreme Court in Transtar.  Subcontractors doing business in Ohio should consult with counsel and be cautious before entering into subcontracts with payment provisions that include the term “condition precedent.”

The Steptoe & Johnson Construction Team stands ready to advise you regarding pay-if-paid provisions and other construction project risks you face.

[1] 2014 Ohio LEXIS 1803 (Ohio July 17, 2014).

about Eric J. Hulett

Eric Hulett has litigated and tried a variety of cases in state and federal courts and focuses his practice in the areas of construction law, surety bond claims, professional liability and insurance coverage.  Mr. Hulett was admitted to the practice of law in 1993.  He leads the firm's Construction Law Team.

about Matthew A. Brandt

Matthew Brandt focuses his practice in the areas of energy and mineral law, energy and real estate transactions and litigation.  Mr. Brandt regularly assists clients with mineral title examinations and title opinions.

For more information about LexisNexis products and solutions, connect with us through our corporate site.