New Jersey Appellate Court Enforces “Pay-if-Paid” Clause Shifting Risk in a Construction Contract

Whether a construction contract contains a pay-if-paid clause and whether such clauses are enforceable are critical to determining a general contractor’s obligation to pay or not pay a subcontractor if the owner has not paid the general contractor. Generally speaking, a pay-if-paid clause shifts the risk of the owner’s nonpayment from the general contractor to the subcontractor by requiring the owner to pay the general contractor as a prerequisite to the general contractor’s obligation to pay its subcontractor. Without it, the general contractor assumes the risk of the owner failing to pay for the work. While other jurisdictions have addressed the enforceability of a pay-if-paid clause, until very recently, their enforceability was a question left unanswered in New Jersey.

In JPC Merger Sub LLC v. Tricon Enterprises, Inc., 286 A.3d 1186, for the first time, a New Jersey appellate court weighed on the enforceability of a pay-if-paid clause in a construction contract. In this case, the general contractor engaged the subcontractor to fulfill orders for beams on a public bridge contract. The general contractor sent the subcontractor a written purchase order with terms and conditions that provided that the general contractor’s obligation to issue payment to the subcontractor did not exist until and was conditioned upon the general contractor’s receipt of payment from the owner. The subcontractor edited the purchase order in handwriting, signed and returned it to the general contractor, but the edits did not remove the pay-if-paid clause.

The subcontractor performed its work fabricating and supplying the beams. Despite being paid for its initial invoices, the general contractor failed to pay the remaining invoices as the owner ceased payment to the general contractor for the subcontractor’s work. Specifically, the owner refused to pay as a result of the general contractor’s inability to use the beams because the utility company refused to move high-voltage power lines – a responsibility the owner contended belonged to the general contractor via the project specifications. As a result, the subcontractor filed a construction lien claim and filed suit asserting a lien foreclosure claim against the owner, breach of contract, breach of the implied covenant of good faith and fair dealing, and violation of the Prompt Payment Act against the general contractor, and breach of the payment bond against the surety, among other claims. The general contractor asserted a counterclaim against the subcontractor for breach of contract alleging the subcontractor was attempting to require payment despite there being no duty to pay. Subsequently, the surety filed a motion for summary judgment relying on the pay-if-paid clause contending that the surety had no duty to pay under the bond because the general contractor had no duty to pay. The trial court granted the surety’s motion for summary judgment, and the subcontractor appealed.

On appeal, the Appellate Division acknowledged that “In New Jersey, there is no statute or published caselaw governing the enforceability of a pay-if-paid contract provision.”  Highlighting the court’s established precedent providing sophisticated, commercial parties with the freedom to contract, and looking to the rationale of other jurisdictions, the court held that:

• A pay-if-paid clause is enforceable in New Jersey “as long as the contract on its face contains clear and unequivocal language that unambiguously sets forth the parties’ intention and agreement that owner payment is a condition precedent to the general contractor’s obligation to pay the subcontractor.”
• Pay-if-paid clauses may not be enforced in circumstances where the general contractor prevented the condition precedent, the owner’s payment, from occurring.

Ultimately, the court reversed the trial court, in part, holding that the lower court should have denied the surety’s motion for summary judgment as there were genuine issues of material fact regarding whether the general contractor’s actions, specifically those in relation to its failure to relocate the utility lines and inability to use the supplied beams, prevented the condition that would have triggered its obligation to pay its subcontractor from occurring.

The JPC Merger Sub LLC decision will embolden general contractors to include a pay-if-paid clause in subcontracts more frequently and, in turn, will make the subcontracting process more critical for subcontractors.

If you are a general contractor utilizing a pay-if-paid clause in your subcontract, it is wise to review your existing contract language or insert new language to comply with the court’s decision. For subcontractors, it is more important to review and understand your subcontract as, to no fault of your own, you may be unable to compel the general contractor to issue payment for your work. However, subcontractors can still protect themselves by other means, such as by filing construction lien claims.

With proper guidance from a knowledgeable professional, general contractors and subcontractors can reduce their risks and protect their interests.