Are pay-when-paid clauses (i.e clauses permitting payment to be made by a contractor only when it has been paid by the employer) permitted? Are they commonly used?
Construction (2nd edition)
Security of payment legislation in all jurisdictions renders void "pay-when-paid" clauses in contracts for the performance of construction works, or supply of related goods and services, in Australia. A recent High Court of Australia decision, Maxcon Constructions Pty Ltd v Vadasz  HCA 5 confirmed this position. It clarified that a pay-when-paid provision will have no effect if it "makes the liability to pay money owing, or the due date for payment of money owing, contingent or dependent on the operation of another contract".
In subcontracts the use of pay-when-paid clauses is very common as a part of the so-called back-to-back nature of the contract, meaning that the rights and obligations of the main contractor towards the employer are deemed to apply to the subcontractor to the same extent (as if he were the main contractor). In this logic, it is the right of the main contractor to receive payment that triggers the right of the subcontractor to payment for works executed.
Pay-when-paid clauses are permitted by law and are rather common in construction subcontracting contracts. In practice, pay-when-paid clauses are normally considered as conditional legal acts where general contractors may have to bear the majority of burden to prove “conditions not met” if it fails to make payment to the subcontractor.
The application of pay-when-paid clauses is not explicitly prohibited but is subject to the provisions of law prescribing the deadline for the payment between certain persons, as explained in point 14.
While pay-when-paid clauses are not illegal under German law, they are not commonly used in building contracts. They are deemed to be invalid if used in standard business terms (section 305 ff. BGB).
Pay-when-paid clauses are not prohibited under Greek law, given that the general payment rule set out in Art. 694 of the GCC is soft law. Such term is often part of a general back-to-back contractual arrangement between the employer, the main contractor and the latter's subcontractor(s). However, such clauses should be reasonable and within the boundaries of the general principles of civil law and most importantly, the principle of good faith, otherwise risking unenforceability. Notwithstanding the above, where the contractor fails to make timely payments to its employees, the latter are entitled to demand payment of their accrued wages directly from the employer (702 GCC).
“Pay-when-paid”-clauses are permitted, but not commonly used in practice.
A “pay when paid” clause is a contract clause that states that the contractor is obligated to pay its subcontractors only following receipt of payment from the owner. General contractors in the United States routinely include such clauses in their subcontracts to avoid cash flow problems by only triggering payment to subcontractors when the contractor is paid by the owner. Thus, if the owner delays payment for four months, the general contractor is not obligated to pay its subcontractors until payment is actually received. Many courts view such a clause as a “timing mechanism,” whereby payment by the owner triggers the timing of when the general contractor must pay its subcontractors. Conversely, if the subcontract does not contain a pay when paid clause, then the subcontractor must be paid within a “reasonable” period of time.
A pay-when-paid clause is generally viewed upon as favorable to subcontractors because the general contractor is deemed obligated to pay the subcontractors even if the owner defaults. A similar yet different type of clause is known as a “pay-if-paid” clause, which shifts the entire risk of owner non-payment to the subcontractor. Thus, under a pay-if-paid clause, subcontractors are paid only if the contractor receives payment from the owner. Both types of clauses are routinely included in construction contracts.
Such clauses are permitted and are customary. However, court jurisprudence in Austria requires general contractors to use their best efforts to urge their client to make payments.
Pay-when-paid clauses are not permitted by Cyprus jurisdiction.
Brazilian legislation does not have any specific provisions regarding “pay-when-paid” clauses.
That does not mean that such condition may be “bullet proof” under our legal system. Brazilian law establishes a statutory duty for both parties to act in good faith. It also establishes that one party cannot be benefited from a contractual condition that such party acts maliciously to avoid happening. For those reasons, any attempt to adopt these kinds of provision will only be solid if the Subcontractor is effectively granted the right to seek for its rights under the contract. If specific clauses or the actual behaviour of the party prevent the Subcontractor from seeking its rights that may easily be considered void under our legal system.
Notwithstanding it can bring some legal challenges, this sort of provisions is not totally rare in our contractual practices. A recent research made by our firm on this subject showed that our courts still didn’t have the opportunity to form a strong precedent on such matter.
Under the Construction Contracts Act, 2013, such clauses are “ineffective” save in limited circumstances relating to insolvency, as set out in Section 3(5) of this Act.
This kind of clauses were not used until recent years. Recently, in private projects such clauses have been included. Since they are not forbidden, there is no issue on including it and there has not been judicial decision stating its illegality.
Pay-when-paid clauses are prohibited by the HGCRA, except in cases of insolvency of the payer “up the line”, in which case they are permitted.
In a situation in which the contractor cannot comply with the payments due to the subcontractors, it is possible that they can demand payment from the promoter, exercising the direct action of article 1,597 of the Civil Code.
In any case, for said payment to be due and to have a liberating effect on the main contractor, it is necessary, on one hand, that the claimed debt is a due and payable debt, not previously paid by the main contractor, and on the other hand that the developer is, in turn, a debtor of the main contractor by virtue of the same work to which the subcontractor's claim refers to.
The payment made to the subcontractor without any of these requirements would not have a liberating effect on the developer against the main contractor. Therefore, the promoter must acquire certainty about the expired and enforceable nature of the payment of the debt which is claimed.
The ideal situation would be to be able to have express agreement of the main contractor on the expired and enforceable nature of the debt at the time of the claim. However, in most cases, it is not possible to obtain such certainty about the maturity and due nature of the debt and, in such cases, it would be prudent not to make any payment - neither to the main contractor nor to the subcontractor - and to consign the amounts in favor of the person who could later prove that he has a real right to collect them. Such consignment would have liberating effects for the promoter (articles 1.176 and following of the Civil Code) and would avoid incurring in default.
Turkish law allows contemplating a contingent event as a condition precedent of maturity of payment obligations. Therefore, it is permissible to agree that receipt of payment from the employer is a condition precedent of the main contractor’s payment obligations. Such a clause should be exercised pursuant to the principle of good faith which draws the limit of application of such clauses. For subcontractors bargaining power of which are considerably low against the main contractors, pay-when-paid clauses are quite common. On the other hand, acceptance of such a clause by qualified subcontractors is not a common practice.
“Pay-when-paid” clauses are currently permitted and are commonly used. Again, however, the Proposed Amendments aim to introduce requirements in relation to, amongst other things, stage payments by ensuring proper cash flow for contractors by prohibiting “pay-when-paid” clauses.
These clauses are not common and their validity is in our view questionable under French law.
Pay-when-paid clauses are permitted but uncommon.
Pay-when-paid clauses are not uncommon in Danish construction contracts.
In a ruling from 2015, an arbitration tribunal found, in a dispute between a main contractor and a sub-contractor regarding a claim for additional work, that it was irrelevant that the contract contained a clause stating that claims for additional work would only be honored to the extent that the employer paid and accepted the claim.
It cannot be concluded that “pay-when-paid” clauses are generally void, as the specific circumstances of the case are not described in detail in the case summary, and it is not clear why the arbitration tribunal found the clause irrelevant, but “pay-when-paid” may be disregarded as unreasonable.
- While the issue of pay-when-paid clauses has not been addressed directly in any publicly available court judgment, the Fair Transactions in Subcontracting Act stipulates that the agreed payment date between a contractor and a subcontractor should not be more than 60 days from the delivery of the work, subject only to limited exceptions. Further, the act prohibits any special terms and conditions that unfairly violate or restrict a subcontractor’s interests.
- In light of this statute, the position of Korean law regarding pay-when-paid clauses remains unclear, and the standard forms of subcontract provided in various government regulations do not include such clauses. Consequently, cautious Korean contractors typically avoid using such clauses.