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Construction suppliers in Virginia can now breathe a sigh of relief when it comes to getting paid for their work.
In April, Virginia Gov. Glenn Youngkin signed SB550 into law, prohibiting the use of pay-if-paid clauses in construction contracts. In doing so, Virginia joined a handful of states that have some sort of statutory 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 main contractor to its subcontractors, lawyers say. In other words, when the wheels fall off a job and money at the top stops flowing, pay-if-paid clauses let the prime off the hook for any money owed to subs further down the chain.
“If for some reason the owner doesn’t pay the general contractor and you’re a subcontractor, you may never get paid, even if it’s completely unrelated to your job,” Shoshana said Rothmana partner in the Tyson’sVirginia, Office of the Civil Law Firm of Smith, Currie & Hancock LLP.
While this may not seem fair to subcontractors who have no control over the dealings between a Prime and the owner, “It’s perfectly enforceable in many jurisdictions,” Judah said LifschitzDirector and Co-President of the Washington, DC based law firm Shapiro, Lifschitz & scratchPC “If you’re not in this industry, pay-if-pay might even seem a little shocking draconian,” he said.
Because of this, Lifschitz says, subs typically try to avoid pay-if-paid clauses in contracts. But they may feel compelled to accept them in situations where they have no means of influence or in times when work is scarce.
“Most demanding subcontractors know better and would not sign a subcontract with a pay-if-paid clause,” said Lifschitz. “But when economic times are tough and people need the work, some subcontractors sign what they have to sign to survive.”
What SB550 does
Virginia’s new law seeks to alleviate this situation for subcontractors in both public and private contracts, putting the payment burden back on the shoulders of prime contractors, regardless of whether they are being paid by a project owner.
“SB 550 prohibits the inclusion of pay-if-pay terms in public or private construction contracts,” said Phillip L. Sampson Jr., partner at Houston-based law firm Bracewell LLP. “The Virginia legislature has taken the step that few other U.S. states have taken to protect subcontractors from potential unfairness and injustice arising from pay-if-paid subcontracting.”
SB550 requires Primes to pay subs within 60 days of receiving an invoice or seven days of receiving payment from the owner, whichever is earlier. In the event of a late transfer, default interest will be charged.
Only six other states have laws on the books that expressly make pay-if-paid clauses unenforceable under the law a survey by the law firm Woods Aitken:
- Delaware (for private contracts).
- New York.
- North Carolina.
- South Carolina.
When SB550 goes into effect on January 1, 2023, Virginia will be the seventh state to have such a law. According to Rothman, the ban applies to contracts from that date.
Protection beyond liens
Nine other states — Illinois, Indiana, Kansas, Maryland, Massachusetts, Montana, Nevada, Ohio and Utah — have language on the books or precedent that makes pay-if-paid clauses unenforceable under certain conditions, according to the Woods Aitken survey make.
In most of these jurisdictions, pay-if-paid clauses are voided when they undermine a sub’s right to file a mechanic’s lien against a private project for non-payment. (For public projects, subs can usually claim a payment deposit.)
Liens, which claim physical property from a third party, have long been used by construction subcontractors to get paid. They are effective because post-financing — for example, converting a home loan into a long-term mortgage after the job is done — is often dependent on an asset being clear of third-party claims.
In other words, subs can still fix defaults on a job by directly chasing the owner of a private project through a lien. Indeed, pay-if-paid advocates point to the deposit option as one reason why laws like Virginia’s are unnecessary.
“Most states have strong lien and capital catching laws that help protect subcontractors’ right to timely payment,” Sampson said. “Proponents of pay-if-paid regulations — contractors — routinely point to these types of laws, which offer adequate protections for subcontractors.”
At the same time, the lien process is often complex, cumbersome and time-consuming. Texas revised its liens recently, for example, to make them slimmer. What SB550 and similar laws offer, attorneys say, is another avenue for subs to get paid the money they’re rightfully owed.
“A lien is always a good bargaining chip for a subcontractor who hasn’t been paid for a private project,” Rothman said. “But with this law now in place, it adds an extra level of protection. Now the general contractor is obliged to make the payment, notwithstanding any prior disputes between the owner and the general contractor.”
Impact beyond Virginia
While the new law applies only within Virginia, attorneys say there is an opportunity for other states to follow suit. One reason for this is Virginia’s historical view of contract law, where statutory contracts usually supersede other provisions.
“It’s a big change for us here in Virginia because contractual terms are traditionally the most important,” Rothman said.
However, any new pay-if-paid changes would likely be on a case-by-case basis.
“It’s not the COVID of construction contract law, where it will simply be contagious across national borders,” said Lifschitz. “I think it’s going to be a state-by-state situation.”
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