Clear and Unequivocal Pay-If-Paid Provision in Construction Contract Establishes Precondition to Payment Between Contractor and Subcontractor

The New Jersey Appellate Division recently upheld the enforceability of “pay-if-paid” provisions in construction contracts, “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,” in JPC Merger Sub v. Tricon Enterprises, 474 N.J. Super. 145, 163 (App. Div. 2022). In JPC Merger, the three-judge appellate panel agreed that “such a provision is neither unfair, unconscionable, nor against public policy.”

A pay-if-paid clause in a construction contract provides that a subcontractor will be paid by the general contractor only if the owner pays the general contractor for the subcontractor’s work. Payment by the owner is an express condition precedent to the general contractor’s duty to pay the subcontractor. In practice, such a clause seeks to shift the risk of the owner’s non-payment from the general contractor to the subcontractor.

In JPC Merger, a public improvement contract was awarded to general contractor Tricon Enterprises Inc. Tricon then entered into a purchase order contract with JPC Merger Sub LLC, d/b/a Jersey Precast, to provide pre-stressed box beams for the public improvement project. Tricon’s surety, QBE Insurance, d/b/a QBE Surety, issued a performance bond and payment bond to the project owner. The “payment” provision in the purchase order contract between Tricon and Jersey Precast provided as follows, where the italicized language constituted the “pay-if-paid” provision:

“Tricon shall pay Vendor for the Work furnished within 14 days after Tricon’s receipt of payment from the Owner … for such Work, less retainage (if any) in the corresponding amount withheld from Tricon. Vendor understands and agrees that Tricon’s obligation to make any payment to Vendor is subject to, and shall not exist unless and until, Tricon’s receipt of payment on account of Vendor’s Work from the Owner … the occurrence and satisfaction of which shall be a condition precedent to Tricon’s duty to remit payment. Payment by Tricon shall not constitute acceptance of any Work or Goods, nor shall tender of payment be a condition to Vendor’s duty to furnish the Work required hereunder.”

Jersey Precast received the purchase order contract from Tricon and made various handwritten revisions, including modifying the pay-if-paid clause by replacing “14” days with “7” days and striking the “retainage” language. The parties then began performing under the purchase order contract without incident until Tricon refused to accept Jersey Precast’s final delivery of beams. Relying on the pay-if-paid language, Tricon took the position that it was “relieved of its obligations” under the purchase order contract to pay Jersey Precast for the beams because Tricon had not received payment from the project owner.

Jersey Precast sued the project owner, Tricon, and QBE, seeking payment under the purchase order contract and under the bonds issued by QBE. Tricon counterclaimed for breach of contract by Jersey Precast for “attempting to enforce payment prior to Tricon having a duty to pay, as the condition precedent set by the pay-if-paid clause had not yet occurred.” Jersey Precast filed a motion to dismiss Tricon’s counterclaim and QBE filed a motion for summary judgment, asserting that, under the pay-if-paid clause neither Tricon nor QBE had a duty to pay Jersey Precast in the absence of payment from the project owner. In opposition to summary judgment, Jersey Precast argued that Tricon’s own default or breach was the reason for the project owner’s non-payment.

Both the trial court and the Appellate Division recognized the underlined language from the “payment” paragraph of the purchase order contract to be the pay-if-paid provision in dispute. The trial court denied Jersey Precast’s motion to dismiss Tricon’s counterclaim and granted QBE’s summary judgment motion, finding the pay-if-paid clause “enforceable as a matter of law.” Secondarily, the trial court found that Article 2 of the Uniform Commercial Code’s (UCC) “knock-out” rule under N.J.S.A. 12A:2-207(3) was inapplicable and did not “knock out” the pay-if-paid provision because Jersey Precast’s handwritten modifications “[were] considered proposals for addition to the contract that were not accepted” by Tricon. The Appellate Division affirmed the trial court’s recognition and enforcement of the pay-if-paid clause, thus affirming the trial court’s holdings, except that it reversed and remanded the grant of summary judgment because a question of fact remained regarding whether “Tricon’s inadvertent actions, deliberate conduct, or poor project management” were the reasons behind the project owner’s non-payment.

Because the pay-if-paid provision in New Jersey construction contracts constituted a matter of first impression, the Appellate Division canvassed the country to assess whether and to what extent other states have enforced pay-if-paid clauses. On the one extreme are the states, such as Kentucky and Alabama, that enforce pay-if-paid clauses as written based on strong adherence to “freedom of contract.” On the other end of the spectrum are those jurisdictions where legislation has been passed that outright declares pay-if-paid provisions unenforceable.

The Appellate Division, noting “there is no statute or published caselaw governing the enforceability of a pay-if-paid contract provision” in New Jersey, settled on the middle-ground approach. The court cited well-established authority that the “familiar rules of contract interpretation” are “based on the intent of the parties” and “the express terms of the contract.” In that vein, the Appellate Division held “that as long as the contract specifies a clear and unambiguous intent and agreement by the parties to shift the risk of nonpayment, a pay-if-paid provision is enforceable subject to the parties’ implied duty to not frustrate conditions precedent to their performance.”

Turning to the particular pay-if-paid provision at issue under the purchase order contract, the appellate panel was “satisfied that the pay-if-paid provision is clear and unambiguous,” citing further the commercial sophistication of both Tricon and Jersey Precast (“certain payment provisions in a commercial contract between sophisticated parties are presumptively reasonable”). Tricon’s receipt of payment from the project owner acted as an “express condition precedent” to Tricon’s obligation to pay Jersey Precast. However, where a party “prevents or hinders” fulfillment of the underlying condition precedent, liability for the non-payment shifts to the preventing/hindering party. Thus, because Jersey Precast injected a factual dispute as to whether Tricon’s actions were the reason for the project owner’s nonpayment, the Appellate Division reversed and remanded for a determination on that issue.

The Appellate Division also assessed the applicability of the “knock-out” rule, finding it inapplicable under the facts. Whereas the trial court determined the “knock-out” rule was inapplicable because the handwritten assertions were conflicting, but unaccepted “proposals for addition to the contract” under N.J.S.A. 12A:2-207(2), the Appellate Division found the “knock-out” rule inapplicable because the handwritten assertions were in fact not conflicting, but rather “merely created a timetable for Tricon’s payment schedule.”

The primary takeaway from JPC Merger for construction litigators is clear: If representing a general contractor, it is good practice to include a clear and unambiguous pay-if-paid provision in the subcontract, modeling it after that found in JPC Merger. And if representing a subcontractor, advise your client that such a provision essentially acts to shift the risk of non-payment from the owner to you, and will be enforced unless you can show that the general contractor’s actions were the cause for the non-payment.

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Reprinted with permission from the April 24, 2023 issue of the New Jersey Law Journal. © 2023 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved. For information, contact 877-257-3382 or reprints@alm.com or visit www.almreprints.com.