Introduction:

In the construction industry, timely payments are critical for maintaining operations, covering labor, materials and other expenses. Yet, subcontractors frequently face payment delays that stretch for months, putting their financial stability at risk. Many of these delays are tied to payment clauses in contracts, such as the “pay-when-paid” clause, which makes subcontractor payments contingent on when the general contractor (GC) is paid by the project owner. Understanding the risks associated with these terms and negotiating better contract conditions is essential for subcontractors to safeguard their cash flow and business health.

Contract payments have a history of being delayed, with some companies not paying until 90 days after invoicing. The most common reason cited for business failure is cash flow issues. Therefore, subcontractors should carefully review and modify any proposal that includes payment contingencies, such as the following:

“Within ten (10) calendar days of the date the last of the following occurs, the Company receives payment from the Owner for all or part of Subcontractor’s Work furnished during a given progress payment period.”

This clause introduces significant challenges for subcontractors:

Payment Contingency on Owner’s Payment

The subcontractor’s payment is contingent on the general contractor (GC) receiving payment from the project owner, commonly referred to as a “pay-when-paid” clause. This creates significant risk for the subcontractor. If the owner delays payment to the GC (or fails to pay altogether), the subcontractor may face long delays in receiving their payment, even if their work is completed and properly invoiced.

Unclear Timing for Payment

The phrase “within ten (10) calendar days of the date the last of the following occurs” adds ambiguity to when the subcontractor will be paid. The timing depends on several factors, such as when the GC is paid by the owner, which can lead to unpredictability in the subcontractor’s cash flow.

Extended Payment Periods

In some cases, companies delay payment until 90 days after invoicing, leaving subcontractors to wait up to three months (or more) for payment. This delay can put strain on subcontractors, who must continue covering costs like labor, materials and equipment during this period.

Risk of Financial Stress or Insolvency

Cash flow is critical to a business’s survival. If a subcontractor cannot cover their expenses while waiting for payment, they may struggle to meet obligations to workers, suppliers and other operational needs. The frequent citation of cash flow as a cause of business failure highlights the risks associated with these delays.

Mitigation Strategies

Subcontractors should negotiate more favorable contract terms, such as:

• A specific payment schedule that is independent of when the GC receives payment from the owner.
• A clause that limits payment delays to a fixed number of days after invoicing, regardless of the owner’s payment.

These strategies would provide greater financial security and predictability for subcontractors.

Transparency Issues with the General Contractor

A significant issue arises when subcontractors cannot easily verify when the GC was paid by the owner, particularly under a “pay-when-paid” clause. This lack of transparency is especially concerning when dealing with a dishonest GC.

1. No Direct Visibility into Payments from the Owner

Subcontractors typically have no direct access to information regarding the payments made by the owner to the GC. This creates a “black hole” where subcontractors must rely solely on the GC’s word about payment status, which may not always be timely or truthful.

2. Potential for Dishonesty or Manipulation

A dishonest GC may claim they haven’t been paid by the owner, even if they have, in order to delay payment to the subcontractor and improve their own cash flow. Without a mechanism for the subcontractor to verify payment, subcontractors may face long delays, unaware that the funds have already been received.

3. Lack of Auditing or Tracking Mechanisms

Most contracts don’t allow subcontractors to audit or track when the GC has been paid. Without these provisions, subcontractors have little recourse to demand proof of payment, allowing unscrupulous GCs to delay payments without consequences.

4. Extended Delays and Cash Flow Stress

This lack of transparency can lead to extended delays, putting subcontractors’ cash flow at risk. Subcontractors need clear payment timelines to plan their finances, and without such visibility, they may face serious financial stress while waiting for payment.

5. Difficulty Enforcing Payment Terms

Even if a subcontractor suspects that the GC has been paid but is withholding payment, enforcing contract terms can be costly and time-consuming. Litigation or arbitration might jeopardize the relationship or future work, leaving subcontractors with limited options for resolving payment disputes. https://www.linkedin.com/in/constructioncontractcoach?lipi=urn%3Ali%3Apage%3Ad_flagship3_profile_view_base_contact_details%3BuzLQLnO%2FS%2BufHpwpYJyWzw%3D%3D

Solutions and Safeguards

To protect against these risks, subcontractors can negotiate the following:

• Payment Bonding: Require a payment bond to ensure payment even if the owner delays paying the GC.
• Conditional Progress Payments: Mandate partial payments at regular intervals, independent of whether the owner has paid the GC.
• Right to Audit: Negotiate the right to audit or request proof of payment from the GC at specific intervals.
• Mechanics’ Liens: In certain jurisdictions, subcontractors can file a mechanics’ lien on the property if they are not paid within a reasonable timeframe.

The General Contractor’s Responsibility to Pay Subcontractors

The use of a “pay-when-paid” model shifts an unfair financial burden onto subcontractors. Fundamentally, the GC is responsible for ensuring they have the financial capacity to pay subcontractors on time, regardless of when they receive payment from the owner.

1. General Contractor’s Role as Financial Intermediary

As the party overseeing the entire project, the GC is responsible for managing contracts with both the owner and subcontractors. Part of this responsibility includes maintaining sufficient working capital to pay subcontractors for completed and properly invoiced work, independent of when the GC is paid by the owner.

2. Subcontractors Should Not Bear the Risk of Nonpayment

Subcontractors often operate on tight margins and have immediate cash flow needs. They should not bear the financial risk associated with the owner’s delay or failure to pay. It is the GC’s responsibility, as the party contracting with the owner, to assume these risks.

3. GCs Should Be Properly Capitalized

A well-managed GC should have access to sufficient capital or financing to meet short-term payment obligations. It is unreasonable for a GC to rely on owner payments to cover subcontractor costs, especially on large projects where payment delays are common.

4. Preserving Subcontractor Business Health

Subcontractors, especially smaller or specialized firms, cannot afford extended payment delays. By shifting financial risks to subcontractors, GCs may put them in a financially vulnerable position, potentially threatening their survival.

5. Moral and Ethical Responsibility

From an ethical standpoint, GCs have a responsibility to pay subcontractors for completed work in a timely manner. Delaying payments creates an imbalance of power, effectively turning subcontractors into lenders to the GC.

6. Legal Concerns

In many jurisdictions, courts interpret “pay-when-paid” clauses as requiring the GC to pay subcontractors within a reasonable time, regardless of the owner’s payment. GCs may be held legally liable to pay subcontractors even if the owner has not paid them, reinforcing the notion that GCs should have sufficient capital to meet their obligations.

7. Encouraging Proper Financial Planning

Requiring GCs to pay subcontractors on time, regardless of owner payments, encourages better financial discipline. GCs would need to plan ahead and manage cash flow responsibly, benefiting the entire project ecosystem.

8. Importance of Payment Bonding

If a GC anticipates potential payment delays, they should use payment bonds to protect subcontractors. This ensures subcontractors are paid for their work, even if the GC faces issues receiving payments from the owner.

Conclusion

GCs hold a position of power in the construction process and must manage their finances responsibly to ensure timely payments to subcontractors. Shifting the financial burden onto subcontractors through “pay-when-paid” clauses is unfair and detrimental to the project’s success. Responsible GCs should maintain adequate cash reserves and financial planning to ensure that subcontractors are paid promptly, fostering trust and continuity across the entire project.