Nevada Supreme Court Declares Pay-If-Paid Clauses Unenforceable Or Did It?

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1 Nevada Supreme Court Declares Pay-If-Paid Clauses Unenforceable Or Did It? by Greg Gledhill, Associate For decades, pay-if-paid and/or pay-when-paid clauses have appeared in typical construction subcontracts. Beginning in the mid-1990s, however, numerous jurisdictions began ruling that such clauses are unenforceable. In 2008, the Nevada Supreme Court followed suit in the case of Lehrer McGovern Bovis, Inc. v. Bullock Insulation, Inc., 197 P.3d 1032 (Nev. 2008), and declared that pay-if-paid clauses are unenforceable and against recognized public policy at least that is what we thought. What Are Pay-If-Paid And Pay-When-Paid Clauses? Basically, a pay-if-paid clause makes payment by and owner to a general contractor ( GC ) a condition precedent to the GC s obligation to make payment to a subcontractor ( Sub ). Under a strict interpretation of a pay-if-paid clause, if a GC is never paid by the owner, then the GC would never have a contractual obligation to pay its Sub. A pay-when-paid clause, on the other hand, is a similar, yet less foreboding payment provision. A pay-when-paid clause does not completely relieve a GC from ever making payment; it merely governs the timing of when payment becomes due. Typically, paywhen-paid provisions have been interpreted to allow a GC a reasonable amount of time to wait for owner payment before paying its Sub. Accordingly, even in the event of owner non-payment, a GC would eventually still have an obligation to pay its Sub after a reasonable time. Historically, Such Payment Provisions Have Become Increasingly Limited Even before courts began expressly ruling that pay-if-paid provisions are unenforceable, courts were historically strict in interpreting such provisions. Pay-if-paid provisions were disfavored because potentially substantial credit risks could be unintentionally shifted to an unwary Sub. See, e.g., The Thomas Dyer Co. v. Bishop Int l Eng g Co., 303 F.2d 655 (6 th Cir. 1962). Basically, court saw it as unfair to expect a Sub to bear the risk of an owner s non-payment when the Sub has a contractual relationship only with the GC. Accordingly, in most cases, pay-if-paid provisions were construed by the courts as paywhen-paid provisions. The GC was typically given a reasonable time to recover payment from the owner, particularly where the money was not being withheld by the owner as a result of the Sub s delay or defective workmanship. Yamanishi v. Bleily and Collishaw, Inc., 105 Cal. Rptr. 580 (Ca. 1972); Midland Eng g Co. v. John A. Hall Constr. Co., 398 F. Supp. 981 (D.C. In. 1975). What constitutes a reasonable time has been interpreted differently by the courts depending on the facts and circumstances of the case, but some courts have relied on the

2 limitations period for filing suit indicated in the contract or accompanying bond. Most of the cases seem to suggest that 90 days is the longest time period that would be reasonable. See AESCO Steel, Inc. v. J.A. Jones Constr. Co., 621 F. Supp (D.C. La. 1985); Howard-Green Elec. Co. v. Chaney & James Constr. Co., 182 S.E. 2d 601, 605 (N.C. 1971); John F. Sanchez Plumbing Co. v. Aetna Cas. & Surety Co., 564 So. 2d 1302, (La. Ct. App. 1990); Havens Steel Co. v. Randolph Eng r Co., 613 F. Supp. 514, 539 (D.C. Mo. 1985) ( a three month period (a calendar quarter) would be the maximum reasonable time for delay ); Moore v. Continental Cas. Co., 366 F. Supp. 954, (W.D. Okla. 1973); A.J. Wolfe Co. v. Baltimore Contractors, Inc., 244 N.E.2d 717, 722 (Mass. 1969). The first jurisdictions to declare pay-if-paid provisions absolutely unenforceable (as opposed to general trend of interpreting pay-if-paid clauses as pay-when-paid clauses) were New York and California. In 1995 and 1997, respectively, courts in New York and California voided pay-if-paid provisions as against public policy. See West-Fair Elec. Contractors v. Aetna Cas. & Sur. Co., 661 N.E. 2d 967 (N.Y. 1995) and Wm. R. Clarke Corp. v. Safeco Ins. Co., 938 P.2d 372 (Ca. 1997). The courts both based their decisions principally upon provisions of the particular state s constitution and statutes that rendered unenforceable any provision in a construction contract that purported to waive a subcontractor s rights under the protective mechanic s lien statutes. In both cases, the courts explained that where the Sub s right to receive payment has been indefinitely postponed, the Sub has essentially waived its mechanic s lien rights. Now, numerous jurisdictions across the country have expressly ruled that pay-if-paid provisions are unenforceable typically using the same mechanic s lien public policy justification. Nevada Case Law In the fall of 2008, Nevada became one of the most recent states to expressly rule on the enforceability of pay-if-paid clauses. See Lehrer McGovern Bovis, Inc. v. Bullock Insulation, Inc., 197 P.3d 1032 (Nev. 2008). In Bovis, the Nevada Supreme Court upheld the lower court s decision that pay-if-paid provisions are unenforceable based on Nevada s strong public policy favoring a subcontractor s mechanic s lien rights. The Court stated: Because a pay-if-paid provision limits a subcontractor s ability to be paid for work already performed, such a provision impairs the subcontractor s statutory right to place a mechanic s lien on the construction project. As noted above, Nevada s public policy favors securing payment for labor and material contractors. Therefore, we conclude that pay-if-paid provisions are unenforceable because they violate public policy. Id. at 1042 (emphasis added). This straightforward language seems to be beyond interpretation. In an accompanying footnote, however, the Court also stated: FN50. We note that in 2001, the Legislature amended NRS Chapter 624 to include the prompt payment provisions contained in NRS through Pay-if-paid provisions entered into subsequent to the Legislature s amendments are enforceable only in limited

3 circumstances and are subject to the restrictions laid out in these sections. Id. at Note 50 (emphasis added). The seemingly contradictory language in the Bovis decision s main text and its footnote has left the door open for some alternative interpretations. Simplest Interpretation of the Bovis Decision Most of the confusion surrounding the Court s decision in Bovis appears to stem from the Court s failure to distinguish between pay-if-paid and pay-when-paid provisions. In Bovis, the Court refered only to pay-if-paid clauses. In the body of the decision, the Court states that such provisions are unenforceable, while in the subsequent footnote, the Court stated that such provisions are enforceable only in limited circumstances and are subject to the restrictions laid out in [Nevada s Prompt Payment Act]. This apparent inconsistency can be easily reconciled by interpreting the Court s statement in the body of the decision as referring only to pay-if-paid provisions, and the Court s statement in the footnote as referring only to pay-when-paid provisions. Under this interpretation, the Bovis decision stands for the proposition that pay-if-paid provisions are absolutely barred as against public policy, while pay-when-paid provisions may be enforceable in very limited circumstances (i.e., if they comply with the requirements of Nevada s Prompt Payment Act, NRS , and Mechanic s Lien statute, NRS 108). Of course, the restrictions and guidelines governing the timing of payment from a GC to a Sub are strictly spelled out in these statutes, and it would be very difficult to draft a true pay-when-paid provision that allowed for anything more or less than what is set forth in the statutes. Perhaps the best approach for drafters of Nevada contracts is to include a payment provision that simply requires payment in accordance with the Nevada Prompt Payment Act. This seems to be the interpretation, however, held by the majority of Nevada practitioners. Some Nevada lawyers have used an alternative interpretation of the Bovis decision to argue that pay-if-paid provisions remain enforceable in Nevada. Alternative Interpretation of the Bovis Decision Based on the apparent wording discrepancy in the Bovis decision, as well as the somewhat ambiguous wording of Nevada Prompt Payment Act, the argument has been made by at least one Nevada attorney that Bovis did not, in fact, declare pay-if-paid provisions unenforceable. See Leon F. Mead II, Nevada Construction Law, 4:14 (West 2009). This alternative interpretation presumes that the Supreme Court intentionally failed to distinguish between pay-if-paid and pay-when-paid clauses, and intended, to hold that pay-if-paid provisions remain enforceable in Nevada if carefully drafted. First, this alternative argument suggests that a cleverly written pay-if-paid provision

4 could postpone payment to a Sub without necessarily waiving the Sub s statutory mechanic s lien rights, and argues for a case-by-case evaluation of each pay-if-paid clause (similar to the Bovis Court s simultaneous decision regarding lien waiver clauses). It is not clear exactly how such a provision would have to be written, but it seems clear that it could not allow for even the potential of indefinite postponement of payment to the Sub this was precisely the Bovis Court s justification for declaring the particular pay-ifpaid clause at issue, as well as the particular mechanic s lien waiver clause at issue, unenforceable (i.e., under the mechanic s lien statute, if payment never becomes due to the Sub then arguably, the Sub could not file a mechanic s lien against the property). The second main substantive argument supporting this alternative interpretation is that the Nevada Prompt Payment Act expressly references pay-if-paid and pay-when-paid clauses, and provides specific notice and timing requirements for a contractor that stops work in response to non-payment specifically pursuant to such a provision. The Act states in pertinent part: 1. If: (b) A higher-tiered contractor fails to pay the lower-tiered subcontractor within 45 days after the 25th day of the month in which the lower-tiered subcontractor submits a request for payment, even if the higher-tiered contractor has not been paid and the agreement contains a provision which requires the higher-tiered contractor to pay the lower-tiered subcontractor only if or when the higher-tiered contractor is paid; the lower-tiered subcontractor may stop work under the agreement until payment is received if the lower-tiered subcontractor gives written notice to the higher-tiered contractor at least 10 days before stopping work. NRS (1)(b) (emphasis added). The argument that follows is essentially that because the Prompt Payment Act provides a different waiting period for a contractor to stop work when payment is withheld pursuant to a pay-if-paid clause (45 days after the 25 th day of the month during which work was performed, as opposed to the typical day waiting periods set forth under NRS ), the Nevada Legislature must have intended that pay-if-paid clauses remain enforceable. Beyond that, the Prompt Payment Act arguably only gives a contractor the right to stop work and not necessarily any direct affirmative cause of action for payment (the argument being that if withholding payment under a pay-if-paid clause was a breach of contract then the Prompt Payment Act would have specified an immediate cause of action for payment as opposed to simply stopping work). Obviously, the Nevada Legislature s provision of at least one remedy for certain conduct is not necessarily the same as condoning that conduct or excluding other available remedies. The wording of the Prompt Payment Act, however, has left the door open for these arguments. Conclusion

5 The simplest interpretation of the Bovis decision is that pay-if-paid clauses are unenforceable, but pay-if-paid clauses may be enforceable, but only if strictly consistent with Nevada s Prompt Payment Act and Mechanic s Lien Statute. The wording discrepancies in the Bovis decision and the Nevada statutes have left the door open for the alternative argument that pay-if-paid provisions remain enforceable in Nevada. These alternative arguments will likely justify further court consideration and clarification in the future. * Watt, Tieder, Hoffar & Fitzgerald, L.L.P Greensboro Drive, Suite 100 McLean Virginia