Construction Contingent Payment Act–The Legislature’s Modifications to the Rules of the Game

Contingent payment clauses (also known as "pay when paid" or "pay if paid" clauses) have long been a tool used by contractors to shift the risk of nonpayment. In short, the payor's payment to the payee is contingent on the payor itself being paid by another party (usually the owner). Under these clauses, if the payor is not paid, it has no obligation to make payments to the payees (subcontractors). These clauses effectively shift the risk of nonpayment from the general contractor to the subcontractor (or from subcontractor to sub-subcontractor).

For more on crafting enforceable contingent payment clauses, see my previous blog article.

In 2007, the Texas Legislature stepped in and placed some additional rules on these clauses through Section 35.521 of the Texas Business & Commerce Code (you can read about the Legislature’s labor here, or you can just see the "baby" here--to borrow a line from Bill Parcels). In a nutshell, the Act established certain situations where a contingent pay clause cannot be used as a defense for not paying subcontractors. A payor may NOT avoid payment in the following situations:

• When the owner’s nonpayment to the GC is the result of the GC not meeting its own obligations, unless the non payment is the result of the subcontractor’s failure to meet its requirements.
  
• When the owner fails to pay the GC because of the work of another subcontractor, the contingent pay clause is not effective as to the innocent subcontractor.
  
• When, after a subcontractor has not been paid for past work, it gives notice to the GC objecting to the further enforceability of the contingent pay clause, the GC may not then enforce the clause on work or materials provided after the notice.
  
• When the owner and GC are essentially the same.
  
• When enforcement of the clause would be "unconscionable."
  
• A contingent pay clause may not be used as a basis for invalidation of the enforceability or perfection of an otherwise valid lien.

The requirements of the Act cannot be waived. However, the Act does allow for the assertion of a contingent pay clause as an affirmative defense to a lawsuit for payment under a contract. Finally, the Act does not apply to design services, civil engineering construction (roads, utilities, water supply projects, etc.), and most residential construction.

What is the lesson to be learned from this statute? First, good faith is generally required on the part of the general contractor to avoid one of the exceptions to enforceability of an otherwise valid contingent pay clause. Second, it is evidence that the Legislature has made increased efforts to protect subcontractors from heavy handed contractual provisions. A contingent pay bill was first introduced (unsuccessfully) in the 2003 Legislative session. Four years later, in 2007, the current version was passed. It will be interesting to see if this year’s legislative session results in any new measures.