Contingent-Pay Clauses in Texas: What Does the Future Hold?

By Joe Dirik

The Texas Legislature will likely attempt to limit the enforceability of contingent-pay clauses during this year's session.

Subcontracts containing "pay-if-paid" (also known as contingent pay) or "pay-when-paid" payment provisions usually receive a lot of attention during contract negotiations. Under both types of provisions, general contractors attempt to shift risk for non-payment by the owner to the subcontractor. The terms, however, are not interchangeable. After unsuccessful attempts in the past, the Texas Legislature will probably try again this year to limit the enforceability of contingent-pay clauses.

A typical pay-when-paid clause might read: "Contractor shall pay subcontractor within seven days of contractor's receipt of payment from owner." Some readers might believe this clause relieves the general contractor's payment obligation if the owner never pays. Texas courts, however, would probably disagree. Several Texas appellate courts have held that similar clauses simply mean that the contractor's obligation to pay is suspended for a reasonable time, but not excused. A pay-when-paid clause, therefore, only addresses timing of the payment. Such clauses do not create a condition precedent to the contractor's payment obligation. Pay-when-paid clauses generally do not shift the risk of nonpayment to the subcontractor; they only delay payment for a reasonable time.

A pay-if-paid, or contingent pay, clause might read: "Contractor's receipt of payment from the owner is a condition precedent to contractor's obligation to make payment to the subcontractor; the subcontractor expressly assumes the risk of the owner's non-payment and the subcontractor's price includes the risk." The difference between these two examples turns on the intent of the parties. In the second example, the words clearly shift the risk of nonpayment to the subcontractor. In the first example, such intent is only implied. Because Texas law disfavors contract interpretations that lead to forfeiture, only clauses that very clearly and expressly shift the risk for nonpayment will be upheld.

Subcontracting groups in Texas generally oppose contingent-pay clauses. In 2003 the Texas Construction Association, a subcontractor and supplier trade association, supported legislation filed as HB 541 by Rep. Warren Chisum, R-Pampa, and SB 256 by Senator Chris Harris, R-Arlington, that sought to limit the enforceability of contingent-pay clauses. The unsuccessful Senate bill would have:

• prohibited a contractor from enforcing a contingent-payment clause to the point of nonpayment by reason of an individual other than the subcontractor claiming payment
• prohibited a contractor or its surety from enforcing a contingent-payment clause, for work performed or materials delivered, past the fifth day after the receipt of a letter objecting to nonpayment
• required submission of a written request for payment as a prerequisite for accrual of unpaid indebtedness
• prohibited using a contingent-payment clause as the basis for invalidating the enforceability or perfection of a mechanic's lien under Chapter 53, Property Code
• prohibited a contractor or its surety from enforcing a contingent-payment clause if doing so would be unconscionable
• established that a contractor, who has not initiated legal proceedings against the owner for failure to pay, acted reasonably if a reasonable business person would consider such legal proceedings futile or cost prohibitive
• established that the assertion of a contingent-payment clause is a justifiable defense to a civil action for payment under contract and that the burden of proof falls to the defendant
• exempted from this section a provision addressing timing of payment for certain services if the timing is reasonable
• prohibited waiving this section by any means and providing that a purported waiver is void.

The Associated General Contractors-Texas Building Branch supported the legislation after reaching a compromise with the TCA. Strong opposition from the AGC-Texas Highway/Heavy Branch and others was enough to short circuit the proposed legislation.

The issue will likely come before the Legislature again this year. It will be interesting to see if the general contractor groups who supported the compromise bill will support similar legislation again. All concerned should study this important issue carefully and let your senator and representative know where you stand.