Pay-if-Pay Clauses May Be Eliminated in Virginia

Pay-if-pay clauses may be eliminated soon in public and private construction contracts in Virginia. The Virginia General Assembly has approved a new law known as Senate Bill 550 that would make a general contractor individually liable for the entire amount owed to any subcontractor.

Payment by the owner shall not be a condition precedent to payment to any lower-tier subcontractor. A condition precedent pay-if-pay clause will be unenforceable. A general contractor can still back charge a subcontractor for noncompliance with the terms of the subcontract. However, the contractor must notify the subcontractor in writing of the intent to withhold and the reason for withholding payment.

This new law eliminating condition precedent pay-if-pay clauses will apply to "every agency of local government that acquires goods or services, or conducts any other type of contractual business with a nongovernmental, privately owned enterprise." This seems to include not only public construction contracts, but also other types of public procurement.

This new law will certainly be welcomed by subcontractors in Virginia. However, this will add considerable risk and administrative expense to general contractors. All parties and especially general contractors will need to police payments more carefully. Virginia has historically been a "Freedom of Contract" state.

For years, most general contractors have passed much of the risk of owner insolvency down to subcontractors, while general contractors were still exposed to a substantial part of the risk. As you know, construction contracts can involve many millions of dollars. An owner insolvency on one major project can now put even a strong general contractor out of business.

It is not clear whether the proposed new law operates retroactively. The portion of the law stating that "Any contract awarded by any state agency, or any contract awarded by any agency of local government . . . shall include" a payment clause that obligates a contractor to be individually liable seems to operate only prospectively.

However, the portion stating that payment to the contractor shall not be a condition precedent to payment to any lower-tier subcontractor and that "any provision in a contract contrary to this section shall be unenforceable" sounds like it would apply to any now existing contract. Pay-if-pay provisions that are now in existing subcontracts may be unenforceable. It is also not clear whether this law applies to sub-subcontracts between first-tier subcontractors and lower-tier subcontractors.

The Virginia Public Procurement Act has contained prompt pay provisions for some time. Any contract awarded by any state agency must include a payment clause that obligates the general contractor to do one of two things within seven days after receipt of payment from the state agency:

a.   Pay subcontractors for the proportionate share of the total payment received from the agency attributable to the work performed by the subcontractor under that contract; or
b.   Notify the agency and subcontractor, in writing, of his intention to withhold all or a part of the subcontractor's payment, with the reason for nonpayment.

Any contract awarded by any state agency must include an interest clause that obligates the general contractor to pay interest at the rate of one percent per month to subcontractors on all amounts that remain unpaid seven days after receipt of payment from the state agency, except for amounts legitimately withheld. A general contractor must include in each subcontract a provision requiring each subcontractor to include the same payment and interest requirements in all lower-tier subcontracts.

The proposed new law extends these prompts pay provisions to private construction contracts. In addition, unlike public contracts, a payment clause must be included in any private general contract that (i) requires the owner to pay the general contractor within 45 days of receipt of an invoice after satisfactory completion and (ii) requires a higher-tier contractor to pay a lower-tier subcontractor within 45 days of satisfactory completion of the work or within seven days after receipt of payment from the owner, whichever is earlier.

Similarly, private subcontracts "shall be deemed to include" provisions that make any higher-tier contractor individually liable to any lower-tier subcontractor for performance of the subcontract. Private subcontracts must require a higher-tier contractor to pay a lower-tier subcontractor within 45 days of receipt of an invoice after satisfactory completion or within seven days after receipt of payment from the owner, whichever is earlier. All of these provisions concerning private construction contracts more clearly apply to sub-subcontracts between first-tier subcontractors and lower-tier subcontractors.

The Governor of Virginia has until April 11, 2022 to sign or veto the new law. Check the status and see the legislative history at https://lis.virginia.gov/cgi-bin/legp604.exe?221+sum+SB550.

Readers are welcome to reprint or republish this article with the following attribution: © (2009, 2022) James D. Fullerton, Fullerton & Knowles, P.C. Clifton, VA (703) 818-2600, www.FullertonLaw.com; to learn more about Fullerton & Knowles, P.C.'s Construction Law Survival Manual, visit here.

-Jim Fullerton, Fullerton & Knowles, P.C.