‘Pay when paid’ clauses • Legal Desk, April 2019
April 12, 2019 - Given recent changes to Ontario’s Construction Act and a series of decisions across Canada involving ‘pay when paid’ clauses, this column will try to provide a dashboard of how such clauses are being interpreted in various jurisdictions.
This type of clause—sometimes characterized as a ‘paid if paid’ clause—typically manifests itself in the contract between (a) a general contractor or construction manager and (b) a subcontractor or trade contractor. In very general terms, it means the subcontractor is not entitled to payment until the general contractor or construction manager is paid by the customer. It is, in a sense, a condition-precedent clause.
For further context on the status of ‘pay when paid’ clauses in Canada, consider the following three recent legal decisions:
In 2013, A&B Mechanical, a subcontractor, sued Canotech Consultants, a general contractor, for monies owing on a project and brought a motion for summary judgment.
The trial court awarded the summary judgment on the basis that the ‘pay when paid’ clause was more logically interpreted as a timing mechanism for payment to A&B, rather than as a condition precedent to payment. The decision was upheld on appeal in 2014, generally applying the reasoning that, in accepting such a clause, the intentions of the subcontractor could not be interpreted as agreeing to never be paid for the work it had performed.
This reasoning has gained traction in other jurisdictions, as well, with the interpretation of the clause going straight to the intention of the parties. It would be very difficult to understand why any subcontractor would accept the full-blown risk of performing work without payment.
EOS Pipeline & Facilities sued Sprague Rosser Contracting and brought a motion for summary judgment in 2016. The Court of Queen’s Bench of Alberta granted this judgment to EOS, despite an argument by Sprague-Rosser that the ‘pay when paid’ clause in the subcontract relieved it of its obligation to pay EOS.
Similar to the approach in Manitoba, the court found the clause was not a condition precedent to payment, but rather dealt with timing of payment; it did not affect entitlement to payment.
This rationale carries more weight when the clause is not sufficiently clear in the complete allocation of risk to the subcontractor. It is worth noting the wording in ‘pay when paid’ clauses can vary widely and there is no single, particular rule for interpreting the intentions of the parties.
In 1988, the Ontario Court of Appeal decision in Timbro Developments v Grimsby Diesel Motors held that agreeing to a ‘pay when paid’ clause did in fact mean a subcontractor assumed the risk of non-payment. Today, it could be argued the law has shifted somewhat, thanks to a 2016 Ontario Divisional Court decision.
In this case, a subcontractor made a claim against Bluelime Enterprises for monies owing. The divisional court upheld a trial judge’s finding that a contractor has a duty of good faith, when relying on a ‘pay when paid’ clause, to make its ‘best efforts’ to seek payment from a customer. And indeed, the court held Bluelime had fulfilled this duty by making many attempts to get an explanation from the customer, Alberta Justice, for the non-payment (which followed a termination of the subcontractor’s services after discovering the latter had failed to disclose insider trading convictions against its principal).
This case is notable for confirming the duty and obligation of a general contractor relying on a ‘pay when paid’ clause to pursue the monies owed on behalf of the subcontractor. Clearly and simply drafted clauses have remained enforceable in Ontario.
This brings to the aforementioned changes to Ontario’s Construction Act, which include ‘prompt payment’ provisions that will come into force on Oct. 1, 2019. They essentially represent a statutory ‘pay when paid’ regime, reflecting earlier case law to some degree.
Under the new rules, if there is non-payment by the owner to the general contractor, then a notice must be provided to the general contractor within 14 days of that contractor’s proper invoice; and a similar notice must be provided to the subcontractor, along with an undertaking from the general contractor to commence an adjudication process (and potentially other proceedings) to pursue the monies owing—i.e. the ‘best efforts’ duty.
Given the diverse interpretations across Canada, for ‘pay when paid’ clauses to be legally enforceable, an unequivocal acknowledgment of the risk of non-payment is likely required by the subcontractor.
This column originally appeared in the April 2019 issue of Electrical Business magazine.