Second Circuit Holds That Pay-When-Paid Clause Violates Public Policy Expressed in New York Lien Law

West-Fair Elec. Contractors v. Aetna Casualty & Surety Co.,
78 F.3d 61, 1996 U.S. App. LEXIS 3912 (2d Cir. March 6, 1996).

Neither general contractor nor surety could assert pay-when-paid clause as defense to payment claim by subcontractor because clause, which operated as a condition precedent to payment, constituted a prospective waiver of lien rights and therefore violated New York Lien Law. 

Defendant Gilbane Construction Co. (“General Contractor”) was the general contractor on a construction project in White Plains, NY. General Contractor hired plaintiff L.J. Coppola, Inc. (“Subcontractor”) to perform a portion of the work. General Contractor maintained a payment bond with defendant Aetna Casualty and Surety Co. (“Surety”) for the benefit of all its subcontractors.

The contract between General Contractor and Subcontractor contained a “pay-when-paid” clause which provided:

It is specifically understood and agreed that the payment to the trade contractor is dependent, as a condition precedent, upon the construction manager receiving payments, including retainer from the owner.

When owner became insolvent and did not pay General Contractor, Surety and General Contractor relied on this provision in defending against Subcontractor’s suit for payment of $220,000 for work performed.

The trial court in the Southern District of New York entered summary judgment in Subcontractor’s favor, finding that the pay-when-paid clause was unenforceable as against public policy. On appeal, the Second Circuit certified to the New York Court of Appeals the question of whether a pay-when-paid clause such as this one, which transfers the risk of an owner’s default from the general contractor to a subcontractor, violates New York public policy.

The New York Court of Appeals answered in the affirmative. It reasoned that when a pay-when-paid clause “operates as a true condition precedent, rather than as a mere schedule for the disbursement of payment,” then the subcontractor’s right to payment does not accrue until the general contractor is paid by the owner. Thus, if the owner never pays, the subcontractor’s right to payment never accrues. Since a subcontractor cannot enforce its lien rights until its right to payment has accrued, a pay-when-paid clause such as the one at issue here in effect constitutes a prospective waiver of a subcontractor’s lien rights in the event that the owner fails to make payment.

The New York Lien Law provides that any contract or agreement that waives a claimant’s right to file or enforce a lien is void as against public policy and is not enforceable. N.Y. Lien Law [[section]] 34 (McKinney 1993). Relying on this statutory provision, the New York Court of Appeals concluded that a pay-when-paid clause that operates as a condition precedent to payment violates New York public policy.

In accordance with the New York Court of Appeals’ decision, the Second Circuit found that neither General Contractor nor Surety could rely on the pay-when-paid clause as a defense to nonpayment, and upheld the grant of summary judgment in favor of Subcontractor.

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