Kentucky Supreme Court Holds “Pay-if-Paid” Provision in Subcontract Is Valid and Enforceable, Shifting Risk to Subcontractor

Superior Steel, Inv. v. Ascent at Roebling’s Bridge, LLC, 2017 Ky. LEXIS 511 (December 14, 2017)

Corporex Development and Construction Management, LLC (“Corporex”), a design builder, contracted with Dugan & Meyers Construction Company (“D&M”), a construction manager and general contractor on the Ascent at Roebling’s Bridge (the “Project”), a 21-floor luxury condominium in Covington, Kentucky.

As a cost saving measure, D&M asked Superior Steel, Inc. (“Superior”) to fabricate the steel and to have Ben Hur Construction Company (“Ben Hur”) complete the erection and installation work.  Superior and D&M entered into a fixed price contract for $1,814,000.  In turn, Superior subcontracted with Ben Hur to erect the steel and metal decking for $444,000.  As structured, the payments would flow from Corporex to D&M to Superior.  Superior would then pay Ben Hur.

During the course of the Project, D&M instructed both Superior and Ben Hur to perform extra work.  Ben Hur and Superior submitted work orders to D&M who in turn submitted work orders to Corporex.  Ultimately, Corporex refused to pay for Superior and Ben Hur’s additional work and refused to pay Superior’s retainage.

Superior and Ben Hur filed a complaint against Corporex and D&M for breach of contract, among other claims, in order to recover monies owed.  The trial court held that a contract existed between Superior and D&M and that an implied contract existed between Ben Hur and D&M, as a matter of law.  The trial court entered judgment in favor of Superior for $124,017.26 for extra work performed and $195,143.40 for unpaid retainage.  Additionally, the trial court entered judgment in favor of Ben Hur for $284,295.53 for extra work performed.

The Court of Appeals vacated the trial court judgment, reasoning that the jury should have been explicitly instructed as to the “pay-if-paid” provisions in the Superior/D&M contract.  Such provisions essentially mandated that Superior was entitled to payment from D&M only if D&M received payment from Corporex.  The Kentucky Supreme Court agreed with the Court of Appeals on this issue.

At the center of Superior and Ben Hur’s breach of contract claims, was the “pay-if-paid” provisions which condition D&M’s payment of Superior on D&M having first been paid by Corporex.  “Pay-if-paid” conditions shift the risk of nonpayment from the contractor to the subcontractor.  The Superior/D&M contract contains two sections with pay-if-paid language.  First, Article 7.11 “Claims Payment,” states:

[n]o additional compensation shall be paid by the Contractor to the Subcontractor for any claim arising out of the performance of this Subcontract, unless the Contractor has collected corresponding additional compensation from the owner, or other party involved, or unless by written agreement from the Contractor to the Subcontractor prior to the execution of the Work performed under said claim, which agreement and work order must be signed by an officer of the Contractor.

Second, Article 8.2.4, “Time of Payment” states:

[r]eceipt of payment by the Contractor from the Owner for the Subcontractor Work is a condition precedent to payment by the Contractor to Subcontractor.  The subcontractor hereby acknowledges that it relied on the credit of the Owner, not the Contractor for payment of the Subcontract Work.

The Supreme Court held that these provisions unambiguously created a condition precedent that D&M must receive payment prior to its obligation to pay Superior.  Therefore, the provisions unequivocally allocated the risk of nonpayment by Corporex to Superior and relieved D&M of its obligation to pay Superior unless and until it received payment from Corporex.  As it was undisputed that Corporex never paid D&M, D&M was not obligated to pay Superior under the contract terms.  The Supreme Court held the “pay-if-paid” provisions were consistent with public policy because Kentucky has long respected freedom of contract and allowed the parties to allocate foreseeable risk among themselves.  Furthermore, the Supreme Court refused to invalidate such a policy without clear direction from the Legislature.

Thus, because the Supreme Court held that the “pay-if-paid” provisions were valid and enforceable, those provisions precluded judgment in favor of Superior against D&M.  Nevertheless, the Supreme Court also held that Superior and Ben Hur, which had obtained a judgment for unjust enrichment against Corporex for the extra work claims, could sustain that judgment.

To view the full text of the court’s decision, courtesy of Lexis®, click here.

Michelle Beth Rosenberg

 

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