How Unfair Contract Clauses Prevent Subcontractors from Getting Paid
By Jonathan Mitz

This article is excerpted from an event at the American Bar Association’s Federal Procurement Institute 2020 Section Meeting.  The event was to be a live panel discussion in Annapolis in March, however, COVID forced it to be a webinar in June. 

In the world of contracting, cash flow is the most important measure of contractor health.   Contractors who perform labor and buy materials are the most vulnerable to cash fluctuations.  Payment delays put more contractors out of business than any other cause. 

In the contracting hierarchy, Owners draft the prime contract. It is full of clear language that requires specific performance for payments to be made.  The next level down is the General Contractor, who drafts the subcontract agreement.  It is full of obvious and subtle language that protects the GC from paying the subcontractor unless the GC has been paid by the Owner.  

On the surface, this seems reasonable.  In practice, most delayed payments are due to disputes or deficiencies between the GC and Owner that don’t involve the subcontractor.  So how does the GC protect its cash flow?  By incorporating contract language that suspends the obligation to pay the subcontractor until the GC has collected the money from the owner.     

Please keep this in mind as we go through a few clauses.  

Condition precedent payment clause.  

Whether we are talking pay-if-paid or pay-when-paid, if the GC’s payment from the Owner is delayed for any reason whatsoever for any length of time, then the GC is not otherwise obligated to pay the subcontractors. While some jurisdictions may have litigated limited exceptions to this blanket clause, the condition precedent method is the normal.  

I’ll give you an example of how this works:  Let’s say we are building a high-rise office building.  The structure and skin are up.  The three major subs now working inside are the drywall, mechanical, and electrical trades. The owner’s inspector discovers that all the windows are installed backwards (this is a true story).  The contracting officer decides to hold $1,000,000 from the next progress payment.  But wait! Those windows were installed months ago and the window sub was paid.  The contracting officer doesn’t care that the window contractor has long since been paid – the problem is the GC’s. The GC now can’t pay the subs who are working, and because of the condition precedent clause the GC doesn’t have to.  Those interior trades must wait until the windows are remedied and the money is released by the contracting officer.  Doesn’t seem fair does it?            

Suspension of bond claims when dispute exists between GC and Owner.

GC’s subcontract agreements typically have a clause that handcuffs the subcontractor from making a claim on the bond while there is a pending dispute between the GC and Owner, even if this dispute does not involve the subcontractor.  Let’s consider the following example: Before final payment is made, let’s say some cracks are observed in the topping slab of a newly constructed pre-cast concrete parking garage.  The owner’s design engineer determines that something is wrong with the concrete installation.  The contracting officer tells the GC that the entire final payment, which includes a whole bunch of change orders that were just settled, is being held to cover the cost of replacing the concrete topping.  The GC objects to replacing the concrete, and proceeds to patch the cracks instead.  

Some of the subcontractors who were anxiously awaiting their final payment, especially that change order money, make a claim on the GC’s bond.  The bonding company says too bad/so sad, the agreement you signed puts your bond rights on hold during a dispute.  

But isn’t the dispute over? Hasn’t the GC patched the concrete? The contracting officer wanted the topping replaced and is not satisfied with the repairs.  The GC then does further repairs.  After eighteen months of repairs and back and forth negotiations, a resolution is finally reached. The contracting officer accepts the repairs, along with a credit from the GC to cover future excess maintenance.  The dispute is now over.  All the subs who are still in business can get paid.    

Waiving all bond rights.

The boilerplate in some subcontracts says that by signing the agreement the subcontractor waives all rights to make claims against the bond.  We all know that the federal government allows subs to waive their bond rights; however, it is a two-step process where the subcontractor must agree to waive those rights a second time when there is an actual payment forthcoming.  In the private world there are states that have codified that such waiver language in subcontracts as void.  So why do subcontractors sign contracts with such language in it?  

Overly broad partial lien waivers

Let’s start with what should be in a lien waiver.  That’s a trick question!  It should just be the subcontractor’s assurance that no liens will be placed on the property.  We all know that you can’t put a lien on government property.  Some GCs require that subcontractors provide a lien waiver when doing federal government work, too.  This waiver really has nothing to do with the property.  It is about all sorts of other money matters.  We see language in lien waivers that waives a subcontractor’s rights to:

• change orders (including settled, unsettled, and unpaid)
• claims (including pending claims)
• work performed since the last billing cycle (that’s right, subs are asked to waive payment of ongoing and unbilled work)
• retention

Subs sign these things all the time, without reading them, so they can just get their money.  As soon as some problem arises and the sub clamors for their money, the GC whips out a stack of signed waivers and tells the sub too bad/so sad.  Subs will not find any judicial relief. The courts routinely side with the plain language of the lien waiver.  

In summary, general contractors write these killer clauses into subcontract agreements to protect their cash flow.  Subcontractors need to read their contract, then negotiate and eliminate the unfair terms. Subcontractors have the leverage to make this happen since general contractors can’t build the project without you.   

Jonathan Mitz is an executive at Ennis Electric in Manassas, VA.  He is a past president of the American Subcontractors Association of Metro Washington and currently is a board member of the National Subcontractors Alliance.  Jonathan’s 40 years of commercial construction experience includes 30 years working for general contractors.