What’s on their Minds: Pay-if-Paid or Pay-When-Paid? Transtar Electric, Inc. v. A.E.M. Electric Services Corp.

Update: On July 17, 2014, the Supreme Court of Ohio handed down a merit decision in this case.  Read the analysis of that decision here.

On November 5, 2013, the Supreme Court of Ohio heard oral argument in the case of Transtar Electric, Inc. v. A.E.M. Electric Services Corp., 2013-0148.  At issue in this case is the language necessary to transfer the risk of nonpayment by the owner on a construction project from the general contractor to a subcontractor.

Case Background

A.E.M was the general contractor on the construction of a swimming pool at a Holiday Inn in Maumee, Ohio. A.E.M. entered into a subcontract with Transtar Electric, Inc. (Transtar) to perform certain electrical work on the project. Transtar performed work pursuant to the contract totaling $186,709.  A.E.M. made payments to Transtar in the amount of $142,620.  A.E.M. did not pay Transtar the remaining balance of $44,088 because it contended the owner failed to pay it for Transtar’s work.

Section 4 of the subcontracting agreement includes this provision, which was in bold and in capital letters: “Receipt of payment by contractor from the owner for work performed by subcontractor is a condition precedent to payment by contractor to subcontractor for that work.”

The parties filed cross-motions for summary judgment. The trial court granted A.E.M.’s motion for summary judgment, concluding that Section 4 was a “pay-if-paid” provision (as opposed to pay-when-paid) that evidenced the parties’ intent to transfer risk of nonpayment from the owner from A.E.M. to Transtar.  Therefore, because A.E.M. wasn’t paid by the owner, A.E.M. was not contractually obligated to pay Transtar for its unpaid work.

The Sixth District Court of Appeals reversed the trial court’s decision, finding that the language was insufficiently clear and unambiguous to indicate the parties’ intent to transfer risk of the owner’s nonpayment. The appeals court held as a matter of law that the contested language must be interpreted as a pay-when-paid provision, and that summary judgment should have been granted to Transtar.   It remanded the case for the determination of what a reasonable time for payment should be. Read the oral argument preview of this case here.

At Oral Argument

A.E.M.’s Argument

The reason A.E.M. did not pay Transtar the $44,000 here at issue is that the owner did not pay A.E.M. The basis for this nonpayment was the contract provision-in bold and in capital letters– clearly and unambiguously transferring the risk of nonpayment to the subcontractor. It was clearly a pay-if-paid clause. The court of appeals decision must be reversed because it incorrectly determined that this is a pay-when-paid provision. That contract language creates a condition precedent to payment that was not met.  This is common in the industry.  It may not be clear to a lay person, but the parties to the contract were sophisticated business people, familiar with industry custom. This was a bargained-for exchange. It isn’t a new concept—it is boilerplate.  If the subcontractor didn’t like it, it should have crossed it out.

There were other ways the subcontractor could have collected what was due from the owner, such as filing an action for unjust enrichment, or filing a lien, which is statutorily permitted despite pay-if-paid language in a contract. The only public policy involved in this situation is the freedom to contract, and that clear and unambiguous language should be enforced. The burden was on Transtar here to prove any breach of contract, and it failed to do so. It could have raised the issue of a failure by A.E.M. to make a good faith collection effort (which A.E.M. denies), but it didn’t.

Transtar’s Argument

The industry interpretation of a clause like the one at issue here is pay-when-paid. No subcontractor would sign a contract intending not to be paid. This contract fails for the most fundamental of reasons-there was no meeting of the minds about the allocation of risk. It is an affirmative defense to nonpayment to prove there was a meeting of the minds, and A.E.M. failed to meet that burden. It never put on the record why it couldn’t meet its obligation. There are always two factual issues with such clauses:  what was the exact risk intended to be shifted and what were the operative facts that led to the non-payment? General contractors want these boilerplate provisions in contracts so they can just walk away if the owner doesn’t pay. General contractors don’t sue owners because they want more work. That is totally unfair to the subs, who have no control over any of this.

The subcontract also says if the sub isn’t paid, A.E.M will pursue the owner or at its option or allow Transtar to do so in its own name, but it did neither-it barred Transtar from seeking a remedy, which is why there is a constitutional issue here. A.E.M. did nothing in this case to collect, but the owner was not insolvent, because Transtar had collected from it in another matter. Furthermore, if A.E.M. is culpable here, this contract is unenforceable under R.C. 2305.31.

What Was on Their Minds

The Industry Standard

What is it, and how do we know what it is, asked Justice Pfeifer? How are judges who don’t know about this kind of work to know this? He commented that the subject was new to him and he thought the contract language was clear when he read it, until he learned from the appellate decision that pay-if-paid language is not encouraged. When counsel for Transtar commented that the language had to be interpreted as pay-when-paid because no subcontractor would sign a subcontract not intending to be paid, Pfeifer commented that no general contractor signs a contract not intending to pay people either.

What is the industry understanding of the contract language here, asked Justice O’Donnell?

The Disputed Contract Language

Does putting the language in bold suffice to put the subcontractor on notice that there has been a shift in the allocation of risk, asked Chief Justice O’Connor? The Chief asked a lot of detailed questions during this argument. Was this type of clause well known in the industry? Wasn’t it inserted by agreement of the parties? Wasn’t the language perfectly clear? Is it important that there was no specific time incorporated into the disputed clause? Was this the first time the subcontractor had ever seen such language? (answer: no, it sees this all the time.)

Is there some other boilerplate language that would add additional language about shifting the risk of loss, asked Justice Lanzinger? Doesn’t  the fact that the language is in bold and in capital letters tell everyone that this is very important, pay attention to this part of the contract? Was this the only part of the contract at issue?

What is wrong with using plain English-if I don’t get paid, you don’t either, asked Justice O’Neill?

Who drafted the contract language, asked Justice O’Donnell?

Policy Implications to Pay-if-Paid

So, the effect would be, the General Contractor owes the sub nothing even though it did all the work at the GC’s behest, asked Justice O’Neill? Is the sub working for the owner, or for the General Contractor?

Does case law or public policy either favor or disfavor pay-if-paid clauses, asked Justice O’Donnell?

Was Transtar saying there can never be a pay-if-paid contact under Ohio law, asked Justice Lanzinger? (answer: not quite)

Pay-When-Paid Language

If the disputed language works for pay-if-paid, what language would work for pay-when-paid, with no shift of the risk of non-payment, asked Chief Justice O’Connor?

If this is a pay-when-paid contract, when is the money due, asked Justice O’Neill?

Procedural Posture
Is there a factual dispute here, asked Justice French? Should the Court reverse and remand? But didn’t Transtar also ask for summary judgment at trial, arguing there were no facts in dispute?

If the Court agrees with Transtar, wouldn’t the Court just affirm the appeals court, asked Justice Pfeifer?

Why is Transtar saying procedurally, please affirm, but keeps insisting operative facts have never been developed, asked Chief Justice O’Connor? Does Transtar want this sent back for a determination of the operative facts? What exactly does it want?

Later the Chief asked counsel for A.E.M. whether, even if there was a meeting of the minds and the risk was transferred, there weren’t still operative facts that could defeat that clause if the general contractor failed to pursue the owner?  Even if the Court were to accept the characterization of the clause as pay-if-paid, isn’t further inquiry necessary at the trial court level as to the good or bad faith of A.E.M. in trying to collect here? (answer: no, because Transtar never raised lack of good faith at the trial court level.  If the Court agrees this is a valid pay-if-paid clause, judgment must be entered for A.E.M.)

Remedies for the Unpaid Subcontractor

Is the reason pay-if-paid provisions are disfavored that the sub would have no ability to collect the unpaid amount because the subcontractor is not in privity with the owner, asked Justice Pfeifer? (the parties sharply disagreed on available remedies for the unpaid sub)

Can Transtar proceed against the owner here if A.E.M. does not, asked Chief Justice O’Connor? Should there have been such a provision in this contract, allowing the sub to stand in the shoes of the general contractor? Was there a surety bond here to let the sub go against the general contractor? (answer: no)

Hasn’t the appeals court already handled the remedy in this case, asked Justice O’Neill? It remanded the case to determine a reasonable time for payment.

Is there any record evidence demonstrating A.E.M.’s culpability in pursuing the owner, asked Justice O’Donnell?

When A.E.M.’s lawyer stated the contactor had submitted an affidavit that it had sought payment from the owner, Chief Justice O’Connor asked how it had done that?

How it Looks from the Bleachers

To Professor Bettman.

Muddled.

When I was on the appeals court, there were times when a subject would come up none of us knew anything about.  This clearly was such a case, as Justice Pfeifer admitted at the outset. When this happens, the lawyers involved—who, as here, are highly expert in the particular area of law—have more of an educational role than they might otherwise.  Here, though, I thought counsel for Transtar muddied more waters than he clarified.

While the issue to be decided in the case is itself is quite simple—was the contact language sufficiently clear to transfer the risk of the owner’s nonpayment from the general contractor to the sub—the case context was not.

Transtar won this case on appeal. The appellate court interpreted the contract language as a pay-when-paid, and not a pay-if-paid provision, and remanded the case solely for a determination of a reasonable time for payment.  And yet, the lawyer for Transtar-a man with an ebullient and freewheeling style-seemed to want some kind of affirmance-plus.  He kept insisting, to the apparent confusion of Justices Pfeifer, French, and the Chief (and to me) that all clauses like the one at issue here require two factual determinations—what was the exact risk intended to be shifted and what were the operative facts that led to the non-payment. So he kept insisting the case needed to be sent back for a determination of the operative facts—even though the case was submitted on cross-motions for summary judgment, and his side won on appeal.  Transtar did take this position before the Sixth District Court of Appeals  (and to some extent at the Supreme Court in its proposed counter-proposition of law).  Its second assignment of error in the court of appeals was that  “the trial court erred when granting summary judgment without a fact determination as to the basis for the owner’s non-payment and A.E.M.’s culpability, rendering the subcontract void as without consideration, and leaving  Transtar without a remedy. ” But the appeals court found this assignment of error moot, it light of its finding as a matter of law that the contract was a pay-when-paid contract.

I think the appeals court decision is going to get reversed, but I don’t think  that will necessarily mean a win for A.E.M, although I think there are some justices, (Justice Lanzinger in particular) who think the contract language did clearly and unambiguously shifted the risk of nonpayment as a matter of law. Justice O’ Neill, on the other hand, clearly did not think so. But I also think the justices grew increasingly concerned over the lack of record evidence of the parties’ intent here, and what A.E.M. did to try and collect. I think a majority seemed to feel a need for further development of this record, including some evidence about the industry standard.  (The Evans case, cited by both sides, does a nice job with this question). I think all the justices are concerned about the policy implications, and do want to know what the industry standard is.

Transtar’s lawyer seemed to be throwing in all kinds of allegations about remedy deprivation that were seemingly unsupported in the record.

To Student Contributor Katlin Rust

This was quite a bare record – no hearing, just motions and affidavits.  Although a few Justices thought the language was clear and unambiguous, I don’t expect that to be the majority determination. The Court really didn’t have a lot to go on, which obviously concerned a few Justices. No one knew what the industry standard was, who wrote the contact, or what efforts A.E.M took to recover from the owner. I expect the court of appeals to be reversed and the case be remanded for development of the record.  With more information, the court can get to the first of Transtar’s purported questions – was there a meeting of the minds to shift the risk of loss.

 

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