Merit Decision: Condition Precedent Language in a Contract Means Pay-if-Paid. Transtar Elec., Inc. v. A.E.M. Elec. Servs. Corp.

On July 17, 2014, the Supreme Court of Ohio handed down a merit decision in Transtar Elec., Inc. v. A.E.M. Elec. Servs. Corp.,2014-Ohio-3095. In a 5-2 opinion authored by Justice Kennedy, the Court held that a contract for work performed by a subcontractor for a general contractor which contains a provision that payment by the project owner to the general contractor is a condition precedent to payment by the general contractor to the sub is a pay-if-paid provision. Such a provision clearly and unequivocally shows the intent of the parties to transfer the risk of the owner’s nonpayment from the general contractor to the subcontractor.  Justice O’Neill dissented, for himself and Justice Pfeifer.  The case was argued November 5, 2013.

Case Background

A.E.M was the general contractor on the construction of a swimming pool at a Holiday Inn. A.E.M. entered into a subcontract with Transtar to perform electrical work on the project. Transtar fully performed the work under the contract, and was paid $142,620. A.E.M. did not pay Transtar the remaining balance of $44,088 because A.E.M. contended the owner failed to pay it for Transtar’s work.

Section 4 of the subcontracting agreement included 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.”

Procedural Posture

At the trial court level, both parties filed motions for summary judgment. A.E.M. argued that under Section 4 of the contract it had no obligation to pay Transtar until the owner paid it for Transtar’s work.  The trial court agreed and granted summary judgment to A.E.M. The Sixth District Court of Appeals reversed the trial court’s decision, finding the language in the contract not sufficiently clear to transfer the risk of the owner’s nonpayment onto the subcontractor. Thus, the contract language had to be interpreted as a pay-when-paid provision, meaning that as a result A.E.M. was liable to Transtar for the work performed whether or not A.E.M. had been paid by the owner. It remanded the case for further proceedings, including the determination of what a reasonable time for payment should be. Read the oral argument preview of this case here and the analysis of that argument here.

Analysis of Merit Decision

Definitions: Pay-when-Paid versus Pay-if-Paid

The Court explains there are two types of contract provisions between general and subcontractors.  A pay-when-paid provision is one in which a general contractor makes an unconditional promise to pay the subcontractor, within a reasonable period of time to allow the general contractor to be paid.  A pay-when-paid provision is not affected by the owner’s nonpayment.

By contrast, a pay-if-paid provision is a conditional promise to pay that is enforceable only if a condition precedent has occurred.  Under this type of contract, the general contractor is only required to pay the subcontractor if the owner pays the general contractor.  Under a pay-if-paid contract, the risk of the owner’s nonpayment is shifted to the subcontractor.

The issue in the case is which kind of contract provision was this one? Short answer: pay-if-paid.

The Court analyzed language in two federal cases and one case from the Tenth District Court of Appeals (see the oral argument preview for a summary of two of these cases, Thos. A. Dyer Co. v. Bishop Internatl. Eng. Co., 303 F.2d 655 (6th Cir. 1962) and Evans, Mechwart, Hamilton & Tilton, Inc. v. Triad Architects,) and from these concluded that contracts are pay-if-pay if they include language that payment by the owner is a condition precedent to payment by the subcontractor.  Condition precedent language shows that the parties intended that the risk of the owner’s nonpayment shifts from the general contractor to the subcontractor. Additionally, use of the term “condition precedent” clearly expresses the intent to transfer this risk, and no other language in the contract is needed to do so.  Additional redundant language—such as “in agreeing to this condition precedent, subcontractor assumes the risk of owner’s insolvency”– would just add a belt to the suspenders, and is unnecessary.

Application of the Rule to the Contract in this Case

The Court held that Section 4 of the contract between A.E.M. and Transfer is a pay-if-paid provision, and clearly and unequivocally shows that the parties intended to transfer the risk of the owner’s nonpayment from A.E.M. to Transtar.

Conclusion

The court of appeals is reversed and the judgment of the trial court granting summary judgment to A.E.M. is reinstated.

Dissent

Justice O’Neill, joined by Justice Pfeifer in dissent, would find the language in this particular contract inadequate as a matter of law to transfer the risk of nonpayment by the owner from A.E.M. to Transtar.  He would find the ambiguities in the wording create genuine issues of material fact that make summary judgment inappropriate.

O’Neill’s statement that he agrees that the Court of Appeals “got it right in holding that that summary judgment was improper, ” is a bit misleading. Although the court of appeals clearly found summary judgment to be improper, I read the court of appeals decision as finding as a matter of law that this contract was a pay-when-paid contract, remanding it to the trial court to determine a reasonable time for payment from A.E.M. to the Transtar. Justice O’Neill, on the other hand, believes a fact question exists on whether the contract language transfers the risk from A.E.M. to Transtar. So his agreement with the appellate court was only that the language didn’t transfer the risk of nonpayment as a matter of law. Where the appeals court found the language created a pay-when-paid contract as a matter of law, O’Neill would find a fact question existed on the intent of the parties.

Justice O’Neill also finds it fundamentally unfair that Transtar completed all of its work, but cannot sue the project owner for breach of contract because of the lack of privity of contract between them.

“Taken to its logical conclusion, the majority decision implies that the contractor can take its profit from the venture, pull up stakes, and wish the subcontractor well as the subcontractor embarks on the task of wrestling with the owner over money owed on a contract to which the owner is not a party,” he wrote.

Case Syllabus

1. When a contract provides that payment by a project owner to a general contractor for work performed by a subcontractor is a condition precedent to payment by the general contractor to the subcontractor, the provision is a pay-if-paid provision.

2. The use of the term “condition precedent” in the payment provision of a contract between a general contractor and a subcontractor clearly and unequivocally shows the intent of those parties to transfer the risk of the project owner’s nonpayment from the general contractor to the subcontractor.

Concluding Observations

I noted after argument that the issue in the case was really quite simple-namely whether the contract language was sufficiently clear to transfer the risk of the owner’s nonpayment from the general contractor to the sub, but commented that the context was less so.  The lawyer for Transtar-even though he won below-was responsible for a great deal of muddle at oral argument. Even though his side won at the court of appeals level, he kept insisting to the high court that the case needed to be sent back for a determination of the operative facts.

I called this case as a reversal, but wrongly thought it was going to go back for a factual determination. Clearly, it didn’t really need to, and the issue was as simple as it originally appeared, and as A.E.M. argued it was. It was apparent from the questioning that Justice Lanzinger and the Chief found the contract language clearly shifted the risk of owner nonpayment to the sub, and equally clear that Justice O’Neill did not.

While there was some discussion at argument and in the briefs about the public policy implications of pay-if-paid contracts, the majority simply did not go there.

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