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Subcontractors BEWARE – Ohio Supreme Court endorses “Pay-if-Paid” Clauses

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It was a long standing principle of construction law in Ohio that between an owner, a contractor and subcontractors, the contractor was in the best position to gauge the economic strength of the owner and thus bore the burden if the owner went insolvent and could not fulfill its obligations under a construction contract.  Further, because subcontractors often have no direct relationship or contractual agreement with the owner (called “privity”), and perform services at the request of and through the contractor, the subs have no remedy against an owner for nonpayment.

Then comes the July 17, 2014 case of Transtar Electric, Inc. v. A.E.M. Electric Services Corp., which turned all of this on its ear.  In Transtar, A.E.M. was subcontracted by Transtar to install electrical systems in a pool under construction for a Holiday Inn.  The owner of the hotel went insolvent, and the contractor, Transtar, refused to pay A.E.M. the final $44,000.00 of services that had been billed under the subcontract agreement between A.E.M. and Transtar (A.E.M. had been previously paid $142,000.00 for work performed prior to the owner’s insolvency).

At issue was whether or not Transtar could pass on to A.E.M. the risk of nonpayment by the owner.  Previously under Ohio law, payment terms of a construction contract would not transfer such a risk unless the terms expressly provided so.  For instance, prior language that was found to properly transfer the risk stated “the subcontractor expressly assumes the risk of the owner’s nonpayment and the subcontract price includes that risk.”  Standard language such as “the contractor first receives payment for the subcontractor’s work before payment to the subcontractor” was previously found to be ineffective to transfer the risk of payment to the subcontractor.

The Court of Appeals had recognized that many states had found such provisions to be void as against public policy and either eliminated the practice by legislation (Illinois, Maryland and Missouri), or court order (New York and California).

However, in the Transtar case, the Ohio Supreme Court found that because the payment terms included the words “condition precedent” to the “first receives payment” language is now sufficient to evince an intent between the parties for the risk of nonpayment to be transferred to the subcontractor.

PRACTICAL POINTERDo NOT rely upon “common practice” or prior relationships!  The business world is an unfair place.  Carefully read any written agreement with particular scrutiny on payment terms.  Certainly take notice of anything using the words “condition precedent.”  Of course, it makes greater sense to have any contract reviewed by legal counsel.  A few dollars spent beforehand is money well invested to avoid a huge financial mistake later on down the road.

With offices in Chardon and Cleveland, the business services attorneys at Thrasher, Dinsmore & Dolan are fully capable of performing professional, thorough and cost effective review of construction and other business contracts.  Please call John Liber or Ezio Listati at 440.285.2242, 216.255.5431, or e-mail: jliber@tddlaw.com, elistati@tddlaw.com.