Elimination of Pay if Paid Clauses and Addition of Prompt Pay Provisions in Virginia
Executive Summary
Revisions to Virginia Code §§ 2.2-4354 and 11-4.6 are now effective for construction contracts signed after January 1, 2023. These revisions generally eliminate or prohibit “Pay if Paid” clauses in public and private construction contracts in Virginia and add “Prompt Pay” provisions in private construction contracts. In 2022, the Virginia General Assembly and Governor had passed these revisions and sent them to a Public Body Procurement Workgroup for review. In its recommendations to the General Assembly, the Workgroup did correctly identify ambiguities and inconsistencies.[i] However, there has been no apparent action on these recommendations and the law became effective on January 1, 2023, without revision from its April 27, 2022 version.[ii]
Payment by the owner cannot be a condition precedent to payment to any lower-tier subcontractor, except that a private project general contractor can still have a condition precedent Pay if Paid subcontract clause that is effective in the event the owner is “insolvent or a debtor in bankruptcy.”
“Prompt Pay” provisions are required in private construction contracts that (i) require the owner to pay the general contractor within sixty (60) days of receipt of an invoice after “satisfactory completion” of the work[iii] and (ii) requires a “higher-tier contractor” to pay a “lower-tier subcontractor" within sixty (60) days of satisfactory completion of the work or within seven (7) days after receipt of payment from the owner, whichever is earlier.[iv]
Action Agenda – A Summary of Things You Need to Do Now
There is more detail below, but a summary of actions you may want to take immediately are:
General Contractor Requirements in Contract with Owner
In any construction contract between an owner and a general contractor, the parties shall include a provision that requires the owner to pay such general contractor within sixty (60) days of the receipt of an invoice following satisfactory completion of the portion of the work for which the general contractor has invoiced.[v]
This Prompt Pay provision is now “required” in any private construction general contract. There is no clear penalty to the owner or general contractor if the parties fail to include this provision. It is also not clear whether a court would enforce this provision, even if the parties fail to include it in their contract. In any event, however, any general contractor would want to include this requirement of sixty (60) days Prompt Pay from the owner. An owner would have difficulty objecting, since it is “required” by the Code of Virginia.
A similar Prompt Pay provision has long been “required” in public general contracts.[vi] A public general contractor would also want to make sure this Prompt Pay provision is in a public general contract. However, most public agencies control the contract forms used and their forms developed by their public attorneys comply with the Code of Virginia.
Subcontractor and Lower-Tier Sub-Subcontractor Forms
Any public general contract now “requires” any subcontract to include an affirmative payment obligation from the general contractor and the elimination of any Pay if Paid condition.[vii] Any subcontract must also include the Prompt Pay provisions.[viii] General contractors are advised to include these required subcontract provisions. Curiously, these provisions are not “required” in a private subcontract. Instead, private subcontracts “shall be deemed to include” these provisions. It is probably a good idea to simply include these provisions in any public or private subcontract.
Any public or private subcontract must also require affirmative payment obligations, the elimination of any Pay if Paid conditions, and Prompt Pay provisions in any lower-tier sub-subcontract. [ix] General contractors and subcontractors are advised to include these required provisions in lower-tier subcontracts.
“Higher-tier” contractors are required to pay “lower-tier” subcontractors within sixty (60) days of satisfactory completion of the work or within seven days after receipt of payment, whichever is earlier. General contractors and higher-tier subcontractors want to make sure satisfactory completion is determined by the owner. Beef up completion terms to say “work is not complete until accepted by the owner” and “satisfactory completion” of subcontract work is determined by the owner.
Proper invoicing should also be determined by the owner. General contractors and higher-tier subcontractors do not want to allow invoicing until work is “satisfactorily complete.” Invoices are not proper or approved until the owner approves them. There is no obligation or promise of payment to the lower-tier subcontractor until the work is approved by the owner for invoicing in accordance with the general contract and payment is not due until seven (7) days after receipt of payment from the owner.[x]
In private contracts, nothing in the new law “shall be construed to apply to or prohibit the inclusion of any retainage provisions in a construction contract.”[xi] Owners and general contractors may push to increase retainage percentages or create more conditions precedent to release of retention, including the payment of retainage by the owner.[xii]
All higher-tier contractors need to start policing subs better on their payroll, because all contractors can be liable for the wages and benefits of employees no matter how low the tier of sub-sub. All contractors need to get sworn certifications from lower-tier contractors at each progress payment. You may be able to avoid liability for the wages and benefits of employees if you were relying on affidavits from your subs that the wages and benefits of employees were paid. You always want waiver affidavits at each progress payment regarding payments to sub-subcontractors and material suppliers to avoid mechanic’s liens. It is possible to include certification of payrolls and payment of wages and benefits of employees in the same sworn progress payment affidavits.
In any private subcontract:
. . . . in the event that a contractor withholds all or a part of the amount invoiced by any lower-tier subcontractor under the contract, the contractor shall notify the subcontractor, in writing, of his intention to withhold all or a part of the subcontractor's payment with the reason for nonpayment, specifically identifying the contractual noncompliance, the dollar amount being withheld, and the lower-tier subcontractor responsible for the contractual noncompliance. [xiii]
This notification requirement will give higher-tier contractors a difficult task determining responsibility for defective work. Higher-tier contractors want to severely limit and monitor the ability of subcontractors to further subcontract work. General contractors and higher-tier subcontractors should add and enforce requirements of complete written lists of all sub-subcontractors and material suppliers and prohibiting the supply of any labor or material from unapproved sub-subcontractors and suppliers. This is especially important in light of potential higher-tier contractor liability for the unpaid wages and benefits of the employees of lower-tier subcontractors.[xiv]
Any public general contract must include an interest clause that obligates the higher-tier contractor to pay interest at the rate of one percent (1%) per month, unless the contract “otherwise provides.” Higher-tier contractors may want to “provide otherwise,” by saying “in the event Contractor fails to make payment in accordance with this Subcontract, Contractor agrees to pay interest to Subcontractor in the amount of one tenth of one percent (.1%) per month of any improperly withheld funds from the time they were due until paid or all for a legal rate of interest of six percent (6%). In any event, the statutory rate of one percent (1%) per month, or twelve percent (12%) per year, is above current market rates. However, it may not be possible to avoid the one percent (1%) per month in the subcontract. It may have to be in the general contract.[xv]
Pay if Paid Clauses Generally Unenforceable
The revised § 2.2-4354 states that any state public contract shall include “A payment clause that obligates a contractor on a construction contract to be liable for the entire amount owed to any subcontractor.” A revised § 11-4.6 (C), applicable to private contracts, states that any private subcontract “shall be deemed to include a provision under which any higher-tier contractor is liable to any lower-tier subcontractor.”
A private project general contractor can still enforce a condition precedent Pay if Paid subcontract clause if the owner is “insolvent or a debtor in bankruptcy.” A public project general contractor does not have this same protection. However, there should be less risk of an insolvent or bankrupt state, county, or municipal government owner.
It is not clear why public general contracts must affirmatively include this payment provision, while private general contracts “shall be deemed to include” it. In any event, a condition precedent Pay if Paid clause will generally be unenforceable in private and public subcontracts.
A general contractor can still withhold payment for noncompliance with the terms of the subcontract. The contractor must notify the subcontractor in writing of the intent to withhold and the reason for withholding payment. However, the penalties for failing to provide this notice are not clear.
Curiously, material suppliers with no on-site presence do not have the protection of this Pay if Paid prohibition, at least on private projects.[xvi] This revised law will impact suppliers’ customers more than the suppliers themselves, although it will impact suppliers indirectly and probably means they are more likely to receive payment.
General contractors will have a greater burden of pursuing payment for subcontractors from solvent owners and cannot use a Pay if Paid clause for protection if the owner did not pay because of general contractor default. Experience has also shown that courts often will not enforce a Pay if Paid clause if a subcontractor can show that general contractor default caused the owner nonpayment, usually based on the “prevention doctrine.” [xvii]
Prompt Pay Provisions
The Virginia Public Procurement Act has contained “Prompt Pay” provisions for some time. Any contract awarded by any state agency must include a payment clause that obligates the general contractor to do one of two things within seven (7) days after receipt of payment from the state agency:
a. Pay subcontractors for the proportionate share of the total payment received from the agency attributable to the work performed by the subcontractor under that contract; or
b. Notify the agency and subcontractor, in writing, of his intention to withhold all or a part of the subcontractor's payment, with the reason for nonpayment. [xviii]
Any contract awarded by any state agency must also include an interest clause that obligates the general contractor to pay interest at the rate of one percent (1%) per month, unless the contract “otherwise provides.” [xix] Interest accrues on all amounts that remain unpaid seven (7) days after receipt of payment from the state agency, except for amounts legitimately withheld. A general contractor must include in each subcontract a provision requiring each subcontractor to include the same payment and interest requirements in all lower-tier subcontracts.[xx]
The revised § 11-4.6 (B) mandates these same “Prompt Pay” provisions in private construction general contracts. In any construction general contract, the parties shall include a provision that requires the owner to pay such general contractor within sixty (60) days of the receipt of an invoice following satisfactory completion of the work. It is not clear the result if the parties fail to include the Prompt Pay provision.
The revised § 11-4.6 (C) states that any subcontract shall be deemed to include a provision that requires a “higher-tier contractor” to pay a “lower-tier subcontractor" within sixty (60) days of satisfactory completion of the work or within seven (7) days after receipt of payment from the owner, whichever is earlier.
It is not clear why public and private general contracts must affirmatively include this Prompt Pay provision, while public and private subcontracts “shall be deemed to include” the provision. It is also not clear whether this results in any difference in enforcement or application. A court might decide a private general contract is “deemed to include” the provision or a court could decide a there is no enforceable Prompt Pay provision in a private general contract unless the parties affirmatively included it.
The revised § 2.2-4354 states that any public subcontract shall require each subcontractor to include the same payment and interest requirements in any lower-tier subcontracts. This lower-tier subcontract requirement does not exist in the private Prompt Pay statute. It is not clear whether this results in any difference in enforcement or application.
General contractors, other higher-tier contractors and private project owners must police payments more carefully and comply with these notice requirements. However, we must wonder how much difference this private Prompt Pay law will make. This requirement is not effective until “satisfactory completion” of the subcontract work and is not applicable to amounts “reducible pursuant to a breach of contract by the subcontractor.” “Satisfactory completion” is not defined. General contractors may now define “satisfactory completion” in the subcontract as acceptance of the work by the owner, acceptance of an invoice and payment by the owner.[xxi]
Neither § 11-4.6 (B) nor (C) make the penalty clear for failure to give the required notice. What happens if no notice is sent? Does the higher-tier contractor lose the right to charge back for the noncompliance? Is there no penalty?
There are also significant differences between private general contracts and private subcontracts. The revised § 11-4.6 (B) states that in any private general contract:
An owner shall not be required to pay amounts invoiced that are subject to withholding pursuant to the contract for the general contractor's noncompliance with the terms of the contract. However, in the event that an owner withholds all or part of the amount invoiced by the general contractor under the contract, the owner shall notify the general contractor, in writing and with reasonable specificity, of his intention to withhold all or a part of the general contractor's payment with the reason for nonpayment.
The revised § 11-4.6 (C) mandates with respect to any private subcontract that:
. . . . in the event that a contractor withholds all or a part of the amount invoiced by any lower-tier subcontractor under the contract, the contractor shall notify the subcontractor, in writing, of his intention to withhold all or a part of the subcontractor's payment with the reason for nonpayment, specifically identifying the contractual noncompliance, the dollar amount being withheld, and the lower-tier subcontractor responsible for the contractual noncompliance.
This puts general contractors and lower-tier subcontractors in a difficult administrative position with their subcontractors. There is also some question whether the last portion is workable from a practical point of view.
The two statutes also have a different standard for withholding payment. An owner on a public or private contract and a general contractor on a public contract[xxii] can withhold payment for “noncompliance with the terms of the contract.” However, on a private project, a “higher-tier contractor” shall not be liable for amounts otherwise reducible pursuant to a breach of contract by their subcontractors or subcontractors[xxiii]. It is not clear whether this results in any difference in enforcement or application.
All parties, and especially general contractors, need to police payments carefully and comply with the notice of withholding requirements. General contractors and higher-tier subcontractors should add and enforce requirements of complete written lists of all sub-subcontractors and material suppliers and prohibiting the supply of any labor or material from unapproved sub-subcontractors and suppliers. This is especially important in light of potential higher-tier contractor liability for the unpaid wages and benefits of the employees of lower-tier subcontractors.[xxiv] General contractors should add and enforce requirements of progress payment waivers and sworn affidavits of the payment of all employee wages and benefits by all approved sub-subcontractors and their lower-tier sub-subcontractors at each progress payment.
There is also some confusion in the use of the terms “general contractor,” “contractor,” “higher-tier contractor,” and “lower-tier subcontractor.” [xxv] It is not clear whether this public contract law § 2.2-4354 or the private contract law § 11-4.6 (C) applies to prohibit Pay if Paid clauses in sub-subcontracts between subcontractors and any lower-tier subcontractors. If payment is withheld, it is also not clear whether the requirement to specifically identify any contractual noncompliance and the lower-tier subcontractor responsible applies only to subcontractors or also apply to third tier and even “lower-tier subcontractor[s].
One sentence in the Prompt Pay provisions in private general and subcontracts, § 11-4.6 (B) and (C), states that “Nothing in this subsection shall be construed to apply to or prohibit the inclusion of any retainage provisions in a construction contract.” This may invite more aggressive retainage provisions in construction general and subcontracts. Owners and general contractors may push to increase retainage percentages or create more conditions precedent to release of retention, including the payment of retainage by the owner. In any event, the deadline for payment of retention on public contracts is not clear. The deadline for payment of retention on private contracts would be within sixty (60) days of satisfactory completion or within seven (7) days of receipt of payment from the owner under the Prompt Pay provisions.
This revised public contract law § 2.2-4354 eliminating condition precedent Pay if Paid clauses will apply to “every agency of local government that acquires goods or services, or conducts any other type of contractual business with a nongovernmental, privately owned enterprise.” This seems to include not only public construction contracts, but also other types of public procurement.
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[i] Public Body Procurement Workgroup Report at https://rga.lis.virginia.gov/Published/2022/SD8
[ii] https://law.lis.virginia.gov/vacode/title2.2/chapter43/section2.2-4354/ and https://law.lis.virginia.gov/vacode/title11/chapter1/section11-4.6/ .
[iii] Va. Code Anno. §11-4.6 (B) (Michie 1950).
[iv] Va. Code Anno. §11-4.6 (C) (Michie 1950).
[v] Va. Code Anno. §11-4.6 (B) (Michie 1950).
[vi] Former Va. Code Anno. §2.2-4354 (1) (Michie 1950), now Va. Code Anno. §2.2-4354 (2) (Michie 1950).
[vii] Va. Code Anno. §2.2-4354 (1) (Michie 1950).
[viii] Virginia Code §2.2-4354 (2) & (4)[“Any such contract awarded shall further require the contractor to include in each of its subcontracts a provision requiring each subcontractor to include or otherwise be subject to the same payment and interest requirements with respect to each lower-tier subcontractor”].
[ix] Virginia Code §2.2-4354 (4) & (5)[“Any such contract awarded shall further require the contractor to include in each of its subcontracts a provision requiring each subcontractor to include or otherwise be subject to the same payment and interest requirements with respect to each lower-tier subcontractor”].
[x] Defining “satisfactory completion” as payment by the owner may violate the prohibition against Pay if Paid provisions.
[xi] Va. Code Anno. §11-4.6 (B) (Michie 1950).
[xii] Defining “satisfactory completion” as payment by the owner may violate the prohibition against Pay if Paid provisions.
[xiii] Va. Code Anno. §11-4.6 (C) (Michie 1950).
[xiv] Va. Code Anno. §11-4.6 (D) & (E) (Michie 1950).
[xv] Virginia Code §2.2-4354 (4) & (5)[Any contract awarded by any state agency shall include an interest clause that obligates the contractor to pay interest to the subcontractor and "unless otherwise provided under the terms of this contract, interest shall accrue at the rate of one percent per month"].
[xvi] Va. Code Anno. §11-4.6 (D) (Michie 1950) states that "’General contractor’ and ‘subcontractor’ have the meanings ascribed thereto in § 43-1, except that those terms shall not include persons solely furnishing materials.” Va. Code Anno. §2.2-4354 does not adopt the definitions in Va. Code Anno. §43-1 (Michie 1950) or the specific exclusion of “persons solely furnishing materials.”
[xvii] See chapter, Changes, Delays & Other Claims; section, Contract Clauses and Theories, subsection Implied Duties and Other Legal Theories, sub-subsection, Prevention of a Condition Precedent or Implied Duty for further discussion of the Prevention Doctrine; Aarow Equip. & Servs. v. Travelers Cas. & Sur. Co. of Am., 2011, 417 Fed. Appx. 366 (4th Cir. Va. 2011); Moore Bros. Co. v. Brown & Root, Inc., 207 F.3d 717 (4th Cir. 2000).
[xviii] Former Va. Code Anno. §2.2-4354 (1) (Michie 1950), now Va. Code Anno. §2.2-4354 (2) (Michie 1950).
[xix] It may not be possible to avoid the one percent (1%) per month in the subcontract. It may be necessary to include it in the general contract. Virginia Code §2.2-4354 (4) & (5) states that “any contract awarded by any state agency shall include an interest clause that obligates the contractor to pay interest to the subcontractor and "unless otherwise provided under the terms of this contract, interest shall accrue at the rate of one percent per month".
[xx] Virginia Code §2.2-4354 (5).
[xxi] Defining “satisfactory completion” as payment by the owner may violate the prohibition against Pay if Paid provisions.
[xxii] Va. Code Anno. §2.2-4354 (Michie 1950).
[xxiii] Va. Code Anno. §11-4.6 (C) (Michie 1950).
[xxiv] Va. Code Anno. §11-4.6 (D) & (E) (Michie 1950).
[xxv] Va. Code Anno. §11-4.6 (D) (Michie 1950) states that "’General contractor’ and ‘subcontractor’ have the meanings ascribed thereto in § 43-1, except that those terms shall not include persons solely furnishing materials.” Va. Code Anno. §2.2-4354 does not adopt the definitions in Va. Code Anno. §43-1 (Michie 1950). Va. Code Anno. §43-1 (Michie 1950) states that the term "general contractor" includes anyone who contracts directly with the owner and the term "subcontractor" includes anyone who contracts with the general contractor. The terms “sub-subcontractor,” “higher-tier subcontractor,” and “lower-tier subcontractor” are not defined in §43-1.