Executive Summary

In April 2022, the Virginia General Assembly and Governor passed SB550 which would eliminate or prohibit “pay if paid” clauses in public and private construction contracts in Virginia. Payment by the owner could no longer be a condition precedent to payment to any lower-tier subcontractor. SB550 now goes to a Public Body Procurement Workgroup for review. The Workgroup shall report its findings and any legislative recommendations to the General Assembly by December 1, 2022, with the law to become effective on January 1, 2023.

However, 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.” General Contractors and their lawyers criticizing the new law may not have noticed this. 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.

The proposed new § 11-4.6 (B) also mandates “prompt pay” provisions in private construction contracts also that (i) requires the owner to pay the general contractor within 60 days of receipt of an invoice after “satisfactory completion” and (ii) requires a “higher-tier contractor” to pay a “lower-tier subcontractor" within 60 days of satisfactory completion of the work or within seven days after receipt of payment from the owner, whichever is earlier.

These two new provisions seem to bring Virginia more in line with Maryland. Although there are still significant differences, general contractors will have a greater burden in both states of pursuing payment for subcontractors from solvent owners. The Maryland Code has long stated that a pay if paid clause “may not abrogate or waive the right of the subcontractor to . . . [c]laim a mechanics' lien."[1] A general contractor is more likely to approve of enforcement of lien rights by a subcontractor if an owner is insolvent or has defaulted in payment.[2] Both states will now have a prompt pay statute for both public and private projects, although Maryland has a shorter payment deadlines.[3]

**************************************************************************************************

The new § 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 new § 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 condition precedent pay if paid clause will be unenforceable in private and public subcontracts. A general contractor can still back charge a subcontractor for noncompliance with the terms of the subcontract. However, the contractor must notify the subcontractor in writing of the intent to withhold and the reason for withholding payment.

This new law will certainly be welcomed by subcontractors in Virginia. However, this will add more risk and administrative expense to general contractors and private project owners. All parties and especially general contractors will need to police payments more carefully and comply with the new notice requirements.

Virginia has historically been a “Freedom of Contract” state. For years, most general contractors have passed much of the risk of owner insolvency down to subcontractors, although general contractors were also still exposed to a substantial risk. However, the extent of the additional risk to general contractors is in this new law is debatable.

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.” 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.

This may mean that general contractors will have a greater burden of pursuing payment for subcontractors from solvent owners and that general contractors cannot use a pay if paid clause for protection if the owner did not pay because of general contractor default.[4] General contractors already expend great resources to collect payment contractually due from solvent owners. However they may now have less leverage to get subcontractors to compromise claims in order to negotiate settlements in such cases.

It does seem clear that there will be no general contractor protection if the owner did not pay because of general contractor default. There is a certain fairness in this result. 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. Will the new law create a greater burden of proof of no general contractor default?

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 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.

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 per month to subcontractors on all amounts that remain unpaid seven 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.

The proposed new § 11-4.6 (B) mandates “prompt pay” provisions in private construction contracts also that (i) requires the owner to pay the general contractor within 60 days of receipt of an invoice after “satisfactory completion” and (ii) requires a “higher-tier contractor” to pay a “lower-tier subcontractor" within 60 days of satisfactory completion of the work or within seven days after receipt of payment from the owner, whichever is earlier.

This new law will certainly add more administrative expense to general contractors and private project owners to police payments more carefully and comply with the new notice requirements. However, it is difficult to argue with the basic fairness of prompt pay statutes. General contractors may like the 60 days payment requirement, although many argue this will delay payments from the 30 day terms they have enjoyed. Subcontractors will like the 7 days after owner payment and maximum 60 day terms for payments from the general contractor.

However, we must wonder how much difference this prompt pay law will make. This private prompt pay 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.” General contractors will still have leeway to contend that subcontract work is simply not complete and subcontractors will still feel pressure to compromise their accounts receivable and difficulty waiting months or years for relief from a court.

In addition, neither § 11-4.6 (B) or (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? The prompt pay provisions already call for a one percent (1%) per month interest charge on unpaid invoices. Perhaps the penalty should be double interest if no such notice is provided. The Maryland Code allows a court to award reasonable attorney’s fees if the owner or contractor “acted in bad faith by failing to pay any undisputed amounts.”[5] This may be a good “penalty” to add to the Virginia statute.

There are also significant differences between private general contracts and private subcontracts. The new § 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 new § 11-4.6 (C) mandates with respect to any private subcontract that:

However, 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 will put general contractors 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. It may be advisable to make the proposed law for general contracts also applicable to subcontracts, requiring only reasonable specificity of the reason for nonpayment and eliminate the requirement that the general contractor specifically identify the contractual noncompliance, the dollar amount being withheld, and the lower-tier subcontractor responsible.

There is also some confusion in the use of the terms “general contractor,” “contractor,” “higher tier contractor,” and “lower tier subcontractor.” It is not clear whether this public contract law § 2.2-4354 applies to prohibit pay if paid clauses in sub-subcontracts between subcontractors and any lower tier subcontractors. The private contract law § 11-4.6 (C) seems to more clearly prohibit pay if paid clauses in sub-subcontracts. However, it is not so clear whether the requirement to specifically identify any contractual noncompliance and the lower-tier subcontractor responsible apply if payment is withheld or whether the provisions apply to third tier and even “lower tier subcontractor[s].”

This new 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.

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 will eliminate some uncertainty whether the contractual right to retention had been eliminated. However, this may also 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.

Also SB550 now states that its provisions shall become effective on January 1, 2023 and shall apply to construction contracts executed on or after January 1, 2023. This means the new law applies only to contracts signed after the date of enactment.

Join our mailing list here: http://www.fullertonlaw.com/contact-us/mailing-list

Readers are welcome to reprint or republish this article with the following attribution:

Use the Free 700 page Construction Law Survival Manual at http://www.fullertonlaw.com/

[1] In Maryland, “pay if paid” clauses are generally enforceable, but do not constitute a defense to a mechanic’s lien, Little Miller Act or private payment bond claim. Gilbane Bldg. Co. v. Brisk Waterproofing Co. Inc., 86 Md. App. 21, 585 A.2d 248, 252 (Ct. Spec. App.1991); Maryland Real Property Code Section 9-113(b); Maryland State Finance and Procurement Code Section 17-108(d)(2).

[2] It seems that in both states, subcontractors will have, but be limited to, their mechanic’s lien rights in the event of owner insolvency. So perhaps the main difference between the states will be the difference in lien priority. In Maryland, the construction lender will have priority over and will usually extinguish the subcontractor mechanic’s lien rights. In Virginia the subcontractor mechanic’s lien rights will largely have priority over the construction loan. Lien rights would also survive an owner bankruptcy in Virginia, but be extinguished in Maryland. See chapter, Mechanic’s Lien Rights and General Principles; section, Priority. See Construction Law Survival Manual at http://www.fullertonlaw.com/; chapter on Mechanic’s Liens in Virginia and chapter on Mechanic’s Liens in Maryland; in both chapters section on Priority.

[3] Maryland Real Property Code Section 9-302(b)(1)(i).

[4] This would be result in most states based on the “prevention doctrine” if not for any other reason. Moore Bros. Co. v. Brown & Root, Inc., 207 F.3d 717, 725 (4th Cir. 2000). See Restatement (Second) of Contracts §245 (1981); 13 Williston on Contracts, 4th ed., Lord, §39:4; 17A Am.Jur.2d, Contracts, §703; 17B C.J.S., Contracts, §530. The Supreme Court of Virginia recognized the prevention doctrine in Parrish v. Wightman, 184 Va. 86, 34 S.E.2d 229, 232 (1945); Mardirossian Family Enterprises v. Clearail, Inc., 324 Md. 191, 203, 596 A.2d 1018 (1991). However, under the new Virginia law, a pay if paid clause would also not protect a general contractor if the owner was not insolvent or in Bankrcupty.

[5] Maryland Real Property Code Section 9-303(b); Capitol Indem. Corp. v. Mountbatten Sur. Co., 2001 U.S. Dist. LEXIS 207 (D. Md. 2001).