Contracts, by their nature, often involve shifting risk from one party to another. Most of the time, provisions that shift risk are legal and bargained for as part of an agreement. However, where a disparity of power exists between contracting parties, risk may be unfairly and unreasonably shifted to an out-leveraged party. Construction contracts are certainly no exception. Where only a limited number of general contractors dominate an area and control much of the work, subcontractors may not have the leverage to negotiate the risk shifting provisions in their subcontracts. 

While subcontractors will continue to be faced with unfavorable provisions drafted by general contractors in their subcontracts, states across the country, including New York, have addressed a particularly perilous provision known as the “pay-if-paid” or “pay-when paid” clause. These clauses shift much of the risk of nonpayment by a project owner to subcontractors by conditioning payment to the subcontractor on payment from the owner. This allows general contractors to greatly reduce out-of-pocket expenditures and generally results in subcontractors effectively financing a portion of the project themselves, pending receipt of payment. 

General contractors understandably use these clauses to reduce their exposure by including pay-if-paid clauses in their subcontracts. However, New York courts have found that pay-if-paid clauses to be generally void and unenforceable. The emphasis on the word generally is crucial however as there exists an ever-evolving grey area of the rule’s applicability. 

The Court of Appeals’ reasoning for prohibiting pay-if paid clauses in West-Fair Elec. Contrs. v. Aetna Cas. & Sur. Co., 87 NYS2d 148 (1995) was based in public policy put forth in New York’s Lien Law. The logic being that pay-if-paid clauses infringe on a subcontractor/materialman’s ability to file a mechanic’s lien and protect its right to payment. Which essentially undermines the purpose of Article 2 of the Lien Law. Given the Court of Appeals reasoning for creating the prohibition, courts have refused to apply the prohibition in cases where the subcontractor has no lien rights, as exemplified in the case illustrated below. 

In, Entech Eng’g, P.C. v. Dewberry Engrs. Inc., 204 AD3d 467 (1st Dep’t. 2022), Dewberry contracted with the New York City Economic Development Corporations to inspect thousands of homes in New York City for asbestos and lead paint dangers. Dewberry subcontracted with Entech Engineering to perform inspections. Dewberry terminated Entech and a lawsuit ensued. Entech claimed it had not been paid for inspections performed totaling $1,464,983 and argued the pay-if-paid provision in its subcontract was unenforceable under New York law.  Dewberry countered by arguing that because Entech’s work of performing inspections was not considered labor for the improvement of real property, as defined by § 3 of the Lien law, the prohibition on pay-if-paid clauses did not apply to Entech’s subcontract. Therefore, Dewberry argued that the pay-if-paid provision justified Dewberry withholding payment to Entech. The trial court agreed with Dewberry, as did the appeals court. The court reasoned that “(w)here a subcontractor has no such Lien Law rights, there is no basis for finding that a pay-if-paid clause violates New York public policy and there is no impediment to enforcement of the Pay-if-Paid clause.”

Additionally, New York’s prohibition against pay-if-paid clauses won’t apply if the law of another state where no such prohibition exists governs the contract. In Prestige Lawn Care of WNY, LLC v Facilitysource, LLC, 233 AD3d 1515 (4th Dept 2024). Prestige Lawn Care contracted to provide lawn care and snowplowing services to commercial properties managed by FacilitySource. Prestige argued that the pay-if-paid clause in its contract was unenforceable in New York. Crucially however the contract included a choice of law clause that provided that Arizona law would govern the “rights and obligations of the parties” under the contract as well as a forum selection clause designating Maricopa County, Arizona as the exclusive jurisdiction of all claims arising out of the contract. The New York appellate court rejected Prestige’s argument because such pay-if-paid provisions are enforceable under Arizona law and the choice of law and forum selection clauses were valid and enforceable.

It is important to note that the holding in the Prestige case would not apply to construction contracts in New York with a total contract price over $150,000.00 as Article 35-E of New York’s General Business Law prohibits forum selection and choice of law provisions in contracts for such construction work located in New York State. It is possible that the contract in the Prestige case should have been considered a “construction contract” as defined in Article 35-E. However, the issue was not raised by the parties or the court and thus the pay-if-paid clause was enforced. 

All of the above being considered, contractors in New York should not take too much solace in New York’s prohibition of pay-if-paid clauses. While generally speaking New York courts will refuse to enforce a pay-if-paid clause in construction contracts, the grey area persists and evolves. Contractors should be aware of what constitutes a “contractor” and “construction contract” under New York’s Lien Law. Also, as made apparent in the Prestige case, contractors should also be wary of language designating an out-of-state forum and/or choosing another state’s law to govern the contract. Contractors can always be well served by objecting to these clauses before signing where possible. 

Jack M. Cassidy is an associate with the law firm Adams Leclair LLP and can be reached at jcassidy@adamsleclair.law

Jack M. Cassidy