Pay-if-paid clauses make a prime contractor’s payment to a subcontractor contingent on the prime contractor receiving payment from the project owner. A recent federal court case illustrates how the failure to include a pay-if-paid clause can end up with a prime contractor paying one of its subcontractors out of pocket.

In Phillips and Jordan, Inc. v. McCarthy Improvement Co., a prime contractor was awarded a design-build contract for the construction of a $31 million roadway project for the South Carolina Department of Transportation. The prime contractor, in turn, entered into a unit-price subcontract with a dirt-work contractor to excavate and place soil at the project.

During construction of the project, numerous issues arose that impacted the prime contractor’s ability to timely complete the project. One of the issues that impacted the prime contractor’s work was the lack of sufficient on-site material, which required the dirt-work subcontractor to perform more work than anticipated.

After completing its work, the subcontractor sued the prime contractor for extra work the subcontractor claimed it performed on the project. The prime contractor asserted a counterclaim against the subcontractor for breach of contract due to the subcontractor’s alleged delays in completing its work.

After conducting a 14-day bench trial, the court held that the subcontractor was entitled to $3.3 million for the work the subcontractor performed at the prime contractor’s direction. The court reasoned that although the project owner may not have paid the prime contractor for the work the subcontractor performed, that would not excuse the prime contractor from paying the subcontractor because the subcontract expressly provided the subcontractor would be paid within 10 days of the date of each invoice. There was no pay-if-paid clause in the subcontract that one may typically see for these types of projects.

While the court made many findings, the court focused on the prime contractor’s missteps in its estimating for the project. For example, the court noted that “[a] loss on a budget item is a function of inadequate estimating at bid time and it is expected to be covered by the prime contractor.” The court found that the prime contractor “failed to provide adequate fill pursuant to the Subcontract, i.e., [the prime contractor’s] initial estimates of on-site material were inaccurate.” Since the prime contractor failed to provide adequate fill dirt, the court concluded the prime contractor breached the Subcontract.

As to damages, the court held that the subcontractor was entitled to $3.3 million. The award included unpaid subcontract billings, rework costs, inefficient impact costs, field overhead costs, and general overhead costs.

Bottom Line: Pay-if-paid clauses make a prime contractor’s payment to a lower tier subcontractor contingent on receiving payment from the project owner. The importance of pay-if-paid clauses cannot be overstated. If there had been one in this case, it is possible that the prime contractor, not the subcontractor, would have prevailed. Instead, the prime contractor had to pay the subcontractor $3.3 million out of pocket.