Potential Change for “Pay-if-Paid” and “Pay-when-Paid” Clauses in Michigan

To understand the difference between the two contractual clauses, it is important for general contractors and subcontractors to know the following:

• A “pay-if-paid” clause makes payment of the general contractor by the owner a condition precedent to the subcontractor getting paid—meaning if the general contractor does not get paid—neither does the subcontractor.
• In contrast, a “pay-when-paid” clause is a mechanism that delays the time in which a general contractor must pay a subcontractor, but never totally extinguishes the responsibility.

Under current Michigan law, a contract may contain a “pay-if-paid” clause stating that the subcontractor will be paid only after the general contractor is paid. Given pay-if-paid provisions are enforceable, there is reason to believe that Michigan courts would also enforce a pay-when-paid provision addressing the timing of the contractor’s payment obligation.

Some states (e.g., New York, Ohio, and Wisconsin) have passed legislation to limit the use of pay-if-paid clauses. In Michigan, courts have emphasized that parties are free to make whatever agreement they like, and courts will enforce the agreement as written, absent highly unusual circumstances (i.e., a contract in violation of law or public policy). Based on the Michigan Supreme Court holding in Berkel, for a “pay-if-paid” provision to be enforced, receiving payment as condition precedent to paying a lower tier subcontractor must be clear, unambiguous, and carefully worded.

Pending House Bill 4837

On June 22, 2023, House Bill  4837 (“HB 4837”), known as the proposed Construction Payment Act was introduced. The passage of HB 4837 would mandate design and construction contracts contain specific payment provisions, override certain negotiated payment terms, and prohibit certain provisions completely.

HB 4837—as related to pay-if-paid clauses—seeks to overturn Berkel and its progeny. Specific to pay-if-paid provisions, Section 7 holds the following requirements of contractual provisions void and unenforceable as against public policy:

1. that a contractor assumes the risk of nonpayment of the owner,
2. that a contractor waive any statutory or other right to commence litigation or arbitration until payment is made to the general or prime contractor,
3. that conditions the obligation of the surety under a payment bond upon payment by the owner, or
4. that a subcontractor or a lower-tiered contractor rely on the credit of the owner and not on the credit of the general or prime contractor or of a bonding company.

Passage of HB 4837(7) would result in the unenforceability of pay-if-paid clauses. Where parties have reached an agreement regarding the payment process and dates, HB 4837 would void conflicting contractual provisions and impose a penalty on “late” payments “wrongfully withheld” at 12% per annum accruing on the “day after the required date and ending on the date the payment amount due is paid.”

HB 4837 has been referred—and is pending in the Michigan House of Representatives, Economic Development and Small Business Committee—waiting to be passed out of committee for amendment or approval.

Current Situation

Under Michigan’s current controlling case, Berkel, there was no ambiguity in a contract clause between a general contractor and subcontractor which provided, “all payments to the subcontractor [were] made only from equivalent payments received by the general contractor from the project owner.” The contract contained no language limiting payment to any “reasonable time,” but instead conditioned payment of the subcontractor to the owner’s payment of the general contractor. Thereafter, the general contractor was not required to pay the subcontractor until the condition precedent of receiving payment from the owner was satisfied.

More recently in Macomb Mechanical, the Michigan Court of Appeals found that a pay-if-paid provision in a subcontract may not apply to compensation for additional work where no change order was issued, and the additional work never became part of the subcontract. Because the additional work never became part of the subcontract, the default payment time is “a reasonable time,” instead of according to the pay-if-paid provision of the subcontract. While Berkel and Macomb Mechanical are precedential, HB 4837 was introduced and seeks to render pay-if-paid clauses unenforceable.

Proper guidance from a knowledgeable professional can help general contractors and subcontractors reduce their risks and protect their interests with pay-if-paid clauses. If you have any questions on the enforceability of such a clause, or its application to your project, consult your attorney or anyone in Clark Hill’s Construction Practice Group.

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