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Pay-if-Paid Clauses Can Destroy Your Bond Claim Rights

kpeil.jpgIn the construction industry, bonds are typically put in place to ensure that a subcontractor is paid if the general contractor fails to receive payment. Currently, in Indiana, pay-if-paid provisions can eliminate a subcontractor's bond claim rights.

On May 11, 2012, the United States Court of Appeals for the Seventh Circuit in BMD Contrs., Inc v. Fidelity & Deposit Co. of Maryland., 2012 U.S. App. LEXIS 9558 (7th Cir. Ind. May 11, 2012) held that pay-if-paid provisions are enforceable in Indiana, and that a surety can assert all defenses available to its principal, including a pay-if-paid provision.

The facts that gave rise to the case involved the construction of a plant for the purpose of manufacturing automobile transmissions in Tipton, Indiana. The general contractor for the construction of the facility, Walbridge, had entered into multiple subcontracts, including one with Industrial Power for mechanical and piping work. Industrial Power entered into a second level subcontract with BMD to perform the piping work.

Industrial Power executed a payment bond with Fidelity, making Fidelity a surety for Industrial Power's payment obligations to BMD. Before construction of the plant was complete, the owner filed for bankruptcy, causing a series of payment defaults to flow down the levels of contractors and subcontractors. Walbridge failed to pay Industrial Power and Industrial Power failed to pay BMD. BMD then made a claim against Fidelity due to Industrial Power's failure to pay, and Fidelity refused to pay BMD. BMD sued Fidelity on the bond.

The subcontract between Industrial Power and BMD contained language conditioning Industrial Power's duty to pay on its own receipt of payment. It stated:

IT IS EXPRESSLY AGREED THAT OWNER'S ACCEPTANCE OF SUBCONTRACTOR'S WORK AND PAYMENT TO THE CONTRACTOR FOR THE SUBCONTRACTOR'S WORK ARE CONDITIONS PRECEDENT TO THE SUBCONTRACTOR'S RIGHT TO PAYMENT BY THE CONTRACTOR.

This language was construed by the Seventh Circuit as a "pay-if-paid" clause, meaning that Industrial Power only had to pay BMD if it received payment under its own contract with Walbridge. The Court rejected BMD's argument that the contract language in question was a "pay-when-paid" clause, which would have merely extended the time that Industrial Power had to pay BMD, not its ultimate duty to pay. The Court also rejected BMD's argument that pay-if-paid clauses were void under Indiana's public policy. And finally, the Court held that Fidelity, as a surety, could assert all the defenses of its principal, Industrial Power, even though the bond itself did not specifically incorporate the pay-if-paid language. The Court ultimately determined that Fidelity was not liable on the bond.

Subcontractors should carefully review their contracts to ensure payment in the event a property owner fails to pay the contractor.

Please contact us at www.hwelaw.com if you have questions regarding this article or if we can be of assistance.

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