A pay-when-paid provision in a subcontract cannot be construed to impair a subcontractor's statutory rights against a payment bond surety. The seminal case in this area is William R. Clarke Corp. v. Safeco Ins. Co. (1997) 15 Cal. 4th 882. Clarke held that a pay-if-paid provision in a subcontract, which makes payment to the general contractor a condition precedent to its obligation to pay its subcontractor, could not be used as a defense by a payment bond surety and such provisions are unenforceable as against public policy. 15 Cal. 4th at 886.
Clarke held that such provisions effectively waive the subcontractor's mechanic's lien rights, violating the anti-waiver provisions of Civ. Code §8122. Ibid.
Civ. Code §8122 provides:
“An owner, direct contractor, or subcontractor may not, by contract or otherwise, waive, affect, or impair any other claimant's rights under this part, whether with or without notice, and any term of a contract that purports to do so is void and unenforceable unless and until the claimant executes and delivers a waiver and release under this article.”
What about pay-when-paid clauses? The short answer is that pay-when-paid provisions are not conditions precedent, but merely provide the time in which the subcontractor would ordinarily be entitled to a progress payment for its work. That is, the time for payment includes an implicit understanding that the subcontractor has a right to payment within a reasonable time. Clarke, supra, 15 Cal. 882, 885; Yamanishi v. Bleily & Collishaw, Inc. (1972) 29 Cal. App. 3d 457 (contract provided direct contractor would pay subcontractor “upon receipt of each payment received from the Owner.”) If the subcontractor is denied payment through no fault of its own and no specific time for payment is provided in the subcontract, the default rule is that payment is due within a reasonable time upon the subcontractor's performance. Yamanishi, 29 Cal. App. 3d at 463.
These principles are equally applicable to public works contracts involving statutory payment bonds and stop notice rights as they are to private works involving mechanic's liens.
The recent case of Crosno Construction, Inc. v. Travelers Casualty and Surety Company of America (2020) 47 Cal. App. 5th 940 had occasion to reexamine these principles where the “reasonable time” for payment by the direct contractor to the sub was defined in the subcontract.
The North Edwards (San Bernardino) Water District entered into a direct contract with Clark Brothers, Inc. to build an arsenic removal water treatment plant. Clark subcontracted with Crosno Construction to build and coat two steel reservoir tanks.
The Clark/Crosno subcontract contained the following provision:
“If Owner or other responsible party delays in making and payment to Contractor from which payment to Subcontractor is to be made, Contractor and its sureties shall have a reasonable time to make payments to Subcontractor. ‘Reasonable time' shall be determined according to the relevant circumstances, but in no event shall be less than the time Contractor and Subcontractor require to pursue to conclusion their legal remedies against Owner or other responsible party to obtain payment, (including but not limited to) mechanic's lien remedies.”
When work was halted as a result of a dispute between Clark and the District, Crosno was owed $562,435.00 for work it had then completed.
Crosno filed a stop payment notice with the District. The District terminated Clark's direct contract and therefore Clark could not pay Crosno what it was owed. Crosno gave Travelers written notice of its payment bond claim. Clark sued the District.
Travelers denied Crosno's bond claim on the ground that until Clark's lawsuit with the District was resolved, no funds were due under the pay-when-paid provision quoted above.
Crosno sued Travelers and filed a summary judgment motion which the court granted. The trial court held that the pay-when-paid provision was void and unenforceable because it violated the policies underlying §8122.
The trial court also awarded Crosno prejudgment interest and attorney's fees. Meanwhile, as a result of settlement negotiations among the District, Clark and Crosno, the District interplead funds sufficient to satisfy Crosno's principal judgment against Travelers, but not the interest and attorney's fees.
Travelers appealed and the Court of Appeal affirmed. Essentially, the Court of Appeal held that Travelers' statutory obligations could not be impaired by the pay-when-paid language in the bonded subcontract. “[A] payment bond ‘shall be construed most strongly against the surety and in favor of all persons for whose benefit the bond is given.' (§8154(a))” 47 Cal. App. 5th at 952. (Note: public works payment bonds are governed generally by Civ, Code §9100.)
The Court also relied on §8152(d) which “prevents a surety from avoiding liability on a bond based on ‘[a] condition precedent or subsequent in the bond purporting to limit the right of recovery of a claimant otherwise entitled to recover pursuant to a contract, agreement or bond.'”
Bottom line for sureties: Do not rely on pay-when-paid clauses as a defense. If the payment bond claimant did the work and met the contractual requirements and the amount owed is reasonable or otherwise agreed upon, it probably should be paid. The surety is not without remedies. It can be subrogated to (or receive an assignment of) the other rights and remedies of the bond claimant, including stop payment (or lien) rights against the owner, contractual rights against the direct contactor and, of course, its indemnity rights against its principal and indemnitors.