South / Regional Reports

Texas Contractors, Subcontractors Agree To Rules For Contingent Payment Clause Enforceability

August 2, 2002
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In November 2001, 15 Texas contractors and subcontractors, two lawyers, and a facilitator from North Carolina set out on a quest. They were determined to do what two major segments of the Texas construction industry had not been able to do for decades: establish fair rules for the use of contingent payment clauses in construction subcontracts. The participants were volunteer general contractors from the Texas Building Branch of the Associated General Contractors (AGC) and subcontractors from the Texas Construction Association (TCA), an organization of subcontractor and supplier trade associations.

Contingent payment clauses or “pay if paid” clauses are common risk shifting clauses used to shift or spread the burden of a project owner’s failure to make payment from the general contractor to its subcontractors. In simple terms, the general contractor uses a subcontract term, which says to the subcontractor, “If I don’t get paid by the owner, you don’t get paid”.

Subcontractors have long argued that they lack the information, the resources, or meaningful lines of communication with the project owner to assess such risks, much less to accept them. They cite abuses where general contractors use such clauses as defenses when the general contractor’s own failings are the reason for non-payment.

General contractors argue that market forces, not the legislature, should determine the extent to which they may shift such risks. They argue that subcontractors are even greater beneficiaries of the profits of construction work, and that the risks of such work should be aligned with those who profit from it.

The time-honored tradition of Texas construction industry lobbying has been for the subcontractors to file a bill outlawing such clauses in their entirety. The general contractors, in turn, lobby to have the bill killed. The feelings have run so deep that middle ground has hardly ever been sought. The arguments have been heated, expensive, and seemingly never ending. That is, until now.

The associations sought the help of a neutral facilitator, an experienced construction attorney from another state. Together, they crafted a set of ground rules that would allow both groups to cease their positional bargaining and seek solutions that would be in their common best interests. It worked.

The solution, in the form of a draft bill that the boards of directors of both groups have approved as part of a joint legislative agenda, was surprisingly simple. The right to shift risks of owner insolvency was preserved, but only in a fashion that did not involve the general contractor shifting risks which it could better control, mitigate, or manage itself. Furthermore, the right to shift the risk was reconciled with the state’s “prompt pay” laws, such that a subcontractor would not find itself both at risk of owner insolvency and obligated to continue performance.

The guiding principles of the bill are:

  • A general contractor may shift the risk of owner insolvency.

  • A general contractor may not enforce the clause when the reason for non-payment by an owner is related to the general contractor’s default or mismanagement, or is the fault of another subcontractor.

  • A general contractor may not enforce the clause if the relationship between the owner and the general contractor is a sham.

  • At or about the time a subcontractor would be entitled to cease work under the Texas Prompt Pay Act as a result of non-payment, it may advise the general contractor that further work will not be subject to the contingent payment clause.

  • A general contractor may not enforce a contingent payment clause when to do so would be unconscionable.

    It is the last point that defied precise definition. Instead, the negotiating teams agreed that a certain amount of uncertainty might well be preferable. By leaving the area somewhat indeterminate, settlement and cooperation would be encouraged out of necessity.

    The draft bill is far from law, but both groups are pleased with it and the prospect of starting a legislative session without the usual rancor on this issue.

    Drafts of the bill and explanatory materials are available at the TCA website: www.texcon.org.

    Risk is president/CEO of the Texas Construction Association. Nelson is president of SureTec Information Systems Inc. and chairman of the Texas Building Branch, AGC Legislative Committee.

    Publication date: 08/05/2002

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