Risk shifting and construction payment go hand in hand. Through transparency and better communication, this can be reversed, but for now – that’s the reality of the industry. Some of the most common methods of shifting risks are no lien clauses, pay when paid provisions, and pay if paid provisions. However, courts will generally disfavor excess risk shifting, and oftentimes these clauses will either be limited by courts or given no effect at all. A recent case helped make it clear that pay if paid clauses won’t stop Louisiana bond claims. The project was for a Walmart in New Roads, Louisiana.
Risk-Shifting is a constant battleground between policy and contract.
Pay If Paid Primer
As mentioned above, courts don’t always let pay if paid clauses operate how they intend to. No, often, pay if paid clauses will be turned into a time shifting provision rather than a risk shifting provision. This means that while the time for making payment might move based on when a higher tiered party is paid, payment is still ultimately due. Meanwhile, under a true pay if paid clause, if payment is never made to the higher tiered party, payment is never required to be made down the chain. While a pay if paid clause will be converted to a time-shifting mechanism in some states, in others, they’re barred altogether.
Here’s more on Pay if Paid clauses and Pay when Paid clauses.
Louisiana Bond Claims vs. Pay If Paid
Back to Louisiana. A recent case, Bear Industries, Inc. v. Hanover Insurance Co., strengthened Louisiana’s position against the use of pay if paid contracts (at least in the context of securing construction payment). JD Supra has a good writeup on the case which can be found here.
Check out the Louisiana Public Project FAQ for more on bond claims in The Bayou State.
Bear Industries (the Supplier) supplied materials to Amtek (the Subcontractor). The Subcontractor was hired by Hudson (the GC), and all were providing labor and materials for a Walmart Supercenter in New Roads, Louisiana. I’m pretty sure I’ve been to that Walmart, actually…but that’s beside the point.
The project was private, but the GC provided a payment bond. Payment bonds on private projects aren’t necessarily common, but they’re not exactly rare either. Anyway, payments were being sent down the chain (from the GC, to the Sub, to the Supplier) via joint checks. However, when a dispute arose between the GC and the Sub, payments stopped making their way down to the Supplier.
As a result, the Supplier filed a mechanics lien against the project under the Louisiana Private Works Act. The Supplier also eventually filed an action against the GC’s payment bond.
The Trial Court
Because surety agreements are just that – agreements, they’re often subject to the rules of contracting. Often, that means whatever is in the surety agreement goes – plus any claims may even be bound by the terms of the contracts between the parties (where the surety wasn’t even involved in the agreement). Of course, many states limit how much a surety agreement (or other agreement) may affect bond claims. The courts involved in this case made it clear that Louisiana won’t let bond claims be affected by outside agreements…
At the trial court level, the Surety argued that they were not liable for the Supplier’s claim due to a pay if paid contract that existed between the GC and the Subcontractor. According to the Surety – payment was not actually owed from the GC to the Sub, so then payment was also no owed to the Supplier. Since payment wasn’t owed, according to the Surety, the Supplier’s claim was invalid.
The court did not agree. The court found that, because the payment bond was obtained under provisions of the Private Works Act (read: Louisiana mechanics lien statute), the provisions of the Act were applicable. Specifically, § 4812(d) of the Act states that the bond “shall be deemed to conform to the requirements of this part notwithstanding any provision of the bond to the contrary…” This means that bond language that contradicts what’s required by the statute will be ignored. Thus, the pay if paid provision was irrelevant.
Not to be deterred, the Surety appealed the decision, but the appellate court agreed with the trial court. They added some great wording, too:
“[a]llowing a surety to assert a ‘pay-if-paid’ clause to defeat payment to a subcontractor on the basis that the contractor has not received full payment from the owner, where the owner has escaped liability to the subcontractors by relying on the payment bond, would render the protections afforded to laborers and suppliers on private works projects set forth in the Private Works Act meaningless.”
In coming to the above conclusion, the trial court actually cited a decision that blocked a pay if paid clause from affecting a payment bond on a public project. Yup – on public projects, too, Louisiana courts have held that a pay if paid clauses will not affect bond claim rights. That’s great news for those in the Louisiana construction industry.