Pay-if-paid language has become ubiquitous in construction contracts throughout the country. These clauses have long been enforceable in Virginia under existing decisional law. Such provisions expressly condition subcontractor and supplier progress payments on receipt of funding by upstream contractors from the owner or other higher-tier contracting parties. Nevertheless, based upon a new statute passed by the Virginia legislature earlier this year, Virginia will no longer permit enforcement of pay-if-paid provisions in a broad range of circumstances on both public and private construction contracts executed on or after January 1, 2023.
Private Construction Contracts
The new Virginia law (Virginia Senate Bill 550), affects both Virginia’s well-established Prompt Payment Act (Va. Code §2.2-4354) along with a more recent statute addressing wage theft (Va. Code § 11-4.6). With respect to private construction projects, the new law requires higher-tier contractors to pay lower-tier subcontractors either (i) within 60 days of the satisfactory completion of the work for which the subcontractor has invoiced or (ii) within 7 days after receipt of funding by the contractor for work performed by a subcontractor. Receipt of payment by the contractor may not be used as a condition precedent to payment with the sole exception of owner insolvency or bankruptcy. Contractors retain the right to withhold funds from subcontractors for “noncompliance” with the terms of the parties’ subcontract. However, in order to withhold funds from payment, the contractor must notify the subcontractor in writing of his intent to do so along with the justification for the withholding and the amount being withheld. Notably, the definition of “subcontractor” under the new statute excludes parties solely furnishing materials, rendering purchase orders for material suppliers outside the coverage of the new law.
Public Construction Contracts
For public construction contracts, the new rules are similar. General contractors are liable for payments to their subcontractors regardless of whether they receive payment of amounts they themselves are due. Payments to subcontractors may not be conditioned upon receipt of payment by the contractor from a public owner. In fact, contractors are required to include a payment clause in their subcontracts that makes them liable for the entire amount owed to the subcontractor under the parties’ agreement. Likewise, in the event a contractor withholds some or all of the amounts due a subcontractor for a reason permitted under their subcontract, it must notify the subcontractor of that withholding in writing along with the basis for the nonpayment.
Practical Considerations
The removal of pay-if-paid provisions from the library of enforceable risk-shifting clauses under Virginia law rebalances some of the traditional leverage in the relationship between contractors and their subcontractors on both public and private construction projects in the Commonwealth. As a natural consequence of this rebalancing, compliance with other risk-shifting provisions that have the potential to impact subcontractor payment rights will take on greater importance and undoubtedly undergo greater scrutiny by all parties. This will make the negotiation of these other risk-shifting provisions prior to contract signing more important than ever as contractors and subcontractors alike work to create a favorable environment for financial success.
