It is well known in California Construction circles that the “Pay If Paid” clause is illegal in this state. There is a great distinction, though, between this clause and a similar clause, known as a “Pay When Paid” clause. A pay if paid clause allows a contractor to tell a subcontractor that if the contractor is unpaid for the subcontractor’s work, then the contractor has no legal obligation to pay the subcontractor, ever. For a great variety of reasons, the California Supreme Court, in the case of Wm. R. Clarke Corp v. Safeco Ins. Co. of America (1997) 15 Cal.4th 882, declared this type of clause illegal in California Construction.
Although the pay if paid clause is illegal in California, the pay when paid clause is still perfectly legal and is found in many subcontracts that contractors issue to their subcontractors. The pay when paid clause allows a contractor to delay paying its subcontractors until the dispute between the contractor and the property owner over payment has been resolved and the contractor is paid by the property owner. Although seemingly reasonable (since it merely delays payment until the contractor is paid by the owner, thereby providing a funding source to pay subcontractors), significant problems still arise.
Perhaps the greatest problem inherent in the pay when paid clause is the delay that ensues between the time when the subcontractor should have been paid in the normal course of events and the date the subcontractor is actually paid under the pay when paid clause. The delay could in fact be several years, with no payment to the subcontractor until after the entire arbitration or litigation process has run its course. For many subcontractors deprived of funding to pay sub-subcontractors, suppliers and even employees, the prospect of waiting years for payment is a financial death knell.
Fortunately, California courts have provided at least some relief to subcontractors on this issue by limiting the pay when paid clause in public works projects where the mandatory payment bond is concerned. In Crosno Construction, Inc. v. Travelers Casualty and Surety Co. of America (2020) 47 Cal.App 5th 940 the California Appellate Court ruled that pay when paid clauses are not enforceable when they allow a payment bond surety on a public works project to delay payment to subcontractors to an uncertain, unspecified point in time, including waiting until the eventual conclusion of arbitrations or litigation. Despite this bit of relief, most find the single limited Appellate Court case to be inadequate. Although the Crosno decision has been applied in some private works contexts, many legal commentators and some lower court judges have attempted to limit the Crosno case to public works projects, and only then solely to where payment bond claims are concerned. The case is thus of little help where subcontractors are pursuing stop payment notice or mechanics lien claims or simple breach of contract claims.
What tools, then, do subcontractors have to protect themselves from pay when paid clauses in the case of a stop payment notice claim on a public works project or on private works projects where a mechanics lien, stop payment notice, private works payment bond or simply breach of contract claim is concerned? Consider the following options:
Tools for Limiting the Pay When Paid Clause:
- Imposing Reasonable Limitations on Delay:
Most contractors will allow minimal negotiations and changes to contract terms. Take the time to seek changes when made available. One option would be to propose a reasonable limitation on an open-ended payment clause. You might add a seemingly reasonable limitation. For example, add, “so long as the delay in payment does not exceed six (6) months from the date of subcontractor’s billing.” Or you might tie it to your own legal obligations by adding, for example, “so long as the delay in payment does not exceed the deadline by which subcontractor must file suit to pursue mechanics lien, stop payment and bond claim rights.” This seems reasonable since the subcontractor is required to pursue claims at that point. But the implications are important because the payment limitation itself then ends and continued failure to pay could constitute a breach of contract, thereby giving the subcontractor the upper hand from that point forward. Successfully introducing revisions similar to either of these examples can produce substantial benefits.
- Include an Attorney Fee Provision as a Strategic Lever:
It is advisable to consider adding an attorney fee clause which provides for attorney fees to the prevailing party in arbitration or litigation if the subcontract does not already contain one. Many subcontracts do not have such a clause because the prospect of a contractor paying attorney fees to each of his subcontractors is too great a threat, so the contractor avoids the clause, and reaps a strategic benefit. The addition of a clause limiting allowable delay, combined with the right to collect attorney fees as the prevailing party can be a powerful duo by a subcontractor against a contractor. When push comes to shove and a contractor has delayed payment to a dozen subcontractors, it is important to consider which of the subcontractors the contractor will settle with and pay sooner, the one that has actively limited the right to delay payment and imposed attorney fees for violating that right, or the one who has not? Clearly, it is best for a contractor to settle with the subcontractor that has protected itself with a limitation of allowable delay and an attorney fee clause. Even a small increment of added protection can make the difference between getting paid and not, or having your subcontracting business survive a delay in payment.
- Document a Failure of Mutual Assent on the Issue:
Another option, although not as powerful, might be found in California Civil Code sec. 1550, which requires that both parties agree or provide “mutual assent” on each contract term. If there is lack of mutual assent on a single term the court might not enforce it. Because of the ambiguity of the language used in some pay when paid clauses and the evolving state of the law (see Clarke v. Safeco and Crosno, above), it might be useful to challenge a pay when paid clause as an initial matter to document a lack of mutual assent. For example, crossing out the clause and writing on the subcontract in the location of the clause: “Illegal pay if paid clause. Clarke v. Safeco, Crosno,” and then add your initials. Even if the other party does not also initial the note, you have made your position clear. There is no mutual assent on that clause.
- Substantive and Procedural Unconscionability
If you receive a contract with terms that are so overly harsh, one sided or unfairly advantageous to one party such that it can be said that those provisions “shock the conscience of the court” (known as “substantive unconscionability”) and the contractor refuses to allow changes to be made to the contract (known as “procedural unconscionability”) then you may be able to convince the court that because you have both “substantive” and “procedural” unconscionability, the offending clauses, or even the entire contract should not be enforced (see Civil Code 1670.5).
The “pay when paid” clause is still arguably valid in most construction cases, particularly in regard to private works projects, mechanics liens, stop payment notices, private payment bonds and contract claims generally. Until the court provides a broader defense to subcontractors awaiting payment in the face of payment disputes, the best that can be done by a subcontractor is to limit the enforceability of the clause through negotiation or challenge. Consideration of some of the above tools may be helpful to you in the process.
Article written by William L. Porter, Esq. in 2026. Mr. Porter is a principal in Porter Law Group, Inc. in Sacramento, California. He can be reached by phone at (916) 381-7868. Visit the firm’s website at www.porterlaw.com.
