Virginia Prohibits Pay If Paid Clauses

Takeaways:

• Virginia amends current law to prohibit “pay if paid” clauses and impose new contract requirements on public and private jobs.

• Virginia contractors need to be aware of this fundamental shift, as well as existing employee wage liabilities.

One of the most important provisions for a subcontractor in any subcontract is a “pay if paid” clause. In a nutshell, that clause, when used with the proper language, conditions payment by the general contractor to the subcontractor on payment by the owner to the general contractor.  If the owner fails to pay the general contractor, the GC does not have to pay the subcontractor.

While subcontractors, at least in Maryland, still have mechanics’ lien rights against the owner of the property notwithstanding a “pay if paid” clause in their subcontract, the clause significantly shifts the risk of nonpayment to the (usually) smaller subcontractor.

Last month, Virginia took steps to remedy this risk-shifting mechanism by amending current law to prohibit “pay if paid” clauses and impose new contract requirements on public and private jobs.

Public Contracts

The amendment (to Virginia Code § 2.2-4354) imposes several new requirements on covered public contracts:

•           Public contracts must contain a payment clause that obligates a contractor to be liable for the entire amount owed to any subcontractor with which it contracts;

•           Contractors are not liable to the subcontractor for amounts attributable to the subcontractor’s noncompliance with the subcontract;

•           If a contractor withholds payment from a subcontractor for noncompliance, it must notify the subcontractor, in writing, of its intention to do so and the reasons for nonpayment.

•           Payment to the contractor shall not be a condition precedent to the contractor paying its subcontractors.

Contractors should keep in mind that the existing statute already requires a payment clause in the contract obligating the contractor, within seven days after being paid for the subcontractor’s work, to:

•           Pay the subcontractor the proportionate share for its work; or

•           Notify the governmental agency and the subcontractor of its intention to withhold payment and the reasons for such withholding.

Finally, the existing law also requires these payment requirements to flow down to subcontractors and their subcontracts.

Private Contracts

Likewise, the new law amends Virginia Code § 11-4.6 and imposes new obligations on private construction contracts:

•           Private construction contracts between an owner and the general contractor must contain a provision that requires the owner to pay the general contractor within 60 days of invoice;

•           Owners can withhold payment based on noncompliance, but it must notify the general contractor in writing of its intention to do so and the reasons for doing so;

•           The amendments exclude retainage;

•           Subcontracts (contracts between the general contractor and a subcontractor) are deemed to include a provision whereby the contractor is liable for the subcontractor’s duties under the subcontract;

•           The general contractor must pay subcontractors within the earlier of (a) 60 days from satisfactory completion of work or (b) seven days after receipt of payment;

•           Contractors are not liable for work by the subcontractor that breaches the subcontract, but the general contractor must notify the subcontractor of its intent to do so and the reasons (as above), but also must advise the subcontractor of the specific contractual noncompliance, the dollar amount being withheld and lower-tiered subcontractor responsible for the noncompliance; and

•           As with public contracts, payment to the contractor shall not be a condition precedent to paying lower-tiered subcontractors.

Liability for Subcontractors’ Wage Claims

As with Maryland, existing Virginia law already contains provisions making the contractor and higher-tiered subcontractors liable for lower-tiered subcontractors’ unpaid wages to its employees.  Those provisions also incorporate penalty and indemnity requirements.

However, in Virginia these specific wage provisions only apply if

•           It can be demonstrated that the general contractor knew or should have known that the subcontractor was not paying its employees all wages due;

•           The construction contract does not involve a single-family residential project, and

•           The value of the project is greater than $500,000.

Virginia also provides contractors a safe harbor. A general contractor may offer a written certification, under oath, from the subcontractor in direct privity of contract with the general contractor stating that

•           The subcontractor and each of his subcontractors have paid all employees all wages due; and

•           To the subcontractor's knowledge, all lower-tiered subcontractors have similarly paid their employees all such wages.

Conclusion

The amendments, which can be found here, take effect on January 1, 2023 and apply to all contracts executed on or after that date.

Finally, Maryland contractors should not confuse a “pay if paid” clause with a “pay when paid” clause, which requires payment within a reasonable amount of time. With a “pay when paid” clause, the underlying obligation for the general contractor to pay subcontractors remains.