87 N.Y.2d 148 (1995)

A ‘pay-when-paid’ provision in a subcontract that transfers the risk of owner non-payment from the general contractor to the subcontractor is void as against public policy under New York Lien Law § 34.

Summary

This case addresses the enforceability of a ‘pay-when-paid’ clause in a construction subcontract under New York Lien Law. West-Fair Electric contracted with Gilbane Building Company (the general contractor) for work on a project. The subcontract contained a clause stating West-Fair would only be paid when the owner paid Gilbane. When the owner became insolvent and failed to pay Gilbane, West-Fair sued Gilbane and Aetna (the surety). The New York Court of Appeals held that the ‘pay-when-paid’ clause was void as against public policy because it effectively waived the subcontractor’s right to file a mechanic’s lien, violating Lien Law § 34, which protects contractors and subcontractors.

Facts

Gilbane Building Company was the general contractor for the Westchester Pavilion construction project.

Gilbane subcontracted with West-Fair Electric Contractors to perform electrical work.

The subcontract contained a “pay-when-paid” clause stating that Gilbane’s payment obligation to West-Fair was contingent on Gilbane receiving payment from the owner.

The owner became insolvent and stopped making payments to Gilbane.

Gilbane, in turn, did not pay West-Fair for the work completed.

West-Fair sued Gilbane and Aetna, the surety, to recover the unpaid balance.

Procedural History

West-Fair sued in federal district court.

The District Court granted summary judgment to West-Fair, holding the pay-when-paid provision void as against public policy.

Defendants appealed to the Second Circuit Court of Appeals.

The Second Circuit certified two questions to the New York Court of Appeals.

The New York Court of Appeals accepted the certified questions.

Issue(s)

Whether a “pay-when-paid” provision in a subcontract, which transfers the risk of the owner’s default from a general contractor to a subcontractor, violates New York public policy as set forth in the Lien Law.

Whether a surety’s liability is contingent on the duty of a contractor to make payment to a subcontractor when the surety bond created an independent obligation to that subcontractor.

Holding

Yes, because a “pay-when-paid” provision that forces a subcontractor to assume the risk of owner non-payment is void as against public policy under Lien Law § 34.

The Court did not reach the second certified question.

Court’s Reasoning

The Court reasoned that Lien Law § 34 prohibits any agreement that waives the right to file or enforce a mechanic’s lien. The court stated, “It is evident from the foregoing that New York’s Lien Law is remedial in nature and intended to protect those who have directly expended labor and materials to improve real property at the direction of the owner or a general contractor.”

The Court distinguished between a “pay-when-paid” provision that merely fixes a time for payment (which is permissible) and one that makes payment contingent on the owner’s payment, effectively shifting the risk of non-payment to the subcontractor.

The Court found the clause at issue to be the latter, stating: “As a matter of contract law, the owner and the general contractor are liable to plaintiff for the work plaintiff has been authorized to perform, and performed, under the subcontract agreement. However, a pay-when-paid provision as a condition precedent requires plaintiff to defer payment for its work until the general contractor has been paid by the owner. As the owner here has become insolvent, the owner may never make another contract payment to the general contractor. Because the lack of future payments by the owner is virtually certain, plaintiff’s right to receive payment has been indefinitely postponed, and plaintiff has effectively waived its right to enforce its mechanics’ liens.”

The Court rejected the argument that the subcontractor retained meaningful rights under the Lien Law because it could still file a lien, stating: “The Lien Law distinguishes between the right to file and the right to enforce mechanics’ liens and prohibits any contract, agreement or understanding waiving either right (Lien Law § 34).”

The court concluded that the pay-when-paid provision extinguished the subcontractor’s ability to enforce a lien because the debt was uncollectible until the owner paid the general contractor, violating the public policy of protecting subcontractors who improve real property.