A contingent payment clause by definition conditions a paying party’s payment upon the independent action of a third party. For instance, if a general contractor agrees to remodel a customer’s kitchen, independently contracting with a plumber to re-route pipes the general contractor may reserve payment to the plumber contingent on payment from the home owner. By doing this a general contractor is able to pass on the risk of non-payment to the subcontractor, the plumber in this scenario. The general contractor would include a contingent payment clause provision within the contract that the general contractor has with the subcontractor.
A contingent payment clause may be worded similar to the following:
8.2.5 TIME OF PAYMENT Receipt of payment by the Contractor from the Owner for the Subcontract Work is a condition precedent to payment by the Contractor to the Subcontractor. The Subcontractor hereby acknowledges that it relies on the credit of the Owner, not the Contractor for payment of Subcontract Work. Progress payments received from the Owner for the Subcontractor for satisfactory performance of the Subcontract Work shall be made no later than seven (7) days after receipt by the Contractor of payment from the Owner for the Subcontract Work.
The transfer of risk, however, has real business consequences, which hold true in most factual scenarios. The passing of risk to the subcontractor generally allows the subcontractor to charge more for his services, as the risk of non-payment must be combined with the actual service and materials charge for an increased new price. Thus, the charge for non-payment risk can be calculated by subtracting the overall charge to the general contractor minus the charges for services and materials.
Contingent payment clauses can become a problem in three separate factual scenarios: (1) when the subcontractor does not have enough cash flow to complete his contractual obligations; (2) the general contractor and end customer have fraudulently conspired to use a contingent payment clause to rid the subcontractor of his contractual benefit of payment; and (3) where there is no alternative remedy to allow the subcontractor to obtain the benefit of his efforts. These problems have three possible remedies. The contractor can void the contingency language of the contract allowing the subcontractor to pursue the contractor for payment with either a lump sum payment, or additional contract for future payments. Or, the parties can contract with another third party to commence an escrow account. As you may have noticed all three of these solutions move toward payment for the subcontractor effectively nullifying the contingent payment clause of the contract between the contractor and subcontractor. This nullification releases the ultimate customer from litigation by the subcontractor due to benefits bestowed upon the customer through the subcontractor’s efforts. Generally, switching liability away from a private party is not a sound legal decision, and this instance is not different in that respect. By changing liability from the private customer to the contractor the subcontractor opens himself to the possibility of bankruptcy and default if the contractor is not backed by the owner’s personal guarantee.