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Caution With “Pay-If-Paid” Contract Clauses

With respect to construction contracts and contracts between a general contractor and a subcontractor, the California Supreme Court has long ago declared that “pay-if-paid” clauses are unenforceable. Back in 1997, the court held a “general contractor’s liability to a subcontractor for work performed may not be made contingent on the owner’s payment to the general contractor….” See William R. Clarke Corp. v. Safeco Ins. Co., 15 Cal.4th 882 (Cal. Supreme Court 1997). In the construction context, the court held such pay-if-paid provisions to be in violation of public policy. The court linked the “violation” of public policy in the California constitution providing subcontractors the express right to file mechanic’s liens if payment is not made for work performed. Any pay-if-paid provisions would jeopardize those statutory rights. Consequently, pay-if-paid clauses were held unenforceable in the construction context.

However, outside of the construction industry, pay-if-paid clauses might be enforceable (although caution is still in order). One case that illustrates the point is the non-precedent case of Nunes v. Central Valley Dairymen, Inc., Case Nos. F056381, F056917, F056943 (Cal. App. 5th Dist. 2010). That case involved several disputes including one over payments for milk delivered to a dairy cooperative. Various individual dairy farmers provided milk and dairy products to the cooperative, Central Valley Dairymen, which then sold the pooled dairy products to others. In one aspect of the dispute, Central Valley provided quantities of dairy products to a company called Valley Gold. But Valley Gold did not pay, for various unrelated reasons, and thus Central Valley did not pay the individual dairy farmers. In the litigation, the farmers contended that this was an unenforceable pay-if-paid contract. At the trial level, the farmers were successful.

However, the California Court of Appeals reversed. The court held that, since the case was not a construction industry case, the public policy issues inherent in mechanic’s lien law were not implicated. Thus, the William R. Clark case was not controlling. Further, the court could not find any other public policy or laws, such as state laws regulating the dairy industry, that would make a pay-if-paid payment system unenforceable. Finally, the court looked at the rules of the cooperative and held Central Valley followed its payment rules. Under the cooperative rules, payment to farmers was based on the net proceeds of the cooperative. Payment was made on that basis, even though the “net proceeds” were substantially diminished by Valley Gold’s non-payment. For these reasons, the California Court of Appeals reversed.

The Nunes case provides a good example of why San Diego businesses should take caution if using any sort of pay-if-paid provision. If you have any contracts containing such provisions or clauses, you should have them reviewed by an experienced San Diego corporate attorney. While such clauses outside of the construction industry will not be automatically void, California courts are hostile to such clauses and will closely examine any sort of pay-if-paid provision.

Contact San Diego Corporate Law

For further information, please contact Michael Leonard, Esq. of San Diego Corporate Law. Mr. Leonard has the experience to help draft and implement all types of business contracts to ensure that they are enforceable. Mr. Leonard has been named a “Rising Star” four years running by and “Best of the Bar” by the San Diego Business Journal. Contact Mr. Leonard via email or by calling (858) 483-9200. Like us on Facebook.

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