Although these two types of payment terms can seem acceptable at first glance, both can create significant commercial risk for the unsuspecting contractor. These payment terms are more likely to apply or be seen when there is a subcontractor/main contractor relationship, rather than a contractor/owner relationship.

It’s not too difficult to understand what these payment terms mean:

Paid When Paid: This means that when the main contractor receives payment from the owner for work that includes the subcontractor’s work, then the main contractor will pay the subcontractor.

Paid If Paid: This means that if the main contractor receives payment from the owner for his work that includes the subcontractor’s work, then and only then will the main contractor pay the subcontractor.

The subcontractors’ commercial risk with both of these types of payment terms is that they basically relieve the general contractor of the obligation to pay them on a timely basis for their work.

Claims, disputes, or other issues may arise between the owner and the main contractor, which may cause the owner to delay paying the contractor on a timely basis. The main contractor may or may not suffer from this payment delay, but one thing is for sure—the subcontractor will certainly suffer from the delay in payment of his invoices.

Main contractors like to use these payment terms because they can avoid having to use their own cash to pay subcontractors. That’s understandable, but it doesn't mean that subcontractors have to agree to these types of payment terms.

The bottom line is that the main construction contract for the project is between the owner and the main contractor, not the subcontractor and the owner. The subcontractor goes through the lengthy exercise of estimating, pricing, bidding, and negotiating the work solely with the main contractor, and the resulting construction contract and its commercial terms and conditions are negotiated with the main contractor, not the owner. The commercial terms and conditions that are negotiated between the owner and the main contractor are their business, and the subcontractor has little or no influence or say in the matter.

How can the subcontractor perform a cash flow analysis of his work without really knowing the time period he can use to receive payments from the main contractor? The main contractor may agree to the subcontractor’s 30-day payment terms, but with a paid when paid or paid if paid provision also applying.

In this case, what does the subcontractor use as timing in his cash flow analysis for his receipt of payments? Thirty days, forty-five, sixty, or more? Maybe it’s okay for the subcontractor not to rock the boat and to agree to these types of payment terms and just keep his fingers crossed that the main contractor will pay him on time, but that’s a formula for a cash flow problem.

When paid when paid or paid if paid provisions arise, it’s important for the subcontractor to try to take some measure of control over the payment terms for his own benefit.

Two good negotiating options are:

1. Delete the contractor’s paid when paid or paid if paid payment terms in the contract, and substitute the subcontractor’s preferred terms of payment.
2. Find some compromise payment terms that include the main contractor’s paid when paid or paid if paid payment terms, but with some time limitations on receipt of payment that favor the subcontractor.

The first option is self-explanatory. If the subcontractor can negotiate including his preferred payment terms into the commercial terms and conditions of his construction contract, then that, of course, is the best way.

However, it may be difficult to get the main contractor to delete the paid when paid or paid if paid terms. The main contractor may agree to some time limit to pay the subcontractor. Therefore, if the main contractor agrees to the subcontractor’s 30-day payment period subject to the paid when paid or paid if paid provisions, he might also agree to payment terms wording similar to the following:

Article 44 ¬Terms of Payment

44.1 Subcontractor’s payment invoices shall be paid within 45 days of receipt by Main Contractor, provided that Main Contractor has also been paid by Owner for the work performed under Subcontractor’s invoices.

44.2 Notwithstanding the above, Main Contractor agrees to pay Subcontractor’s payment invoices in any event no later than 70 days from date of receipt by Main Contractor of Subcontractor’s invoice.

Allowing the main contractor 70 days to pay the subcontractor’s invoices is certainly not the best. But considering that the contractor might not have to pay the subcontractor’s invoices for a much longer time under the paid when paid orpaid if paid terms of payment, at least there is a maximum time period in place within which the contractor must pay the subcontractor’s invoices.

Article 44.2 obligates the main contractor to pay the subcontractor, regardless of whether or not he has been paid for the subcontractor’s work by the owner. That’s good. The subcontractor could have tried to negotiate a shorter time period in Article 44.2, such as 45 days.

Excerpted from Understanding & Negotiating Construction Contracts: A Contractor's & Subcontractor's Guide to Protecting Company Assets, available through RSMeans