“Pay If Paid” Provision in General Contractor/Project Manager’s Contract with Subcontractor Upheld in Face of Claims of Fraudulent Concealment of Financial Status of Project Owner

In Walbridge Aldinger v. Iafrate Constr., et al.07.25.2013, the Michigan Court of Appeals upheld a “pay if paid” provision in the contractual agreement between the general contractor and project manager and a subcontractor.  Anticipating the pending difficulties with its subcontractors in light of the financial status of the project owner, the general contractor filed a declaratory judgment action in Oakland County, Michigan seeking a declaration concerning its liability to subcontractors under the contract, which contained a “pay if paid” provision – essentially guaranteeing payment to the subcontractors only if the general contractor / project manager were paid for the project by the project’s owner / developer.

After addressing several preliminary challenges regarding choice of law, choice of forum and venue (all of which were explicitly provided for in the contractual agreements and specified Oakland County, Michigan as the forum for any litigation (the project was in Indiana)), the Court of Appeals addresses the main substance of the underlying arguments.

The subcontractor filed a motion for summary disposition alleging that the “pay if paid” provision was void due to fraudulent concealment by the general contractor / project manager of the true financial condition of the project owner.  The argument was had the subcontractor known about the shaky financial status of the project’s owner / investors, it may not have entered into a contractual agreement in which it accepted payment only if the general contractor / project manager was paid by the site owner.

The Court of Appeals affirmed the trial court’s rejection of this argument.  In a commercial setting, contracting parties are expected to exercise that degree of diligence necessary to protect their own rights vis-a-vis the other parties.  The Court of Appeals points out there was ample opportunity and information to glean the financial status of the project owner without having to rely on any representations or alleged misrepresentations of the general contractor.  Indeed, the subcontractor explicitly agreed to the contract’s terms, which acknowledged it had considered the site owner’s solvency and ability to pay.  The explicit language of the contract prevented the subcontractor from arguing the contract contemplated only a “reasonable delay” in payment.  In fact, the contract shifted the entire risk of nonpayment to the subcontractor.  There was no question the parties agreed to transfer the risk of upstream default or insolvency.

In short, contracting parties are expected to (1) read and understand the contract’s provisions, and (2) perform due diligence in the event payment for services rendered is conditioned on payment of a superior contractor.

To be sure, the primary argument regarding forum and jurisdiction may very well have resulted in a different outcome as the courts in Indiana are inclined to favor the insured, even in commercial settings like the present, and have allowed movement away from entire risk shifting contractual agreements.

In any event, this is an interesting case which teaches important lessons to the advocates of contractors and subcontractors.

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