(Part one of a two-part article series)
Confused about “pay-when-paid”, “pay-if-paid” clauses and the requirements of Virginia’s Prompt Payment Act on Virginia construction contracts? A new law intending to change the payment landscape may have just created more uncertainty for Virginia contractors. On April 11, 2022 Governor Younkin signed Senate Bill 550 with proposed amendments that, once approved by the General Assembly, create a new statutory framework for the timing of payment on all construction contracts in Virginia. Starting with contracts executed on or after January 1, 2023, this new payment framework applies to both public and private construction projects and applies to all tiers in the contracting chain. However, the statute includes confusing and conflicting language that leaves many open questions. This first article addresses payment terms on public projects in Virginia, while the second article will focus on payment requirements for all other projects.
NEW PROMPT PAYMENT REQUIREMENTS ON PUBLIC PROJECTS
For decades, Virginia’s Prompt Payment Act, Va. Code §2.2-4354, required a contractor and each subcontractor to take one of two actions within seven days of receipt of payment on a public project:
i. Pay the subcontractor the proportionate share of the total payment received, or
ii. Notify the agency and subcontractor in writing of its intention to withhold all or part of the payment with the reason for non-payment.
This is a simple, well-understood payment requirement based on similar prompt payment requirements on federally funded contracts. The statute is now amended by the addition of new Paragraph 1:
1. A payment clause that obligates a contractor on a construction contract to be liable for the entire amount owed to any subcontractor with which it contracts. Such contractor shall not be liable for amounts otherwise reducible due to the subcontractor’s noncompliance with the terms of the contract. However, in the event that the contractor withholds all or a part of the amount promised to the subcontractor under the contract, the contractor shall notify the subcontractor, in writing, of his intention to withhold all or a part of the subcontractor’s payment with the reason for nonpayment. Payment by the party contracting with the contractor shall not be a condition precedent to the payment to any lower-tier subcontractor, regardless of that contractor receiving payment for amounts owed to that contractor. Any provision in any contract contrary to this section shall be unenforceable.
Breaking down this new paragraph by each sentence reveals the new obligations, as well as the ambiguities, and conflicts in the statute.
A payment clause that obligates a contractor on a construction contract to be liable for the entire amount owed to any subcontractor with which it contracts.
Every contract for construction involves the payment of a price for the provision of labor, material, and services. This sentence does not seem to alter the right of the parties to agree on contract terms to determine “the entire amount owed.” The phrase “with which it contracts” reinforces existing Virginia law that, absent another statutory remedy, a party is only liable to a party with whom it contracts — the privity rule. A supplier to a subcontractor can still not sue the general contractor for breach of contract relating to nonpayment. This sentence adds nothing to existing law, except to create confusion as to the meaning of “entire amount owed.” The Prompt Payment Act already required the contractor to make payment for a “proportionate share” of the total payment received, so is “entire amount owed” a different determination? A wise contractor will modify its subcontracts to make clear that NO amount is “owed” until the owner approves and pays the contractor’s invoice containing the subcontractor’s work. This sentence is an unnecessary source of ambiguity.
Such contractor shall not be liable for amounts otherwise reducible due to the subcontractor’s noncompliance with the terms of the contract.
Again, construction contracts provide the terms under which payment will be made, so this sentence appears to not serve any purpose in altering the common law of contracts in Virginia.
However, in the event that the contractor withholds all or a part of the amount promised to the subcontractor under the contract, the contractor shall notify the subcontractor, in writing, of his intention to withhold all or a part of the subcontractor’s payment with the reason for nonpayment.
The Prompt Payment Act already contained a requirement for written notice of the reasons for nonpayment within seven days of receipt of payment from the owner. This sentence appears to duplicate the existing Prompt Payment provisions, except that it does not contain any time limitation on when such notice must occur, and uses the vague phrase “amount promised to the subcontractor under the contract.” Certainly, savvy contractors will make clear that no amount is “promised” until work is approved and paid by the owner. Moreover, the statute does not provide any consequences for not providing notice, making this provision seem unnecessary.
Payment by the party contracting with the contractor shall not be a condition precedent to the payment to any lower-tier subcontractor, regardless of that contractor receiving payment for amounts owed to that contractor.
This is the heart of the statutory change. A contractor, subcontractor or sub-subcontractor is now obligated to all lower-tier subcontractors, regardless of payment by the public body. The general contractor and each subcontractor must be prepared to finance the cost of a public project — a major change in risk allocation. But when does this obligation arise? The statute is silent. Instead, the next paragraph of this statute contains the original prompt payment language that still requires contractors within seven days of receipt of payment, to pay the subcontractor, or notify the agency and subcontractor in writing of the withholding.
So, how long does a subcontractor have to wait to demand payment from a general contractor even if the public body has not made payment? This statute provides no guidance. To answer this question, we must look to the other part of this new law — the changes applicable to all construction projects, public and private at Virginia Code §11-4.6. As discussed in the next article, the changes to this statute requires payment to be made the earlier of 60 days after “satisfactory completion of the work for which the subcontractor has invoiced,” or 7 days after receipt of payment from the owner. This may be a more complicated determination than the statute anticipates as owners rarely affirm “satisfactory completion” of work before final completion of the project. Expect more disputes over whether a subcontractor properly invoiced for its work to claim a right to payment in 60 days.
The statute does not address payment for disputed extra work, changes, or delay costs. Instead, the normal claims procedures remain unchanged. Moreover, the statute only references payment obligations to “lower-tier subcontractors,” and its definition of “contractor” and “subcontractor” specifically excludes persons solely furnishing materials. This means that suppliers are most likely excluded from the benefits of these new payment requirements.
Contractors will now likely modify their “pay-when-paid” clauses in their subcontracts to make clear that they have no obligation of payment to the subcontractor until the work is approved by the owner for invoicing in accordance with the contract, and even then, payment is not due until seven days after receipt of payment from the owner.
Any provision in any contract contrary to this section shall be unenforceable.
This appears to be a statement of public policy targeting conflicting language in subcontracts. It makes those terms unenforceable, leaving only the terms of the Prompt Payment Act. A wise contractor will modify its payment terms to address the ambiguities in this statute and limit potential liability for interest on overdue payments.
The Prompt Payment Act provides the following remedy for untimely payment, “Unless otherwise provided under the terms of this contract, interest shall accrue at the rate of one percent per month.” Subcontracts rarely provide an interest rate on late payments to the subcontractor, and the 12% per annum rate will appear as an attractive remedy for subcontractors. However, the general contractor now has a strong incentive to include an extremely low interest rate on unpaid funds to avoid this statutory rate. If the subcontract provides that all unpaid sums accrue interest at the rate of, for instance, 0.1 per year, then this newly permitted contract provision effectively blunts any consequences for non-compliance with the statute.
While the changes to Virginia’s Prompt Payment Act might have been well intentioned, they appear confusing, unnecessary, conflicting, and in the end, may not create the change intended. General contractors and subcontractors should be wary to make sure their payment terms attempt to comply with these new changes.
We will be providing a continuation on this topic where we will discuss new payment terms for all construction contracts in Virginia in our next article.