When Do Subcontractors Have the Right to Stop Work?
The construction industry is rife with project delays – a single setback can create a domino effect leading to delayed payments, legal ramifications, and compounding costs – consequences that are especially difficult for subcontractors to manage.
Contrary to what many general contractors in construction would like to think, subcontractors are not finance companies. Subcontractors actually rely upon timely payment from their customers to make payroll, purchase supplies and materials, and otherwise keep the lights on. Many construction equipment suppliers and other material suppliers will cut off a customer once the aged receivable reaches 60 or 90 days, or at minimum, will switch to a COD arrangement.
In my experience, once a subcontractor has consecutively not been paid two or more monthly invoices – particularly on a large project – the subcontractor’s job site performance will likely take a serious hit, and the long-term detrimental impact could be irreparable.
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Many of our subcontractor clients at Katz Law routinely ask whether they can stop work on a project due to a late payment from the general contractor. While stopping work because of non-payment can be an effective negotiating tool, it can also be a catastrophic breach of contract in its own right. Each situation will be different and must be independently reviewed.
Here are 3 major factors that must be considered before determining whether a subcontractor may stop work on a construction project:
1. Whether Payment is Currently Due
To determine whether any given invoice is actually due, the first question to ask is “What does the subcontract say?” Contract obligations tend to operate parallel to one another, meaning that each side must perform their agreed-upon obligations despite whether or not the other party is performing their obligations. Typically, in order for a subcontractor to sue for an overdue payment, it must have first performed its contractual obligations in full.
Moreover, many subcontracts contain pay-if or pay-when paid clauses, hinging payment to the subcontractor on actual receipt of payment to the GC from the owner. And a typical subcontract will have various ‘hold-back’ clauses, permitting the GC to hold back payment for a laundry list of items, usually in the sole discretion of the GC.
What all this means is that under the terms of the subcontract, the GC may not actually be in breach of contract for not paying a 90 day old invoice, but the subcontractor will be in immediate breach if it stops work. To add insult to injury, some subcontracts will have language requiring the subcontractor to continue work at all costs, even in the face of nonpayment.
2. Consider “Claim” and “Flow-Down” Clauses
Many subcontracts will have a section on claims which set forth a detailed dispute resolution process, which can be useful for the subcontractor. The downside? Often it will require the work to continue during the claims resolution process, so as not to jeopardize the project schedule. This means a work stoppage while the claim process is ongoing is a breach of contract in its own right.
Another common trap for the unwary is the “flow-down” provision. This provision obligates the subcontractor to the general contractor just as the general contractor is obligated to the owner. If the nonpayment is stemming from the owner, than the subcontractor is bound to whatever the prime contract provides in that scenario.
Incredibly, through both of these provisions, a subcontractor’s obligation to proceed with their work is separate from the GC’s obligation to pay for that work, without actually ever stating that the subcontractor must proceed with their work despite non-payment… A difficult situation.
3. Lien and Bond Rights
Depending on the jurisdiction, mechanic’s lien rights and action under the payment bond can be taken while still under contract and performing work. For example, in Maryland the existence of a pay-if-paid clause does not prevent a lien filing or bond claim, and the failure of the owner to pay the GC cannot be used as a defense for nonpayment in those cases.
Before stopping work, subcontractors should file a mechanic’s lien notice, or make demand under the payment bond, bringing the lack of payment to a documented head – forcing the GC to either pay up or go on record as to why they are not.
If all else fails, it’s often in the subcontractor’s best interest to go ahead and stop work on the project – but only as a last resort.
Savvy subcontractors avoid this problem at the pass, and negotiate that boilerplate language to include a right to stop work clause in the event of nonpayment. While negotiating for this language will be met with substantial resistance, it is worth its weight in gold. The following snippet is all that’s required to do the trick:
“Notwithstanding anything herein to the contrary, Subcontractor shall have the right to stop work in the event it fails to receive payment for any work following 45 days after satisfactory performance thereof.”
Simply including this language will provide the subcontractor with the right to stop working without payment in most cases. It also relinquishes the subcontractor from that flow-down obligation, mentioned above. This language is far-reaching enough to include all amounts and generally halts the severe hemorrhaging that occurs when subcontractors work for months on end without pay.
If you are a subcontractor and find yourself facing a similar situation, be sure that all of your bases are completely covered before moving forward. Consider scheduling a free, 15-minute consultation with Katz Law to review your case and provide legal counsel accordingly.