Can I Withhold Payment to Subcontractors? Pay When Paid Clause Change is Coming Soon to Virginia

Real Estate, Land Use & Construction Law

Can I Withhold Payment to Subcontractors? Pay When Paid Clause Change is Coming Soon to Virginia

Nov 4, 2022 | Real Estate, Land Use & Construction Law

In 1995, the Virginia Supreme Court expressly held that general contractors could assert an absolute “pay when paid” defense against subcontractors claiming monetary damages for non-payment of work on a construction project. See Galloway Corp. v. S.B. Ballard Constr. Co., 250 Va. 493, 506 (1995).  Since then, the law of the land had been that general contractors could negotiate in their contracts to withhold payment from subcontractors if the general contractors had not been paid by the owner of a construction project, so long as “the parties mutually intended the contract to create such a defense.”  This meant that contractors were permitted to shift the risk of an owner’s non-payment to the subcontractor so long as the owner’s payment was a “condition precedent” to payment to the subcontractor in the applicable contract. The result would be that a subcontractor, who otherwise performed satisfactorily on a construction job, would not receive payment if the owner, for whatever reason, did not pay the general contractor.  In such circumstances, subcontractors would not have a remedy against the general contractor, and their only recourse may be through a mechanic’s lien filed against the property.

Change in the Commonwealth of Virginia

Pay when paid clauses will no longer be available as an absolute defense in Virginia beginning in 2023. Virginia Governor Glenn Youngkin ratified amendments to Sections 2.2-4354 (construction contracts from state agencies) and 11-4.6 (construction contracts from owners other than a state agency).

State-Agency Construction Contracts

For construction contracts from a state agency, the contract must include 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 subcontracts,” though the contractor would not be liable for amounts reduced due to the subcontractor’s breach, or noncompliance, of the contract. A contractor also must notify a subcontractor, in writing, if part or all of an amount promised to the subcontractor is being withheld, and the contractor must specify the reason for non-payment.  Importantly, “[p]ayment by the party contracting with the contractor shall not be a condition precedent to payment for amounts owed to that contractor.”

Private Construction Contracts

For private construction contracts, Section 11-4.6 of the Virginia Code now states that “[p]ayment by the party contracting with the contractor shall not be a condition precedent to payment to any lower-tier subcontractor, regardless of that contractor receiving payment for amounts owed to that contractor, unless the party contracting with the contractor is insolvent or a debtor in bankruptcy.” Like the state-agency amendment, private contracts also must include a clause that provides that “any higher-tier contractor is liable to any lower-tier subcontractor with whom the higher-tier contractor contracts for satisfactory performance of the subcontractor’s duties under the contract.”

Notably, the contract shall provide that the higher-tier contractor must pay the lower-tier contractor within the earlier of: (i) 60 days of the satisfactory completion of the portion of the work for which the subcontractor has invoiced or (ii) seven days after receipt of amounts paid by the owner to the general contractor or the higher-tiered contractor to the lower tier contractor for work performed by a subcontractor pursuant to the terms of the contract.

If a contractor withholds payment, the contractor must notify the subcontractor, in writing, of the intent to withhold, the reason for nonpayment, the specific identification of the subcontractor’s non-compliance, the dollar amount being withheld, and the lower-tier subcontractor responsible for the contractual non-compliance.

The amendment clarifies that a general contractor, or higher tier contractor, still may withhold payment for the subcontractor or lower tier contractor’s non-compliance with the applicable contract. The amendment also states that retainage provisions in a construction contract are still permitted and unaffected.

What Does this All Mean for General Contractors and Subcontractors

The new law changes the landscape of how construction contracts in Virginia must be drafted. The new laws not only eliminate the age old “pay when paid” defense, but also impose strict obligations on general contractors to inform subcontractors in writing of their decision to withhold payment for non-compliance with the contract.  Subcontractors have gained more contractual leverage and general contractors have more landmines to navigate. 

The new laws are effective and apply to any construction contracts executed on or after January 1, 2023. General contractors and owners of construction projects should now take the time to review their form contracts and implement necessary changes before the law takes effect.

The construction law team at Bean Kinney & Korman will closely watch as the amendment progresses. As always, please contact us with any questions pertaining to this law or other construction law matters.

This article is for informational purposes only and does not contain or convey legal advice. Consult a lawyer. Any views or opinions expressed herein are those of the author and are not necessarily the views of any client.

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