Virginia's New Construction Payment Terms: Are "Pay-When-Paid" Clauses A Thing of the Past in Virginia?
By James Harvey, Vandeventer Black LLP
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. Starting with contracts executed on or after Jan. 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 article attempts to explain the new law and some of the uncertainties it creates.
I. 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. In other words, 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 or any delay in payment by the public body – 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 below, 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 a nominal rate (for example, 0.1 per year), then this newly permitted contract provision effectively blunts any consequence 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.
II. NEW PAYMENT REQUIREMENTS FOR ALL VIRGINIA CONSTRUCTION PROJECTS.
Along with changes to the Virginia Prompt Payment Act, §2.2-4354, for projects subject to the Virginia Public Procurement Act, changes to Virginia’s “wage theft” statute, Va. Code §11-4.6, specify new payment requirements to lower-tier subcontractors for all projects, public or private in Virginia.
A. New Payment Obligation for Owners
For the first time by statute, Virginia now requires that the owner of any project pay the general contractor “within 60 days of the receipt of an invoice following satisfactory completion of the portion of the work for which the general contractor has invoiced.” Satisfactory completion is not defined, and most contracts expressly provide that a progress payment is not acceptance of the work, as approval and acceptance usually occur at final completion. If the owner is going to withhold payment, it must do so in writing and with reasonable specificity of the reasons for nonpayment. This does not affect the right to withhold retainage on a project until final completion. Importantly, this 60-day payment requirement does not apply to public bodies as they are excluded from the definition of “owner.”
The owner’s failure to make timely payment now exposes it to liability for interest payments under the Prompt Payment Act at 1% per month unless otherwise stated in the contract. A smart owner will now include a nominal interest rate in its contracts to blunt any impact arising from this new requirement.
B. Prompt Pay on all Construction Projects? Kind of.
The new payment provisions of Va. Code §11-4.6 then focuses on payment requirements between contractors and subcontractors. The statute expressly excludes persons solely furnishing materials, so material suppliers are unlikely to reap the benefits of its new payment terms. Any contract between a higher-tier and lower-tier contractor is now deemed to include a provision that the higher-tier contractor is liable to the lower-tier contractor “for satisfactory performance of the subcontractor’s duties under the contract” and must make payment within the earlier of:
i. 60 days of the satisfactory completion of the portion of the work for which the subcontractor has invoices, or
ii. Seven days after receipt of the amounts paid by the owner or higher-tiered contractors for work performed by a subcontractor “pursuant to the terms of the contract.”
A contractor is not liable for amounts “reducible pursuant to a breach of contract by the subcontractor.” Like the Prompt Payment Act, the contractor withholding payment must notify the subcontractor, in writing, with the reason for nonpayment, specifically identifying the contractual non-compliance, the dollar amount being withheld, and the lower-tier subcontractor responsible for the contractual noncompliance. This last phrase gives general contractors a difficult task of determining how a subcontractor sub-subcontracted different portions of its work so it can assign responsibility to the right sub-subcontractors.
Because this statute applies to all contractors and subcontractors, even if a public body does not make payment to a general contractor within 60 days, the general contractor is still obligated to pay its subcontractor within that time. If an owner waits a full 60 days to make payment to the general contractor, the general contractor will have to pay its subcontractors before that same 60-day period elapses. Even more confusing, the subcontractor’s invoice may be dated prior to date of the general contractor’s invoice to the owner so that the general contractor must now monitor multiple 60-day clocks with the owner and each of its subcontractors. This promises to be a logistical headache for even the most sophisticated of general contractors. General contractors will now likely engage in a lengthy process to evaluate and approve every aspect of a subcontractor’s invoice, down to the date, often rejecting the invoice and frustrating subcontractors.
Again, the failure to make timely payment results in the Prompt Payment Interest provision of 1% per month, unless the contract states otherwise. Expect contracts to make clear that “satisfactory completion” of subcontract work is something to be determined by the owner and that invoices are not proper or approved until the owner provides its consent. Contractors now have a strong incentive to include a nominal interest provision for late payments to avoid the 12% statutory rate resulting from any violation of this new prompt payment requirement.
C. No Pay-When-Paid in Virginia? Sort of.
The statute also attempts to eliminate pay-when-paid provisions in Virginia, with a curious caveat:
Payment 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 as defined in §50-73.79.
This means that every general contractor and subcontractor must be prepared to finance the entire scope of work subcontracted to lower-tier contractors. General contractors will need to demand proof of financial assurance of owners, negotiating strict terms of payment before proceeding with work, since payment seemingly is due 60 days after properly invoiced. Yet, the statute then provides an exception to this payment obligation if the owner or general contractor (“party contracting with the contractor”) is insolvent or filed for Chapter 11 bankruptcy protection. So, if the contractor or owner is insolvent, there is no obligation to pay subcontractors for work performed and properly invoiced. Contractors will now modify their subcontracts to make clear that “pay-if-paid” liability still resides with the subcontractor. The statute does not define insolvency and only references corporate liquidation bankruptcy proceeding, not personal bankruptcies or reorganizations, leaving confusion over when these exceptions apply. Also, it is not clear whether there liability exists if the contractor makes a “good faith” determination of insolvency, but it is later determined that the owner was not insolvent.
Contractors of all tiers now appear to be responsible for “slow-pay” situations, but rarely “no-pay” projects where financing disappears, and owners or contractors become “insolvent.” They may be able to limit their exposure to this new liability by carefully drafting payment and interest terms, paying strict attention to when work may be invoiced. While 60-day payment terms may be an improvement for contractors, many will still want to include quicker payment requirements in their individual contracts.
The new payment laws create confusion in construction contracts. Owners and contractors are now statutorily required to make payment within 60-days of “satisfactory completion” of work subject to an invoice, regardless of payment from the owner or higher-tier contractor. While this obligation does not apply when an owner is “insolvent,” the statute provides little guidance on how a contractor is to make that determination. However, owners and contractors can blunt the impact of this statute with insertion of a nominal interest fee. The Department of General Services is tasked with reviewing payment conditions on public projects by the end of 2022, but contractors should not expect that review to resolve all the confusion caused by this statute.
Ignoring this new law will only cause more headaches later. Contractors, at all levels, need to review their contracts now and proactively craft language to meet project needs for this changing construction landscape in Virginia.