In a very important reported case handed down by a California Appeals Court on April 17, 2020, Crosno Construction v. Travelers Casualty and Surety Company, (2020 WL 1899278) the Court held that denying a public works payment bond claim by the surety on the grounds that the subcontract contained a “pay when paid” clause was precluded when payment to the subcontractor was delayed until the general contractor’s litigation concluded against the owner public agency.
In Crosno, the Appeals Court ruled that Travelers Casualty and Surety Company could not use a “pay when paid” clause contained in its subcontractor’s agreement as a defense to a statutory payment bond claim. Because, like a “pay if paid” clause, the “pay when paid” clause had the same effect: to alter or impair the subcontractor’s right to receive payment under the a payment bond. Therefore, the surety could not simply rely on that clause in denying the subcontractor’s bond claim.
So, what does this decision mean for the construction industry?
General Contractors: This is not good news. General contractors will have to carefully review their “pay when paid” provisions within their subcontracts to determine whether they run afoul of this decision. If the provision functions to alter or impair the subcontractor’s rights against the statutory payment bond, the clause cannot be enforced. In practical terms, what this means is that general contractors may be forced to pay subcontractors for amounts owed even when they have not yet been paid by the owner; essentially financing the owner dispute. The subcontractor may no longer have to wait to get paid until the dispute with the owner is resolved.
Sureties: This is likewise not good news. The payment bond surety may no longer be able to rely upon a “pay when paid” provision to deny an otherwise valid and timely payment bond claim. This defense may or may not be available to the surety depending on the exact language of the payment provision. Once again, provisions which function to alter or impair the subcontractor’s rights to payment, rather than realistically establish a “reasonable” period for payment will not apply and may force the surety to validate the claim.
Impact on Change Orders/Extras: Another unknown consequence of this decision is what impact it will have on change order and extra claims. If the subcontractor is directed by the general contractor to perform change order work and the owner has yet to pay for these extras, could the subcontractor simply submit a payment bond claim and receive payment? Once again, the specific “pay when paid” clause becomes critical.
We are recommending that all parties consult with legal counsel immediately about updating “pay when paid” clauses to ensure they fall outside of the restrictions of this decision. Because this opinion has been certified for publication, it can be cited throughout the State as authority.
Pursu Agency