Virginia General Assembly Passes Law Prohibiting the Application of Pay-if-Paid Clauses on Both Public and Private Projects

During the 2022 Session, the Virginia General Assembly passed SB 550, which, among other things, prohibits the application of contingent payment or condition precedent payment clauses (known as “pay-if-paid” clauses) under most circumstances. The bill also establishes prompt payment clauses for prime contracts and subcontracts on private projects, whereas, Virginia’s Prompt Payment Act was formerly applicable only to public projects. The final language of the bill included a delayed enactment clause so that the statutory changes in SB 550 will not take effect until January 1, 2023. This delay gives project owners, developers, design professionals, general contractors, and subcontractors the opportunity to work with counsel to modify contracts, subcontracts, and the payment application review and approval processes, to both comply with the new statutory language and to provide the maximum amount of protection available to prevent a catastrophic outcome. It also allows time for stakeholders to work towards agreement on revisions to the language of the bill addressing its numerous ambiguities.

This is a link to the final language of the bill, which looks very different from the language of the original bill that was introduced by Senator Bell, or the first substitute presented in committee. The bill passed the Senate but was extensively amended by the House committee, which added two exceptions to the prohibition on pay-if-paid clauses and prompt payment language for private contracts. The Governor proposed a substitute bill that incorporated several changes to the language of the bill that passed the House and was approved by the Senate.

• Language was added to the Virginia Public Procurement Act (VA Code 2.2-4354) section that establishes clauses that must be included in public construction contracts:

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, if 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 payment to any lower-tier subcontractor, regardless of that contractor receiving payment for amounts owed to that contractor. Any provision in a contract contrary to this section shall be unenforceable.

Pursuant to this new clause, contracts for public projects must include a clause “that obligates a contractor on a construction contract to be liable for the entire amount owed to any subcontractor with which it contracts.” However, the contractor is not liable to pay the subcontractor “for amounts otherwise reducible due to the subcontractor’s noncompliance with the terms of the contract.” But, if the contractor intends to withhold all or part of a payment from the subcontractor, the contractor must provide written notice to the subcontractor “of his intention to withhold all or a part of the subcontractor’s payment with the reason for nonpayment.” Last, but certainly not least, pay-if-paid clauses in contracts for public projects will be unenforceable, without exception.

• Language was added to the Virginia Wage Theft Law (Virginia Code 11-4.6):

“Owner” means a person or entity, other than a public body as defined in § 2.2-4301, responsible for contracting with a general contractor for the procurement of a construction contract.

B. In any construction contract between an owner and a general contractor, the parties shall include a provision that requires the owner to pay such 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. An owner shall not be required to pay amounts invoiced that are subject to withholding pursuant to the contract for the general contractor’s noncompliance with the terms of the contract. However, if an owner withholds all or a part of the amount invoiced by the general contractor under the terms of the contract, the owner shall notify the general contractor, in writing and with reasonable specificity, of his intention to withhold all or part of the general contractor’s payment with the reason for nonpayment. Failure of an owner to make timely payment as provided in this subsection shall result in interest penalties consistent with § 2.2-4355. Nothing in this subsection shall be construed to apply to or prohibit the inclusion of any retainage provisions in a construction contract.

C. Any contract in which there is at least one general contractor and one subcontractor shall be deemed to include a provision under which 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. Such contract shall require such higher-tier contractor to pay such lower-tier subcontractor 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 by the higher-tier contractor to the lower-tier contractor for work performed by a subcontractor pursuant to the terms of the contract. Such contractors shall not be liable for amounts otherwise reducible pursuant to a breach of contract by the subcontractor. However, if a contractor withholds all or a part of the amount invoiced by any lower-tier 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, specifically identifying the contractual noncompliance, the dollar amount being withheld, and the lower-tier subcontractor responsible for the contractual noncompliance. 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. Any provision in a contract contrary to this section shall be unenforceable. Failure of a contractor to make timely payment as provided in this subsection shall result in interest penalties consistent with § 2.2-4355. Nothing in this subsection shall be construed to apply to or prohibit the inclusion of any retainage provisions in a construction contract.

These new requirements apply to “Construction Contracts,” defined in the Wage Theft Law as “a contract between a general contractor and a subcontractor relating to the construction, alteration, repair, or maintenance of a building, structure, or appurtenance thereto, including moving, demolition, and excavation connected therewith, or any provision contained in any contract relating to the construction of projects other than buildings.” In the new language, “General Contractor” and “Subcontractor” continue to use definitions from the Virginia Mechanic’s Lien Statute (Virginia Code § 43-1).

Pursuant to new subsection B, any prime contract on a private construction project must include a provision requiring “the owner to pay such 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.” It is unclear if this provision will prevent owners and contractors from entering into a contract with milestone payments rather than payments after invoices are submitted at regular intervals. It is also unclear how this new prompt payment language will affect the submission of pencil copies of payment applications prior to the submission of final versions for approval and payment. As in the changes to the Prompt Payment Act, subsection B states that the Owner “shall not be required to pay amounts invoiced that are subject to withholding pursuant to the contract for the general contractor’s noncompliance with the terms of the contract.” If the Owner intends to withhold all or part of the amount invoiced, “the owner shall notify the general contractor, in writing and with reasonable specificity, of his intention to withhold all or part of the general contractor’s payment with the reason for nonpayment.”  Subsection B also imposes interest penalties under Virginia Code § 2.2-4355 on owners who fail to make timely payments. Virginia Code § 2.2-4355(B) establishes that the rate of interest shall be the base rate on corporate loans (prime rate) at large United States money center commercial banks as reported daily in the Wall Street Journal. The new language does not apply to or prohibit retainage provisions in prime contracts.

Subsection C applies to subcontracts between the General Contractor and Subcontractor. These subcontracts must include a provision “under which 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.” Subsection C states that the contract “shall require such higher-tier contractor to pay such lower-tier subcontractor 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 by the higher-tier contractor to the lower-tier contractor for work performed by a subcontractor pursuant to the terms of the contract.” Note that there is a potential gap between the 60-day payment period in subsection C and the 60-day payment period in subsection B so that a General Contractor may be obligated to pay its subcontractors prior to the General Contractor receiving payment from the Owner.

Using the language in the first sentence of Subsection C and the definitions in Virginia Code § 11-4.6 and § 43-1, it remains unclear if Virginia Courts will apply the requirements in Subsection C to sub-subcontracts, although it appears that the General Assembly intended these provisions to apply to subcontracts and sub-subcontracts, regardless of tier.

Subsection C also states that “such contractors shall not be liable for amounts otherwise reducible pursuant to a breach of contract by the subcontractor.” But, as in Subsection B, if the contractor withholds all or a part of the amount invoiced by any lower-tier subcontractor, the contractor must provide written notice to its subcontractor “of his intention to withhold all or a part of the subcontractor’s payment with the reason for nonpayment, specifically identifying the contractual noncompliance, the dollar amount being withheld, and the lower-tier subcontractor responsible for the contractual noncompliance.” If a higher-tier contractor intends to withhold payment of any amount invoiced, then they must be proactive in providing written notice with the information required. We expect that General Contractors and Subcontractors will err on the side of caution, providing written notice of withholding payment any time there is even the slightest discrepancy, question, or problem with a payment application. It may prove difficult for a contractor to meet the requirements of this section, particularly in identifying the “lower-tier subcontractor responsible for the contractual noncompliance” if the contractor does not yet know who is responsible at the time that the payment application is pending.

Subsection C also includes a provision rendering pay-if-paid clauses unenforceable in subcontracts for private projects, but with two exceptions: “unless the party contracting with the contractor is insolvent or a debtor in bankruptcy as defined in § 50-73.79.” General Contractors pushed for these exceptions to be added to the bill. These exceptions protect General Contractors and higher-tier Subcontractors in the event that the party above them in the chain of contract becomes insolvent as defined in the Virginia code, or files for bankruptcy. However, it is unclear if these exceptions apply to downstream subcontractors if the Owner is insolvent or files for bankruptcy, or if this protection is limited to the General Contractor.

Although subcontractors are excited that SB 550 prohibits the enforcement of pay-if-paid clauses in most circumstances, SB 550 will not solve some thorny issues, like non-payment for work that is performed subject to a change order rejected due to a dispute over whether the work is an extra or falls within the contract scope. Furthermore, on private projects, lower-tier subcontractors still run the risk of being left holding the bag if the owner goes bankrupt or is insolvent. Discussions are already underway concerning potential modifications and clarifications to be proposed during the 2023 General Assembly Session. Now is the time to discuss with counsel how to modify the contract and subcontract forms and procedures for review, approval, and payment of invoices and payment applications to ensure compliance with these new provisions.