(Part one of a two-part article series)
Confused about pay-when-paid, pay-if-paid, and Virginia Prompt Payment Act requirements on Virginia construction contracts? A new law aimed at changing the payments landscape may have just created more uncertainty for entrepreneurs in Virginia. On April 11, 2022, Governor Younkin signed Senate Bill 550 with proposed amendments that, when approved by the General Assembly, create a new statutory framework for the payment schedule for all construction contracts. in Virginia. From contracts executed from 1 January 2023, this new payment framework applies to public and private construction projects and applies to all levels of the procurement chain. However, the law includes confusing and contradictory language that leaves many questions open. This first article discusses payment terms on public projects in Virginia, while the second article will focus on payment requirements for all other projects.
NEW PROMPT PAYMENT REQUIREMENTS FOR 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 receiving payment on a public project:
I. Pay the subcontractor the proportionate share of the total payment received, or
ii. Notify the agency and the subcontractor in writing of its intention to withhold all or part of the payment with the reason for non-payment.
This is a simple and well understood payment requirement based on similar prompt payment requirements on federally funded contracts. The statute is now modified by the addition of the new paragraph 1:
1. A payment clause which obliges a contractor on a construction contract to be liable for the full amount due to any subcontractor with whom he contracts. Such contractor shall not be liable for amounts otherwise reducible due to the subcontractor’s failure to comply with the terms of the contract. However, in the event that the Contractor withholds all or part of the amount promised to the Subcontractor under the Contract, the Contractor shall notify the Subcontractor in writing of its intention to withhold all or part of the payment from the Subcontractor to the reason for non-payment. Payment by the party contracting with the Contractor shall not be a condition precedent to payment to any lower level subcontractor, regardless of whether such Contractor receives payment of monies due to such Contractor. Any provision of any contract contrary to this article 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 full amount due to any subcontractor with whom it contracts.
Any construction contract involves the payment of a price for the supply of labour, materials and services. This sentence does not appear to affect the right of the parties to agree on the contractual terms to determine “the full amount due”. The phrase “with which it contracts” reinforces existing Virginia law that, in the absence of any other legal remedy, a party is liable only to a party with which it contracts – the confidentiality rule. A supplier of a subcontractor still cannot sue the general contractor for breach of contract related to non-payment. This sentence adds nothing to the existing law, except to create confusion as to the meaning of “the full amount due”. The Prompt Payment Act already required the contractor to make payment of a “proportionate share” of the total payment received. So is “total amount due” a different determination? A savvy contractor will amend their subcontracts to specify that NO amounts are “due” 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 failure to comply with the terms of the contract.
Again, construction contracts provide for the terms under which payment will be made, so this sentence does not appear to be used to change common contract law in Virginia.
However, in the event that the Contractor withholds all or part of the amount promised to the Subcontractor under the Contract, the Contractor shall notify the Subcontractor in writing of its intention to withhold all or part of the payment from the Subcontractor to the reason for non-payment.
The Prompt Payment Act already provided for a requirement for written notification of the reasons for non-payment within seven days of receipt of payment by the landlord. This sentence appears to duplicate existing provisions on prompt payment, except that it contains no time limit as to when such notice must occur and uses the vague phrase “amount promised to subcontractor under contract “. Certainly, savvy contractors will make it clear that no money is “promised” until the work is approved and paid for by the owner. Moreover, the law does not provide for any consequences in the event of non-notification, which makes this provision unnecessary.
Payment by the party contracting with the Contractor shall not be a condition precedent to payment to any lower level subcontractor, regardless of whether such Contractor receives payment of monies due to such Contractor.
This is the heart of the statutory change. A contractor, sub-contractor or sub-contractor is now liable to all lower level sub-contractors regardless of payment by the public body. The general contractor and each subcontractor must be prepared to finance the cost of a public project – a major change in the allocation of risk. But when does this obligation arise? The status is silent. Instead, the next paragraph of this law contains the original prompt payment language which still requires contractors within seven days of receiving payment, to pay the subcontractor, or notify the agency and the sub -dealing in writing with the deduction.
So how long should a subcontractor wait to demand payment from a general contractor even though the public body has not made payment? This law gives no indication. To answer this question, we must turn to the other part of this new law – the changes applicable to all construction projects, public and private to Virginia Code §11-4.6. As noted in the following article, changes to this law require payment to be made no earlier than 60 days after “satisfactory completion of the work for which the subcontractor has invoiced”, or 7 days after receipt of payment of the owner. This can be a more complicated determination than the law requires, as owners rarely claim “satisfactory completion” of the work before the final completion of the project. Expect more litigation over whether a subcontractor correctly invoiced their work to claim a right to payment within 60 days.
The law does not address payment for disputed additional work, alterations, or late fees. Instead, the normal complaints procedures remain unchanged. Additionally, the law only refers to payment obligations to “lower-level subcontractors” and its definition of “contractor” and “subcontractor” specifically excludes persons supplying only materials. This means that suppliers are most likely excluded from the benefits of these new payment requirements.
Contractors will likely modify their “pay-when-paid” clauses in their subcontracts to make it clear that they have no payment obligation 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 by the owner.
Any provision of any contract contrary to this article shall be unenforceable.
This appears to be a public policy statement targeting contradictory language in subcontracts. This renders these terms unenforceable, leaving only the terms of the Prompt Payment Act. A savvy contractor will change their terms of payment to resolve ambiguities in this law and limit potential liability for interest on overdue payments.
Provision of interest
The Prompt Payment Act provides the following remedy for untimely payment: “Except as otherwise provided in the terms of this contract, interest accrues at the rate of one percent per month.” Subcontracts rarely provide for an interest rate on late payment to the subcontractor, and the rate of 12% per annum will appear to be an attractive recourse for subcontractors. However, the general contractor is now strongly encouraged to include an extremely low interest rate on unpaid funds to avoid this legal rate. If the subcontract provides that all unpaid sums bear interest at the rate of, for example, 0.1 per annum, then this newly authorized contractual provision will effectively mitigate the consequences of non-compliance with the law.
While the changes to Virginia’s Prompt Payment Act may have been well-intentioned, they seem confusing, unnecessary, contradictory, and ultimately may not create the intended change. General contractors and subcontractors should be careful to ensure that their payment terms try to comply with these new changes.