December 28, 2007

The prevention doctrine may have an effect on a carefully drafted pay-if-paid or pay-when-paid provision – that is, one that attempts to condition and limit a
subcontractor’s right to receive payment on whether the general contractor has received payment from the owner. Two federal Circuit Courts of Appeals have applied the prevention doctrine to repudiate a pay-if-paid or pay-when-paid provision and it is possible the Arizona and other state courts will follow this lead. This article addresses the prevention doctrine and its potential effect on pay-if-paid or pay-when-paid clauses.

Prevention Doctrine
The prevention doctrine provides that a party who prevents performance of a contract may not complain of such nonperformance. In applying the prevention doctrine, the Arizona courts have noted that the party’s conduct must have been unjustified, wrongful and not authorized under the terms of the contract to prevent them from maintaining an action under the contract. In fact, in Security National Life Insurance Co. v. Pre-Need Camelback Plan, Inc., the Arizona Court of Appeals refused to apply the prevention doctrine because the parties did not engage in wrongful conduct.

Effect on Third-Party Payment Provisions
Pay-when-paid clauses and pay-if-paid clauses are often referred to as third-party payment provisions. Pay-when-paid clauses refer to contract language that has been held to merely delay the timing of payment, making payment to a subcontractor due within a reasonable time after the subcontractor completes performance. Conversely, pay-if-paid clauses make payment to a subcontractor contingent upon the owner’s payment to the general contractor. Generally, the provision’s language explicitly states that the owner’s payment to the contractor is a condition precedent to the contractor’s payment to the subcontractor.

Once a court interprets a payment provision as a condition precedent, the written agreement generally defeats the subcontractor’s claim against the contractor for payment. However, a determination that a payment provision is a condition precedent does not supersede a subcontractor’s claim for payment under all circumstances. A subcontractor will be entitled to payment if the general contractor prevents the condition precedent from occurring. This is the essence of the prevention doctrine.

In Moore Brothers Co. v. Brown & Root, Inc., the 4th Circuit Court of Appeals held that a contractor was unable to rely on a pay-when-paid clause as a defense to its failure to pay because the contractor hindered the fulfillment of a condition precedent. Toll Road Investors Partnership contracted with Brown & Root for the construction of the Dulles Toll Road extension. Brown & Root then contracted with Moore Brothers & Lane Construction. The subcontract stated that Brown & Root had no obligation to pay Moore Brothers until it received payment from TRIP. 

As the construction of the Dulles Toll Road extension progressed, Brown & Root noticed the need for a thicker pavement subbase. Brown & Root, however, assured the lenders financing the highway project that no substantial changes in the work were anticipated. Additionally, Brown & Root removed the design change illustrations from the prime construction contract and placed those illustrations in a side agreement (the existence of which was not revealed to the lenders). Because the lenders were not aware that any additional work was necessary, they did not arrange for additional financing. Thus, TRIP did not have the funds to pay Brown & Root for the additional work, and as a result, Brown & Root claimed that it was not obligated to pay Moore Brothers.

The 4th Circuit concluded that Brown & Root hindered the fulfillment of the condition precedent. Therefore, the court held that the trial court correctly invoked the prevention doctrine to waive the performance of the condition precedent, making Brown & Root liable to Moore Brothers for payment for the additional work.

In the most recent case applying the prevention doctrine to a third-party payment provision, Northeast Drilling, Inc. v. Inner Space Services, Inc., the 8th Circuit Court of Appeals similarly held that a subcontractor could not invoke a pay-when-paid clause after it prevented fulfillment of a condition precedent. Because the subcontractor failed to submit a change-order request to the contractor after drilling in an expanded area, it contributed to the contractor’s failure to pay. Thus, the subcontractor was required to pay the sub-subcontractor because the prevention doctrine applied and rendered the pay-when-paid clause void.

Although Arizona and other state courts have yet to apply the prevention doctrine to third-party payment provisions, other courts provide guidance on the issue. Because there is no case law holding otherwise, Arizona and other state courts will likely invoke the prevention doctrine to waive performance of a condition precedent if the contractor hinders performance.

For more information please contact:
Jim Sienicki at 602.382.6351 | [email protected]