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By Richard P. Dyer
Thelen Reid Brown Raysman & Steiner LLP
New York's highest court has provided a clear and guiding ruling on the application of pay-if-paid clauses in contracts governed by laws of other states. The ruling resolves the split in authority resulting from directly conflicting decisions handed down in 2005 by the First and Second Departments of the Appellate Division of the New York Supreme Court.
Pay-if-paid contract clauses now will be enforceable by the courts of New York when applying non-New York law even though such clauses are not being permitted under New York law. Welsbach Electric Corp. v. MasTec North America, Inc., 2006 NY Slip Op. 8632 (2006).
However, given the New York Prompt Payment Act of 2002, which voids any non-New York choice of law provisions in contracts for New York projects, such pay-if-paid clauses will be enforceable as to New York projects only if the contract was entered into before January 14, 2003, the effective date of the statute. The Court of Appeals held in 1995 that pay-if-paid clauses are void and unenforceable under New York law and are contrary to public policy because they force subcontractors to assume the risk of non-payment when general contractors are not paid by owners. The court based its reasoning on Lien Law §34's prohibition of lien waivers. West-Fair Electric Constructors v. Aetna Casualty & Surety Co., 87 N.Y.2d 148, 638 N.Y.S.2d 394 (1995).
However, the Court of Appeals now has decided that New York public policy against such clauses is not sufficiently fundamental to warrant overriding the parties' choice of law. New York courts generally will enforce a choice-of-law clause if the chosen law bears a reasonable relationship to the parties or the transaction, given that agreements are construed to effectuate the parties' intent. This freedom to contract is disregarded if the courts are requested to enforce an illegal agreement or when the chosen law violates "some fundamental principle of justice, some prevalent conception of good morals, some deep-rooted tradition of the common weal."
In this case, the court referred to the statute that outlawed discrimination in the sale of cooperative real estate interests as "fundamental public policy of New York." The court held that the risk of non-payment of subcontractors resulting from pay-if-paid clauses in contracts with non-New York choices of law is not of the same tenor as establishing equality of opportunity in the sale of cooperative real estate interests. Alleviating such risks to subcontractors simply is not "fundamental public policy of New York."
Further, the court reasoned that New York Lien §34, upon which pay-if-paid clauses have been outlawed, seeks to protect New York subcontractors from the oppressive use of bargaining power. However, in this case, neither party was a New York corporation, the subcontractor was a Delaware corporation and the general contractor was a Florida corporation.
The court noted that both parties were sophisticated commercial entities that knowingly and voluntarily entered into the subcontract. Given these two factors and the "checkered" history of pay-if-paid clauses, the court held that such clauses were not "truly obnoxious" and that the subcontractor had not sustained its "heavy burden" of proving that application of such clauses was offensive to fundamental public policy of the State of New York.
The ruling mirrors the reasoning of the First Department in Hugh O'Kane Electric Co., LLC v. MasTec North America, Inc., 19 A.D.3d 126, 797 N.Y.S.2d 45, which rejected the reasoning of the Second Department (23 A.D.3d 639, 804 N.Y.S.2d 805), from which this Court of Appeal case arose.
Unlike the Second Department, the Court of Appeals made no reference to New York State having a long-standing policy to "advance building construction by assuring subcontractors of payment in the event of the insolvency of the owner or general contractor."
However, the New York Prompt Payment Act (Chapter 127, Laws of 2002), particularly §757, voids any construction contract provision that seeks to make a New York project subject to the laws of another state. Therefore, any construction contracts for work in New York that seek to apply pay-if-paid clauses via non-New York law will be enforceable only if such entered into before January 14, 2003, the effective date of the statute.
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For more information about the issues covered in this report, please contact Richard P. Dyer in our New York office at 212-895-2117 or at rpdyer@thelen.com or contact your Thelen attorney. For more information about Thelen's Construction and Government Contracts Department, click here.
©2007 Thelen Reid Brown Raysman & Steiner LLP
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