Canada: Pay-When-Paid Clauses And Prompt Payment

Thirty-five years ago, the Ontario Court of Appeal, in Timbro Developments Ltd. v. Grimsby Diesel Motors Inc., upheld the following clause: "Payments will be made not more than thirty (30) days after the submission date or ten (10) days after certification or when we have been paid by the owner, whichever is the later." Subsequent cases have confirmed that at least in Ontario, such clauses, known as pay-when-paid clauses, can operate as conditions precedent to payment as long as they are drafted in a clear and specific manner.

When the new prompt payment provisions of the Construction Act came into force, questions were raised about the continued validity of pay-when-paid clauses. There has been debate as to whether such provisions are void or whether "pay-when-paid" is now effectively legislated. Similar debate has arisen in Alberta, where lien legislation has also been amended to include prompt payment schemes.

Part I.1 of Ontario's Construction Act requires owners to pay a proper invoice with 28 days of receipt, unless a notice of non-payment is given, and contractors to pay their subcontractors within seven days of receipt of the owners' payment, again unless a notice of non-payment is given. Subcontractors, in turn, must pay their suppliers and subcontractors within seven days of receiving the contractors' payment, subject to the non-payment notice.

In the consultation process leading up to the new Act, the prohibition of pay-when-paid clauses was expressly contemplated. In their report Striking the Balance: Expert Review of Ontario's Construction Lien Act, the authors note that when prompt payment and adjudication were introduced in the U.K., the U.K. Construction Act was amended to include the following prohibition:

113 Prohibition of conditional payment provisions. (1) A provision making payment under a construction contract conditional on the payer receiving payment from a third person is ineffective, unless that third person, or any other person payment by whom is under the contract (directly or indirectly) a condition of payment by that third person, is insolvent.

That prohibition of "pay when paid" provisions was later extended to "pay-when-certified" provisions, which had been used to circumvent the prohibition on pay-when-paid provisions subsequent to the initial amendment. The Report noted that similar prohibitions are in place in Ireland, Australia, New Zealand and a number of U.S. states.

Submissions were made to the Ontario Expert Review by multiple stakeholders advocating for a similar express prohibition in Ontario. Such clauses were therefore very much a live issue before the Expert Review.

In the result, however, the authors decided not to recommend a prohibition:

In our view, the policy reasons for permitting pay-when-paid clauses continue to apply, such that a lack of payment by an owner constitutes a valid reason not to pay a sub-contractor, subject to the observation that the ability of general contractors, and downstream payers, to rely on such clauses should be circumscribed by requiring that appropriately detailed notices be provided to subcontractors in a timely way notifying that payment that has been withheld by an owner, or downstream payer, providing the reasons for non-payment, and undertaking to commence or to continue proceedings necessary to enforce payment.

As a result, no prohibition of pay-when-paid clauses made its way into the new Construction Act.

To the contrary, non-payment of the contractor by the owner was expressly endorsed as a valid reason for the contractor not paying a subcontractor. While section 6.5(4) of the Construction Act generally states that if the owner does not pay some or all of a contractor's proper invoice within the stipulated time, the contractor must still pay subcontractors included in the proper invoice within 35 days. This obligation is made subject to giving a notice of non-payment as follows:

Exception, notice of non-payment if owner does not pay

Therefore, a pay-when-paid clause does not violate the spirit of the Construction Act, as long as it is in line with s. 6.5(5) and as long as the contractor follows the steps mandated in the Act. The contractor must give the notice of non-payment, in the prescribed form, stating that money owing to the subcontractor is not being paid by the owner, and must undertake to send the matter to adjudication within 21 days of that notice.

Not only are pay-when-paid clauses still valid, arguably they have now been made part of every subcontract by virtue of s. 4 and s. 5 of the Construction Act, which, read together, provide that an agreement by a party who supplies services or materials to an improvement that the Act does not apply is void and that every contract or subcontract related to an improvement is deemed to be amended to conform with the Act. Since s. 6.5(5), cited above, gives the general contractor the right to withhold payment, and in light of ss. 4 and 5, every subcontract in Ontario now effectively includes a pay-when-paid clause as long as the contractor complies with its statutory prompt payment obligations.

That does not leave an unpaid subcontractor without recourse, however.

To begin with, where the contractor does not give a notice of non-payment, it must pay its subcontractors as outlined above, whether it is paid by the owner or not, and regardless of any contractual pay-when-paid clause.

Further, where the owner does give the contractor a proper notice of non-payment and the contractor in turn gives a notice to its subcontractors, the contractor must also provide an undertaking that the matter will be referred to adjudication within 21 days of that notice, leading to a determination one way or another.

Finally, where the owner does not pay the general contractor for the subcontractor's work because the general contractor fails to include the subcontractor's work in its proper invoice to the general contractor, the subcontractor can refer that matter to adjudication under s. 13.5(2).

In sum, Ontario's Construction Act does not prohibit pay-when-paid clauses, with the reasoning set out in the report, Striking the Balance: Expert Review of Ontario's Construction Lien Act. Ontario courts have not yet had to consider this issue, perhaps due to the availability of statutory adjudication. Subcontractors and suppliers now have a legislated path towards resolution of unpaid invoices within an expedited timeframe, even where pay-when-paid clauses exist, if contractors fail to comply with prompt payment rules.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.