Thoughts on New Pay if Paid Legislation (UPDATED with Final Text)

Recently, the Virginia General Assembly closed its session having passed legislation essentially banning “pay if paid” clauses in construction contracts, both public and private.  Assuming that Governor Youngkin signs the bill into law on or before his deadline of April 11, 2022, the following new requirement will be grafted into any Virginia construction contract:

Such contract shall require such higher-tier contractor to pay such lower-tier subcontractor within the earlier of (i) 45 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.

This is the main operative language (the 45-day payment requirement is also applied to project owners), but the legislation also imposes certain other notice duties upon both the owner and any higher-tier contractor on a construction project.  Interestingly, the legislation does not include a provision making it only effective for those contracts entered into after its effective date.  More on that later.

As a Virginia construction attorney that routinely represents construction professionals here in the Commonwealth, this represents a sea change in construction contracting akin to the earlier ban on pre-payment waiver of lien rights by contract.  This legislation can be seen as a boon for subcontractors that felt that they were required to finance the project while general contractors were able to wait on payment until the owners got around to paying the general contractor, regardless of the reasons for the owner’s non-payment.  Should this legislation pass, project owners and general contractors will be required to either pay the downstream contractors within a maximum of 45 days from completion of the work or provide reasons in writing for any non-payment, including the names of the lower-tier subcontractor(s) that provided the faulty performance justifying the non-payment.

Among the various questions that would have to be ironed out, presumably in court, are the following:

1. What about contracts entered into prior to the effective date of the legislation?  The argument can be made that because the legislature did not explicitly state that the legislation is not retroactive, the ban on pay-if-paid applies to all construction contracts currently in place.  While this seems harsh, the General Assembly has explicitly stated that certain legislation only affects actions after that legislation’s effective date but did not do so here.  It will certainly be a point of litigation moving forward.
2. How will retainage be handled?  Owners routinely withhold a percentage of the amount of any payment application from the general contractor by contract.  Will owners now have to provide notice every time such payment is withheld?  What effect does that have on a general contractor’s ability to withhold that same retention?  Unlike the mechanic’s lien statutes that state that retention is not subject to the 150-day rule, this bill does not mention retention in any way, leaving the door open to an argument that at the very least the owner would have to notify the general contractor every time it withholds retention.
3. What if a higher-tier owner or contractor misidentifies the lower-tier subcontractor at fault?  Does this misidentification nullify any notice and subject the higher-tier entity to the interest and penalties in the statute?  What if there is a change in the trade subcontractor performing a certain scope of work and that is not communicated up the chain?

I raise these questions because I think they will play out in the courts of the Commonwealth of Virginia absent some clarity.  I also believe that construction contracts should take them into account.  For instance, higher-tier contractors and owners should routinely require a list of lower-tier subcontractors and further impose a requirement that this list is updated if there are changes.

I would love to hear other questions that you as readers come up with when reading the legislation.  I am sure I haven’t hit on all points of potential controversy.

UPDATE:  Governor Glen Youngkin has sent a recommendation back to the Senate.  I will keep an eye on where this goes from here.

UPDATE 2:  Governor Youngkin has submitted an amendment by way of substitution that changes the outside payment deadline to 60 days from performance, specifically allows for retainage, removes some of the specificity requirements for Owners, and specifically states that the new legislation will only apply to contracts entered into after January 1, 2023.  Thus many of my above questions have been answered.

SB550 now goes to a Public Body Procurement Workgroup for review. The Workgroup shall report its findings and any legislative recommendations to the General Assembly by December 1, 2022.

UPDATE 3:  The Governor’s amendment has been accepted and passed into law.  The final text of this pay if paid legislation is here.

As always, I welcome your comments below. Please subscribe to keep up with this and other Construction Law Musings.