Robert Angelillo is an attorney with Meyer, Suozzi, English & Klein PC, in Garden City, N.Y., practicing construction law and litigation.

N.Y. Renders Final Word on "Pay-if-Paid" Contracts

The state's high court finally chooses sides in a judicial debate over whether certain subcontractors can be governed by another state's law.

by Robert C. Angelillo

In 2005, two state appellate courts, one in Manhattan and one in Brooklyn, issued conflicting decisions about the enforceability of certain "pay-if-paid" subcontracts.

Although the construction industry thought it had seen the last of these subcontracts in 1995, when New York's highest court found them to be unenforceable in West-Fair Electric Contractors v. Aetna Casualty & Surety Company, the 2005 decisions addressed a loophole that brought the issue back to the fore.

In the original West-Fair decision, the Court of Appeals barred the use of pay-if-paid subcontracts, which permit a contractor to withhold payment from a subcontractor until the contractor itself receives payment from the owner. It held that these contracts were against New York's public policy because they could prevent subcontractors from enforcing properly filed mechanics' liens.

However, in 2005, the appellate court in Manhattan found that West-Fair did not dispose of all pay-if-paid subcontracts.

In the case, Hugh O'Kane Electric Company, LLC v. MasTec North America, Inc., the Manhattan court found that if a contractor and subcontractor agreed to use another state's law to control their subcontract, and that state allows pay-if-paid contracts, then such a subcontract would be enforceable, regardless of West-Fair's public policy considerations. While this decision only directly affected courts in Manhattan and the Bronx, it was an eye-opening decision for all courts in the state because it seemed to conflict with the principles of West-Fair.

Several months after the Hugh O'Kane decision, Brooklyn's appellate court issued a decision in another case, Welsbach Electric Corp. v. MasTec North America, Inc., that came to the exact opposite conclusion as the Manhattan court. The Brooklyn court found that even if another state's law controlled the contract, and that state permitted pay-if-paid contracts, a New York court should not enforce the pay-if-paid provision because New York's public policy discussed in West-Fair was too important.

Because of these conflicting decisions, contractors who used courts in Manhattan and the Bronx could enforce their pay-if-paid subcontracts if another state's law controlling their contracts permitted them, while contractors using Brooklyn courts - as well as courts in Long Island, Westchester, and others in the state - could not.

This set the stage for the state's highest court, the Court of Appeals, to step in and render a statewide decision on the issue. It did just that in November after the contractor in the Welsbach case, MasTec, appealed the Brooklyn appellate court's ruling. The result: the contractor in both cases, MasTec, won.

In the Welsbach appeal, the Court of Appeals focused on the right of contracting parties to choose the state law that they wanted to apply to their subcontract. The high court agreed with the appellate court in Hugh O'Kane and found that the public policy discussed in West-Fair was simply not important enough to overcome this right.

Therefore, the Court of Appeals found that, when the contracting parties agreed that another state's law applied to their subcontract, and that state permitted pay-if-paid contracts, those subcontracts could be enforced in any court in New York.

So, what is the overall effect of the Court of Appeals decision? On a practical level, it means that a contractor who has pay-if-paid provisions in a subcontract controlled - and permitted - by another state's law can refuse to pay a subcontractor until the contractor itself receives payment from the owner.

However, the broader impact of the decision is limited due to another factor. A law passed by the New York Legislature and signed by Gov. George Pataki in 2003 forbids contractors and subcontractors from choosing another state's law in all construction contracts entered into after Jan. 14, 2003. By requiring use of New York law, the parties must adhere to West-Fair, which bars pay-if-paid contracts.

While this law applies to most contracts entered into after Jan. 14, 2003, it does not apply to subcontracts entered into before that date, or for subcontracts entered into after that date on projects that had already been in existence. Therefore, the new court decision only directly affects subcontracts older than January 2003 and recently entered subcontracts on long-existing projects.

However, perhaps more importantly, the Court of Appeals decision in the Welsbach appeal seems to diminish the key point of the West-Fair decision - that protecting subcontractor rights under the New York lien law is a fundamental public policy of this state.

If the right to choose another state's law is more important than the right to enforce a mechanics' lien, what, if any, other considerations will also triumph over the lien law in the future? Only time, and future court cases, will tell.