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I have always despised these payment terms in subcontracts. Subcontractor A/R managers scoff each time they see them knowing their leverage to collect payment is altered from its normal state; drastically reduced. The only fair, practical application I can see them used is where the subcontractor performs the preponderance of the prime contract SOW, and the prime is just a pass through. From a cash flow perspective the prime doesn’t want to go out pocket to pay the subk knowing the invoice could be held up or rejected by the client for various reasons, and payment to the subk could have already occurred.

Are there any other practical uses for these clauses? Does anyone feel these clauses are misused and except in special cases, should not be agreed to by subcontractors? Are there any primes out there who have held some false sense of security that the a pay when paid clause protects the prime from ever having to pay the subk if there is an issue at the prime contract? If a subcontractor performed the work as intended, they should be reimbursed. Whether the prime is paid by the ultimate client is the prime’s job to figure out. It is silly to think the two should be linked, in my opinion. Does anyone know of a subk that was stiffed by a prime because of this type of payment clause, took the prime to court, and what happened?

 

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Perhaps you could clarify and/or provide language examples for a "pay when paid" clause? Is it a FAR clause? Which one(s)? Are you talking commercial items or?? Also, there is at least one prime contract clause that prohibits a prime from being "just a pass through."

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Correct. 

Thanks, Neil. Sorry for not clarifying that up front.

I do not have any language in front me, but this would not be a FAR clause of any sort, rather a commercial payment term negotiated into a subcontract. 

For example, instead of saying “subcontractor will be reimbursed within 30 days receipt of an acceptable invoice” the agreement says “subcontractor shall be paid 30 days after corresponding payment is made to prime contractor”

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@Needforspeed, as you said, it is negotiated. The leverage is at time of negotiation. Net 30 would be normal after receipt of invoice. You could offer 1%10 days, net 30. If you can't negotiate that, find a bank that will agree to advance you $ for your accounts receivable pending payment, and put the interest cost of doing this into your G&A expenses. FAR is not very generous either. FAR 52.242-5, for example, permits payment up to 90 days after the the contractor receives payment from the government.

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@Neil Roberts Let me try to rephrase what I’m really after. I agree that a subk’s opportunity to nix this payment clause is during the negotiations. And for me a subk should really never agree to it unless there is a specific application that makes sense. Again, it seems unfair and unreasonable to have your payment tied to some means far outside your control. But that is still not what I’m after here. I want to know what happens if a subk delivers exactly as prescribed in their subcontractor. The prime accepts said deliverables. For whatever reason, small hypothetical, the prime is never paid for work purported to include a portion of the said work subk performed. Therefore, prime never pays subk. Is subk left holding the bag, even though they complied with all requirements of the subk? Why would anyone agree to this?

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@Needforspeed, what your are asking is more of a legal question. I asked the internet something like "52.242-5 contractor never pays subcontractor", and found the following result:

https://www.jdsupra.com/legalnews/government-involvement-when-prime-1226148/

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The ability to negotiate such a payment clause out of a subcontract depends on several factors. One important factor is prime contract type. If the prime contract contains 52.216-7, then the prime's ability to enforce a "pay when paid" clause may run afoul of--

Quote

(b) Reimbursing costs. 

(1) For the purpose of reimbursing allowable costs (except as provided in paragraph (b)(2) of this clause, with respect to pension, deferred profit sharing, and employee stock ownership plan contributions), the term "costs" includes only—

(i) Those recorded costs that, at the time of the request for reimbursement, the Contractor has paid by cash, check, or other form of actual payment for items or services purchased directly for the contract;

(ii) When the Contractor is not delinquent in paying costs of contract performance in the ordinary course of business, costs incurred, but not necessarily paid, for-

(A) Supplies and services purchased directly for the contract and associated financing payments to subcontractors, provided payments determined due will be made–

(1) In accordance with the terms and conditions of a subcontract or invoice; and

(2) Ordinarily within 30 days of the submission of the Contractor’s payment request to the Government;

(B) Materials issued from the Contractor’s inventory and placed in the production process for use on the contract;

(C) Direct labor;

(D) Direct travel;

(E) Other direct in-house costs; and

(F) Properly allocable and allowable indirect costs, as shown in the records maintained by the Contractor for purposes of obtaining reimbursement under Government contracts; and

(iii) The amount of financing payments that have been paid by cash, check, or other forms of payment to subcontractors.

In other words, the clause requires the prime contractor to pay its suppliers within 30 days after submitting its invoice to the Government.

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@Neil Roberts thanks for proving that link, interesting. Reading FAR 31.112 it allows the government CO to ‘encourage’ contractor payment for unpaid subks, ‘reduce or suspend’ payments to prime contractor when subks are left unpaid, and shall ‘advise the subcontractor’ whether ‘final payment under the contract has been made…’

So, as a prospective subk where the prime inserts pay-when-paid language, if one cannot strike the language altogether, it seems reasonable to request FAR 31.112-1,2 be added to allow for some escalation to the government when a subk goes unpaid. That is something, I guess.

I did see an old 2001 wifcon thread on the web that suggested this FAR only applies if the prime is using progress payments, not sure if that still applies.

@here_2_help thank you that is very helpful as well. Not to mention risking noncompliance with prompt payment for small business etc.

These are smart factors to consider in a subk where the prime is covered by the FAR. It does not help where the prime may be under a state or local government for example, but the idea of crafting specific language that allows for the unpaid subk to go directly to the ultimate client contracting office is compelling. Essentially a threat to expose a prime contractor for not paying their bills. Will probably get most folks’ attention.

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On 1/12/2024 at 11:16 AM, Neil Roberts said:

@Needforspeed, what your are asking is more of a legal question. I asked the internet something like "52.242-5 contractor never pays subcontractor", and found the following result:

https://www.jdsupra.com/legalnews/government-involvement-when-prime-1226148/

The referenced article isn’t completely accurate concerning progress payments for construction contracts. In accordance with the Prompt Payment for Construction Contracts clause at Federal Acquisition Regulation 52.232-27, the prime contractor isn’t allowed to be paid retainage from subcontractor progress payments. The contractor must inform the government of any retainage withheld from subcontractor progress invoices.  The government is then supposed to subtract such retainage from progress payments and hold them until the prime releases the retainage.

That was implemented in the Prompt Payment Act Amendments of 1988, in response to subcontractor complaints to Congress of prime contractors traditionally withholding retainage from government prime contractor progress payments for subcontractor earnings to reduce the primes’ contract financing costs. The government is now supposed to hold such retainage- not the prime.

This was done to disincentivize widespread prime contractor practices of using retainage from government progress payments for the purpose of financing prime contractors’ contract costs at the expense of their subcontractors.

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Per the Payments for Fixed Price Construction clause at 52.232-5, the prime must certify that it won’t retain funds from the progress payments due subs for performance, that it has paid the subs from previous progress payments and that it will timely pay the subs (within seven days after receipt) among other requirements

It must identify in the progress payment invoice, among other things,

“i) An itemization of the amounts requested, related to the various elements of work required by the contract covered by the payment requested.

(ii) A listing of the amount included for work performed by each subcontractor under the contract.

(iii) A listing of the total amount of each subcontract under the contract.

(iv) A listing of the amounts previously paid to each such subcontractor under the contract.

(v) Additional supporting data in a form and detail required by the Contracting Officer.”

And as previously stated, the prime must pay its subs within seven days of receipt of payment by the government.

i don’t know whether government employees understand all the ramifications and requirements. I suspect not. I don’t think that the author of the article at the website that Neil referenced earlier does, either.

The contractor can withhold payment from a sub’s progress if consistent with the subcontract terms but it can’t ask for payment of or retain such withholding from progress payments. The government must not pay the contractor for withheld subcontractor earnings. 

This was a huge change resulting from the Prompt Payment Act (PPA) Amendments of 1988, implemented through an OMB Circular,  effective in April of 1989.

I was responsible for providing the policy and guidance to all of my District’s  ACO offices back then. I developed and included forms for contractors to include in their progress payment requests. I still have my PPA file folder, which is several inches thick, 

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