“Pay if Paid” Clauses Are Void and Unenforceable as Against Public Policy Because They Interfere with Subcontractor’s Constitutional Right to Assert Mechanic’s Lien

Wm. R. Clarke Corp. v. Safeco Ins. Co., 15 Cal. 4th 882 (1997)

In this case, general contractor Keller Construction Company was hired to perform work on a commercial building.  Keller entered into subcontracts with various subcontractors, including Wm. R. Clarke Corporation, and each subcontract contained a “pay if paid” provision.  An addendum to each subcontract stated that the “pay if paid” limitation did not waive the subcontractor’s lien rights and provided that each subcontractor’s mechanic’s lien rights were to be the subcontractor’s sole remedy in the event that the owner failed to pay Keller.  Pursuant to the terms of the prime contract, Keller obtained a payment bond from Safeco Insurance Company that was intended to protect the owner from mechanic’s lien claims brought by any subcontractor.  The bond terms stated that, if Keller failed to pay claims brought by subcontractors, Safeco would assume the obligation to pay.  The building owner became insolvent and stopped making payments to Keller, and Keller declined to pay subcontractors who had recorded mechanic’s liens and filed actions on the payment bond.  The trial court ruled in favor of the subcontractors on the payment bond claim against Safeco.  Safeco appealed, the court of appeals affirmed, and Safeco appealed to the California Supreme Court.

The Supreme Court ruled that “pay if paid” clauses are against public policy because they interfere with a subcontractor’s constitutional right to enforce a mechanic’s lien.  The Court determined that a general contractor’s liability to a subcontractor for work performed may not be made contingent on the owner’s payment to the general contractor.  The Court concluded that Keller was liable to the subcontractors for the work they performed, and that Safeco, as Keller’s surety, was likewise liable on the payment bond.