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F I S C A L I M P A C T R E P O R T

SPONSOR Cisneros

ORIGINAL DATE

LAST UPDATED

2/23/2007

HB

SHORT TITLE Prohibit Certain Contract Agreements

SB 641

ANALYST Schuss

APPROPRIATION (dollars in thousands)

Appropriation

Recurring

or Non-Rec

Fund

Affected

FY07

FY08

NFI

(Parenthesis ( ) Indicate Expenditure Decreases)

SOURCES OF INFORMATION

LFC Files

Responses Received From

Regulation and Licensing Department (RLD)

Administrative Office of the Courts (AOC)

Attorney General’s Office (AGO)

SUMMARY

Synopsis of Bill

Senate Bill 641 would provide that “Payment by the owner to a contractor shall not be a

condition precedent for payment to a subcontractor, and payment by a contractor to a

subcontractor shall not be a condition precedent for payment to any other subcontractor. An

agreement to the contrary is void, unenforceable and against the public policy of the state."

FISCAL IMPLICATIONS

AOC notes that there will be a minimal administrative cost for statewide update, distribution and

documentation of statutory changes. Any additional fiscal impact on the judiciary would be

proportional to challenges to the law’s prohibition. New laws, amendments to existing laws and

new hearings have the potential to increase caseloads in the courts, thus requiring additional

resources to handle the increase.

Senate Bill 641 – Page

2

SIGNIFICANT ISSUES

AOC has included the following in their analysis:

Clauses in construction contracts that condition payment to the subcontractor on the

general contractor's receipt of payment from the owner are generally referred to as “pay when

paid" or “pay if paid" provisions. American courts differ on the enforceability and interpretation

of such clauses. There is a distinction to be made between the two types of provisions. As

attorneys associated with the International Association of Foundation Drilling explain:

Simply put, the difference between the two clauses is that, under a "pay-if-paid"

provision, the subcontractor will be paid only if the general contractor is first paid by the

owner, whereas under a "pay-when-paid" provision, the subcontractor will be paid when

the contractor is paid by the owner. A pay-if-paid provision creates a condition precedent

to the contractor’s duty to pay its subcontractor and the risk of an owner’s non-payment

is shared by the contractor and the subcontractor. With a pay-when-paid clause, the

contractor has a duty to pay the subcontractor whether or not the contractor receives

payment from the owner, and payment will be due the subcontractor within a reasonable

time after the owner should have paid the contractor.

It appears that SB 641 does not draw a distinction between “pay when paid" or “pay if

paid" provisions. If it did, and if it permitted “pay when paid" provisions calling for payment to

a subcontractor within a reasonable time after the owner should have paid the contractor, it

would be more likely to withstand legislative and legal challenge.

According to AGO, presumably the bill would apply to all contracts entered into between private

parties and governmental agencies. It does not restrict or define the agreements to which it

applies. Its prohibitions are not restricted to construction contracts, even though the bill uses

terms commonly found in those contracts.

The bill seems to require payment to subcontractors regardless of whether the primary contractor

has received payment from an “owner". This could be problematic for contractors with

insufficient funds available prior to receiving payment themselves. Although the bill appears

intended to prevent a primary contractor from granting payment priority to certain

subcontractors, it also prohibits subcontractors from withholding payment to their subcontractors

regardless of whether the primary contractor has paid the first subcontractor. This raises the same

issue regarding availability and sufficiency of funds.

BS/nt