Galloway Corp. v. S.B. Ballard Const. Co.

• Decision Date: 03 November 1995
• Docket Number: 950529,Nos. 942077,s. 942077
• Citation: 464 S.E.2d 349,250 Va. 493
• Parties: GALLOWAY CORPORATION v. S.B. BALLARD CONSTRUCTION CO., et al. GALLOWAY CORPORATION v. CAPE HENRY MECHANICAL, INC., et al. Record
• Court: Virginia Supreme Court

Page 349

464 S.E.2d 349

250 Va. 493

GALLOWAY CORPORATION v. S.B. BALLARD CONSTRUCTION CO., et al.

GALLOWAY CORPORATION v. CAPE HENRY MECHANICAL, INC., et al.

Record Nos. 942077, 950529.

Supreme Court of Virginia.

Nov. 3, 1995.

Stephen G. Test, Virginia Beach (Clark & Stant, on briefs), for appellant.

James L. Windsor, Newport News (David N. Anthony; Kaufman & Canoles, on brief), for appellee S.B. Ballard Construction Co., Inc.

No brief or argument for Sprinkle Masonry, Inc. and Empire Granite Corporation.

(Peter S. Lake; Heilig, McKenry, Fraim & Lollar, Norfolk, on brief), for appellee Cape Henry Mechanical, Inc.

No brief or argument for Dover Elevator Company.

Present: All the Justices.

KOONTZ, Justice.

This appeal arises from a contract dispute between a general contractor and several of its subcontractors on a construction project following the project owner's default in making payment on its contract with the general contractor. The issue we consider is whether the terms of the subcontracts provide the general contractor an absolute "pay when paid" defense to its subcontractors' breach of contract claims based upon the owner's failure to pay. Stated differently, the issue we consider is whether the terms of the subcontracts in question shift the risk of the owner's default on payment for labor and materials from the general contractor to the subcontractors.

I. BACKGROUND

On August 17, 1988, Galloway Corporation (Galloway), a construction contractor, entered into a contract with Rowe Properties--Bank Street Limited Partnership (Rowe) for the construction of the First American Financial Center, a fourteen-story commercial office complex in downtown Norfolk. Rowe and Galloway used a standard, pre-printed American Institute of Architects (AIA) contract with attachments to form the basis of their agreement. The stated contract price was $10,960,000. Within the general conditions of the contract was the following requirement:

The Contractor shall promptly pay each Subcontractor, upon receipt of payment from the Owner, out of the amount paid to the Contractor on account of such Subcontractor's Work, the amount to which said Subcontractor is entitled....

Galloway immediately commenced work on the construction project and let subcontracts to numerous suppliers of labor and materials. Galloway also used a standard, pre-printed AIA form in letting these subcontracts. Separate paragraphs of the subcontract form The Contractor shall pay the Subcontractor each progress payment within three working days after the Contractor receives payment from the Owner. If the Architect does not issue a Certificate of Payment or the Contractor does not receive payment for any cause which is not the fault of the Subcontractor, the Contractor shall pay the Subcontractor, on demand, a progress payment computed as provided in Paragraphs 11.7 and 11.8.

specify the manner in which progress payments and final payment will be made by Galloway to the subcontractor. Paragraph 11.3 contains the following pertinent language:

(Emphasis added.) In each contract, Galloway struck out all the language following the word "Owner", initialed the change and requested that the subcontractor initial the change.

Paragraph 12.1, entitled "Final Payment," contains the following pertinent language:

Final payment, constituting the entire unpaid balance of the Subcontract Sum, shall be made by the Contractor to the Subcontractor when the Subcontractor's Work is fully performed in accordance with the requirements of the Contract Documents, the Architect has issued a Certificate of Payment covering the Subcontractor's completed Work and the Contractor has received payment from the Owner. If, for any cause which is not the fault of the Subcontractor, a Certificate for Payment is not issued or the Contractor does not receive timely payment or does not pay the subcontractor within three working days after receipt of payment from the Owner, final payment to the Subcontractor shall be made upon demand.

(Emphasis added. ^* ) Again, in each contract, Galloway struck out all the language following the word "Owner", initialed the change and requested that the subcontractor initial the change.

Work on the project continued from August 1988 until May 1990 when Rowe, suffering severe financial difficulties, stopped making progress payments to Galloway. On May 31, 1990, Galloway informed Rowe and the architect that it would stop work on the project and notified its subcontractors to secure their tools, equipment, and materials on the job site in anticipation of work being stopped. Work actually continued until July 17, 1990, when Galloway terminated its contract with Rowe. At that time Rowe had failed to make three progress payments to Galloway totaling slightly less that $3,000,000.

On September 20, 1990, Galloway filed a bill of complaint against Rowe to enforce its mechanic's liens. S.B. Ballard Construction Company (Ballard), Sprinkle Masonry, Inc. (Sprinkle), Empire Granite Corporation (Empire), Cape Henry Mechanical Corporation (Cape Henry), and Dover Elevator Company (Dover), subcontractors on the project, filed individual bills or cross-bills against Rowe and Galloway for their mechanic's liens and sought damages from Galloway for breach of contract. The trial court consolidated all these claims into the suit filed by Galloway against Rowe.

In a January 13, 1992 pre-trial order, the parties outlined the issues and stipulated to various elements of the evidence. Galloway asserted that the modification of the AIA contract form used in the subcontracts provided it with a "pay when paid" defense. That is, that the phrases "after the Contractor receives payment from the Owner" and "has received payment from the Owner," in paragraphs 11.3 and 12.1, respectively, create a condition precedent that Galloway must first receive payment from Rowe before being required to make payment under the subcontracts. Some, though not all, of the subcontractors agreed that if their contracts provided Galloway with a "pay when paid" defense, their sole course of recovery was against Rowe through their mechanic's liens. Also within the stipulations were agreements between Galloway and the various subcontractors that parol and other extrinsic evidence could be produced on the "pay when paid" issue.

Testimony was received over six weeks. Following the conclusion of the evidence and argument of counsel, the trial court determined the validity, priority, and amount of the mechanic's liens plus interest and approved the sale of the property, deferring the satisfaction of the mechanic's liens until after the completion of the sale. The trial court delayed further proceedings on the breach of contract claims until after the conclusion of the sale.

Following the sale and division of the proceeds, the subcontractors, whose liens had precedence over Galloway's, sought to recover the remaining unpaid balances due under their contracts with Galloway. On January 21, 1994, the trial court, by letter to counsel, stated its finding that there remained unpaid balances on the contracts and that Galloway did not have an absolute "pay when paid" defense based on the contracts as written. Rather, the trial court found that the phrases "after the Contractor receives payment from the Owner" and "has received payment from the Owner" only permitted Galloway to "delay payment[,] but the contract[s] cannot be construed to say that each sub[contractor] must bear its own loss if Galloway never got paid [on its contract with the owner]."

Galloway filed a motion for reconsideration, which was denied. Thereafter, the trial court entered final orders directing judgment for the subcontractors and awarding them the balance of their unpaid contracts plus interest. We awarded Galloway an appeal to consider the question of the "pay when paid" defense.

II. THE "PAY WHEN PAID" DEFENSE

This appeal presents our first opportunity to consider the use of "pay when paid" (sometimes rendered as "paid when paid") clauses in construction contracts. The use of such clauses rose significantly in the 1980s because economic conditions made successful completion of private construction projects more difficult and engendered a cautious attitude throughout the construction industry. See generally, Francis J. Mootz, III, The Enforceability of Paid When Paid Clauses in Construction Contracts, 64 Conn.B.J. 257 (1990).

The leading case to address the enforceability of "pay when paid" clauses is Thos. J. Dyer Co. v. Bishop International Engineering Co., 303 F.2d 655 (6th Cir.1962). In Dyer, the contract provided that "no part of [the price to be paid to the subcontractor] shall be due until five (5) days after Owner shall have paid Contractor therefor." Id. at 656. Following the insolvency of the owner, a subcontractor sought to enforce its contract with the general contractor. The Sixth Circuit rejected the general contractor's argument that the language of the contract constituted a condition precedent giving it a defense to the breach of contract claim. The court explained its rationale in the following language:

In the case before us we see no reason why the usual credit risk of the owner's insolvency assumed by the general contractor should be transferred from the general contractor to the subcontractor. It seems clear to us under the facts of this case that it was the intention of the parties that the subcontractor would be paid by the general contractor for the labor and materials put into the project. We believe that to be the normal construction of the relationship between the parties. If such was not the intention of the parties it could have been so expressed in unequivocal terms dealing with the possible insolvency of the owner. North American Graphite Corp. v. Allan, 87 U.S.App.D.C. 154, 184 F.2d 387, 390. Paragraph 3 of the subcontract does not refer to the possible insolvency of the owner. On the other...