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Seventh Circuit Holds Pay-if-Paid Provisions Are Not Void Under Indiana Public Policy: Construction Law Alert

On May 11, 2012, the U.S. Court of Appeals for the Seventh Circuit issued a decision in BMD Contractors, Inc. v. Fidelity and Deposit Company of Maryland (No. 11-1345), affirming a lower court summary judgment in favor of a surety on a payment bond.

The case arose from the construction of an automobile transmission manufacturing plant. Before construction was completed, the owner filed bankruptcy, resulting in missed payments that flowed down the chain of contractors. BMD, a second-tier subcontractor, sued on a payment bond. The surety prevailed because its principal, with whom BMD contracted, was not liable for payment under the “pay-if-paid” provision in the subcontract:

“It is expressly agreed that the owner's acceptance of the subcontractor's work and payment to the contractor for the subcontractor's work are conditions precedent to the subcontractor's right to payments by the contractor.”

The Court rejected arguments that the conditional language in the subcontract should be construed as a “pay-when-paid” clause which governs the timing of payment, but not the ultimate obligation to pay.

Sitting in diversity jurisdiction and applying Indiana law, the Court made its best prediction of how the Indiana Supreme Court would decide the case. While Indiana courts had not previously decided the specific issue, based on prior decisions the Court concluded that the condition precedent language in the subcontract was sufficient to create a pay-if-paid provision under Indiana law.

The Court also rejected arguments that such provisions are void under Indiana public policy, given Indiana's “strong background presumption favoring freedom of contract” and the clearly stated language in the subcontract. The surety could assert all defenses available to its principal, including the pay-if-paid provision, and was not liable under the payment bond.

This Barnes & Thornburg LLP publication should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own lawyer on any specific legal questions you may have concerning your situation.

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Scott R. Murphy, Barnes Thornburg Law Firm, Grand Rapids, Construction and Litigation Law Attorney
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Scott R. Murphy is a partner in the Grand Rapids, Michigan, office of Barnes & Thornburg LLP, where he serves as vice chair of the firm’s Construction Law Practice Group. He is also a member of the firm’s Commercial Litigation practice group, where he concentrates his practice on business torts, contract disputes and securities fraud as well as shareholder oppression claims. A seasoned litigator, Mr. Murphy has experience in numerous forums, including state and federal courts, arbitration tribunals and appellate courts. His representative clients range from Fortune...

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Clifford J. Shapiro, Barnes Thornburg Law Firm, Chicago, Construction Law Attorney
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Clifford J. Shapiro is a partner in the Chicago office of Barnes & Thornburg LLP and Chairperson of the Construction Law Practice Group which consists of attorneys in the firm’s 14 offices. He is a Fellow in the prestigious American College of Construction Lawyers, is ranked as a “Band One” construction attorney by Chambers USA, is listed as one of the top 10 construction lawyers in Illinois by Leading Lawyers and listed in the Best Lawyers in America. He is also a past president of the Society of Illinois Construction Attorneys.

Mr. Shapiro and the Construction Law Practice Group handle matters in mediation, arbitration and litigation on behalf of public entities, owners and contractors. They have been involved in virtually every kind of claim or dispute related to a construction project, including construction defect claims, extra work claims, claims for delay and/or disruption and architect and engineering professional liability claims. In addition, Mr. Shapiro is a member of the American Arbitration Association's national roster of arbitrators, and he serves as a neutral mediator and arbitrator in connection with construction claims.

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