A Tale of Two States: Pay-if-Paid Clauses in Arbitration
In 1995, New York banned pay-if-paid clauses, enforcing only pay-when-paid provisions that set payment schedules, not conditions. Other states like New Jersey still enforce pay-if-paid clauses if clearly written. When contracts specify foreign law or arbitration, conflicts may arise—New York courts may uphold pay-if-paid clauses, but arbitration decisions can vary, and courts rarely overturn arbitration awards for legal errors. Parties should carefully consider choice-of-law and arbitration clauses to avoid uncertainty.
By Robert C. Angelillo
In 1995, New York’s highest court issued a landmark decision in construction law in West-Fair Electric v. Aetna Casualty and Surety Company, 87 N.Y.2d 148 (1995). In that decision, New York joined a number of other states in banning “pay-if-paid” clauses in construction contracts. Broadly defined, a “pay-if-paid” clause conditions payment to a subcontractor upon payment by the owner to the general contractor.
The New York Court of Appeals determined that, because payment by the owner to the contractor is an event that may never happen, a pay-if-paid clause could potentially indefinitely delay—or preclude altogether—a subcontractor’s right to payment.
That, in turn, would preclude the subcontractor from filing a mechanics’ lien. The court concluded that a pay-if-paid clause therefore constituted a waiver of a subcontractor’s lien rights, which is void as against public policy as set forth in Lien Law 34, which states:
Notwithstanding the provisions of any other law, any contract, agreement or understanding whereby the right to file or enforce any lien created under article two is waived, shall be void as against public policy and wholly unenforceable.
Following West-Fair, there was continued litigation surrounding the issue of linking payment to a subcontractor to payment to the contractor, and New York courts settled on a framework wherein “pay-when-paid” clauses were enforceable, but “pay-if-paid” clauses were not.
The lynchpin in these cases was essentially that a clause that casts payment by the owner to the contractor as a condition precedent to payment to the subcontractor is unenforceable as against public policy, whereas a clause that merely sets a time frame for payment is enforceable. See, e.g., Welsbach Elec. Corp. v. MasTec N. Am., Inc., 7 N.Y.3d 624, 629 n.2 (2006) (distinguishing between “pay-when-paid” and “pay-if-paid” clauses, while acknowledging that some courts use the terms interchangeably); Bank of Am., N.A. v. ASD Gem Realty LLC, 205 A.D.3d 1, 6 n.3 (1st Dep’t 2022) (same).
However, not all states share New York’s position on this issue—with New York’s neighbor to the west, New Jersey, taking a decidedly different approach. As recently as 2022, New Jersey courts have reiterated that state’s position that pay-if-paid clauses are enforceable in that state, even if they are clear conditions precedent to payment to the subcontractor. In JPC Merger Sub LLC v. Tricon Enterprises, Inc., 474 N.J. Super. 145 (2022), the Superior Court of New Jersey, Appellate Division held that:
In some states, legislatures have passed statutes declaring pay-if-paid provisions unenforceable, often as against public policy due, in part, to their impact on mechanic’s lien rights.
Although industry custom generally places the risk of an owner’s nonpayment on the general contractor rather than the subcontractor, we believe that as long as the contract on its face contains clear and unequivocal language that unambiguously sets forth the parties’ intention and agreement that owner payment is a condition precedent to the general contractor’s obligation to pay the subcontractor, such a provision is neither unfair, unconscionable, nor against public policy.
These two states—so close geographically and so intertwined commercially—plainly have very different views on the public policy implications underlying pay-if-paid clauses. While the issue may appear esoteric, it is often highly consequential in construction law cases.
Simply stated, an enforceable pay-if-paid clause can provide a complete defense to a contractor and therefore determine the outcome of the entire case if that contractor is sued by a subcontractor for non-payment. This issue should therefore factor heavily in the risk-analysis of any subcontractor contemplating entering into such a contract.
This divergence between New York and New Jersey law leads to the interesting question of what happens if, for example, your New York construction subcontract contains a provision applying New Jersey law? As it happens, New York’s courts have spoken to this issue—with the New York Court of Appeals stepping in to resolve a conflict of opinion between the First Department (covering New York County and Bronx County) and the Second Department (covering Long Island and the remaining boroughs of New York City and the lower Hudson Valley).
In 2005, the First Department upheld a choice-of-law provision selecting Florida law (which allows pay-if-paid clauses) where it had a reasonable relationship to the agreement, positing that the prohibition against pay-if-paid provisions was “not a deeply rooted tradition of this state.” Hugh O’Kane Elec. Co., LLC v MasTec N. Am., Inc., 19 A.D.3d 126, 126-28 (1st Dep’t 2005).
That same year, the Second Department reached the opposite conclusion—holding that the public policy considerations identified in West-Fair were strong enough to override the parties’ negotiated agreement as to the choice of law. Welsbach Elec. Corp. v MasTec N. Am., Inc., 23 A.D.3d 639, 641-42 (2d Dep’t 2005) (criticizing and declining to follow Hugh O’Kane), rev’d, 7 N.Y.3d 624 (2006).
In 2006, the New York Court of Appeals reversed the Second Department’s decision in Welsbach Electric and thus resolved the split between the First Department and the Second Department. The Court of Appeals clarified that New York courts will enforce a pay-if-paid clause if the contract in question contains a choice-of-law provision in favor of a state that permits it. Welsbach Elec., 7 N.Y.3d at 631-32. Accordingly, the issue is resolved as it pertains to litigating in a New York court.
But what if that same contract contains an arbitration clause? As most practitioners are aware, arbitrators are not bound by the law in the same manner as the courts. See, e.g., Barzilay v. Siegman, 161 A.D.2d 427, 428 (1st Dep’t 1990) (“An arbitrator is not bound by principles of substantive law or by rules of evidence… He may do justice as he sees it, applying his own sense of law and equity to the facts as he finds them to be and making an award reflecting the spirit rather than the letter of agreement, even though the award exceeds the remedy requested by the parties.” (citation omitted)).
So, what happens if an arbitrator decides not to enforce a pay-if-paid clause in a New York arbitration with a New Jersey choice-of-law provision? Is there a remedy for the contractor? Generally, the final step in the arbitration process is to make a motion seeking judicial confirmation of the arbitrator’s award (from the winner’s standpoint) or a motion seeking vacatur or modification of the arbitrator’s award (from the loser’s standpoint). See generally CPLR §§7510, 7511.
While a vacatur motion would appear to be the final fail-safe for a contractor so-aggrieved, the availability of such a motion is cold comfort. On a motion to vacate or modify an arbitration award, courts generally will not overturn an arbitrator’s decision unless there is evidence of bias or fraud, or evidence that the arbitrator exceeded the scope of the arbitration agreement. CPLR §7511. Improper application of the law, either by mistake or by design, is usually not enough to warrant vacatur. Barzilay, 161 A.D.2d at 428 (“An award will not be vacated for errors of fact or law committed by the arbitrators.”).
Accordingly, understanding the interplay between the relevant clauses—pay-if-paid, choice-of-law, and arbitration—before entering a contract is critical to ensuring that you are best-positioned in a potential arbitration. For example, the decision to seek and/or agree to a choice-of-law provision should be carefully considered. In this instance, the application of New Jersey law can be highly consequential and should give subcontractors pause.
Similarly, subcontractors and contractors alike should consider carefully whether to agree to arbitration clauses, as an arbitrator’s ability to disregard New York court decisions means that arbitration outcomes can be unpredictable.
Finally, if arbitration is the only forum available because of incorporation provisions or by insistence of the counterparty, each party should consider framing the issues to be resolved in the arbitration agreement to anticipate and avoid potential pitfalls.
While, in this way, practitioners may attempt to ensure certainty as to the law to be applied in their case, and even after all of the Court of Appeals decisions that have clearly established the contours of the pay-if-paid issue in New York courts, the issue can still come to the fore and be a basis for uncertainty in the arbitral forum.
Reprinted with permission from the August 10, 2026 edition of the “New York Law Journal” © 2026 ALM Global Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-256-2472 or asset-and-logo-licensing@alm.com.