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

Present: All the Justices

GALLOWAY CORPORATION

v. Record No. 942077

S.B. BALLARD CONSTRUCTION CO., ET AL.

OPINION BY JUSTICE LAWRENCE L. KOONTZ, JR.
November 3, 1995
GALLOWAY CORPORATION

v. Record No. 950529

CAPE HENRY MECHANICAL, INC., ET AL.

FROM THE CIRCUIT COURT OF THE CITY OF NORFOLK
John E. Clarkson, Judge

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 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:
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.

(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
*
The phrase "after the Contractor receives payment from the
Owner" in paragraph 11.3, supra, and the phrase "and the
Contractor has received payment from the Owner" in paragraph 12.1
form the basis of Galloway's "pay when paid" defense discussed
later in this opinion.
(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 hand, it deals with the
amount, time, and method of payment, which are
essential provisions in every construction contract,
without regard to possible insolvency. In our opinion,
paragraph 3 of the subcontract is a reasonable
 provision designed to postpone payment for a reasonable
period of time after the work was completed, during
which the general contractor would be afforded the
opportunity of procuring from the owner the funds
necessary to pay the subcontractor. Stewart v. Herron,
77 Ohio St. 130, [146,] 82 N.E. 956 [,959]. To
construe it as requiring the subcontractor to wait to
be paid for an indefinite period of time until the
general contractor has been paid by the owner, which
may never occur, is to give to it an unreasonable
construction which the parties did not intend at the
time the subcontract was entered into.

Id. at 661.

The contract in Dyer further provided that 90 percent of the

payment was due in any case 35 days after completion of the work.
Id. at 656. The court construed this provision of the contract

together with the term relied on by the general contractor as

merely postponing the time of payment to the subcontractor on an

unconditional promise to pay until payment by the owner, "or for

a reasonable period of time if it develops that such event does

not take place." Id. at 659. The court premised its result on

the fact that it is the general contractor who contracts with the

owner. Id. at 660. The court further held that the credit risk

inherent in the general contractor's undertaking may be shifted

to the subcontractor, but in order to do so, "the contract

between the general contractor and subcontractor should contain

an express condition clearly showing that to be the intention of

the parties." Id. at 661

Since the Dyer decision, the majority of jurisdictions which

have considered the "pay when paid" defense have adopted the

reasoning of the Sixth Circuit. See Mootz, Enforceability, 64

Conn. B.J. at 263 and cases cited therein at n.17; see also
Gilbane Building Co. v. Brisk Waterproofing Co., Inc., 585 A.2d

248, 250 (Md. Ct. Spec. App. 1991) (holding that use of term

"condition precedent" in "pay when paid" clause clearly

establishes intent of parties to shift credit risk of owner's

insolvency to subcontractor). A minority of jurisdictions as a

matter of policy do not allow the risk of owner insolvency to be

shifted from the general contractor to the subcontractors. See,

e.g., N.C. Gen. Stat. § 22C-2 (1994).
We find the reasoning of the Dyer decision to be sound and

in concert with traditional notions of the freedom to contract.

See Worrie v. Boze, 191 Va. 916, 928, 62 S.E.2d 876, 882 (1951).

However, that reasoning is applicable only where the language of

the contract in question is clear on its face. If, as in Dyer, a

contract on its face reasonably contemplates eventual payment by

the general contractor to the subcontractor, or, as in Gilbane,

the parties clearly intend there to be a condition precedent

fulfilled before payment comes due, the contract will be

construed as written and will not be reformed by the court

through the introduction of parol and other extrinsic evidence of

a contrary intent. Accordingly, we must consider whether the

contracts sub judice are clear on their face as to the parties'
intent.

III.

CONSTRUCTION OF THE CONTRACTS

Although the parties stipulated that parol and other

extrinsic evidence could be adduced as to the meaning of the

disputed parts of the contracts, neither the trial court, nor
this Court, is thereby precluded from examining the contracts

first, following the usual rules of contract construction. See

Whitt v. Godwin, 205 Va. 797, 802, 139 S.E.2d 841, 845 (1965).

The mere fact that terms of a contract are in dispute is not

evidence that the language is not clear and explicit and requires

extrinsic evidence to aid in its construction. If the terms of

the parties' agreement are contained in a clear and explicit

writing, that writing is the sole memorial of the contract and

the sole evidence of the agreement. In that event, parol

evidence cannot be used to explain the written contractual terms.
See Amos v. Coffey, 228 Va. 88, 91-92, 320 S.E.2d 335, 337

(1984).

Similarly, "parol evidence cannot be considered to explain a

patent ambiguity, that is, to supply the understanding that the

parties could have reasonably been expected to reach where the

language of an instrument reflects no understanding." Zehler v.

E.L. Bruce Co., Inc., 208 Va. 796, 799, 160 S.E.2d 786, 789

(1968); see also City of Roanoke v. Blair, 107 Va. 639, 641, 60

S.E. 75, 76 (1908). Only where the ambiguity is not self-evident

from the writing, that is, where there is a "latent ambiguity,"

is the use of parol and other extrinsic evidence permissible to

aid the trier of fact in determining the intention of the

parties. Portsmouth Gas Co. v. Shebar, 209 Va. 250, 253, 163

S.E.2d 205, 208 (1968).

"An ambiguity exists when language is of doubtful import,

admits of being understood in more than one way, admits of two or

more meanings, or refers to two or more things at the same time."
 Allen v. Green, 229 Va. 588, 592, 331 S.E.2d 472, 475 (1985);

see also Renner Plumbing, Heating & Air Conditioning, Inc. v.

Renner, 225 Va. 508, 515, 303 S.E.2d 894, 898 (1983). Ambiguity

is created by the "[d]oubtfulness [or] doubleness of meaning

. . . of an expression used in a written instrument." Berry v.

Klinger, 225 Va. 201, 207, 300 S.E.2d 792, 796 (1983).

Here, as in Dyer, the terms in paragraphs 11.3 and 12.1,

respectively, deal with the amount, time, and method of payment

to the subcontractor by the contractor, without regard to

possible insolvency of the owner. As such, they are essential

provisions in any construction subcontract. Unlike the facts in
Dyer, however, there is no additional language here which would

permit us to find that the parties contemplated payment "within a

reasonable time." Likewise, nothing in the contracts would

permit us to find, as in Gilbane, that the parties clearly

understood these terms to assert a condition precedent on

payment. Moreover, the contracts are completely devoid of any

unequivocal terms dealing with the possible insolvency of Rowe to

show that the subcontractors assumed the risk of that insolvency.

Thus, the language of the contracts is not patently ambiguous;

the latent ambiguity in the contracts was exposed only after the

default of the owner brought the issue into focus.

Thus, we conclude that the phrases "after the Contractor

receives payment from the Owner" and "has received payment from

the Owner" constitute latent ambiguities in the contracts. That

is, the phrases, while appearing perfectly clear at the time the

contracts were formed, because of subsequently discovered or
developed facts, may reasonably be interpreted in either of two

ways. See Zehler, 208 Va. at 799 n.5, 160 S.E.2d at 789 n.5.

Here, the contracts in question could be interpreted to require

Galloway to pay a subcontractor only if it received a payment

demanded from Rowe identifiable with the progress or completion

of a subcontract, or merely to provide for a reasonable time to

pay after such demand was made to Rowe. Because this ambiguity

was not patently evident on the face of the contract, the trial

court was permitted to look beyond the contract and determine the

intent of the parties using parol and other extrinsic evidence.
IV.
CONSIDERATION OF INDIVIDUAL CONTRACTS

When resolving a dispute between the parties to a contract

with a latent ambiguity, the court may first consider, among

other things, whether negotiations and prior dealings of the

parties manifested their intent with respect to the ambiguous

term. If the parties both manifested the same intent with

respect to the ambiguity, that intent will be enforced. If, on

the other hand, the parties do not manifest the same intent

regarding the ambiguity, there has been no meeting of the minds

on that term of the contract, and the intent of one party will

not control. It is apparent from the record of this case that

Galloway intended, in each case, that the contract would provide

it with an absolute "pay when paid" defense. Thus, only if the

subcontractor to each contract manifested the same intent will an

absolute "pay when paid" defense be available to Galloway.
Ballard Construction
 Ballard's president, Steven B. Ballard, testified that he

had previous experience with "pay when paid" clauses and that he

had "been educated the hard way" as to their effect. He further

testified that he was aware that Galloway had altered the AIA

form contract, but that he was depending on a separate "scope of

work" agreement, that pre-dated the contract, which included a

discount "to expedite the payment from the contractor to

[Ballard] without worrying about the payment from the owner to

the contractor." Under that agreement, before and after signing

the contract, Ballard received twelve progress payments from

Galloway without Galloway first receiving a payment from Rowe

identifiable to the work performed by Ballard. Based upon this

evidence, the trial court properly construed the contract to

permit Galloway only a reasonable amount of time in which to make

progress and final payments to Ballard. Accordingly, we will

affirm the trial court's award to Ballard.
Dover Elevator
After receiving the contract as modified by Galloway, Dover

submitted an amendment which modified Article 12 to require

"final" payment within 30 days of certain conditions being

fulfilled by Dover. Dover was to receive payment if Rowe

accepted the installation of the elevator cabs provided by Dover

or if Rowe accepted the completion of the project in whole

including acceptance of the elevator installation. Paul A.

Galloway, Galloway's president, testified that neither of these

conditions had occurred prior to Rowe's default. He further

testified that he understood this to be a modification of the
"pay when paid" clauses to eliminate the defense only in the

event of one of the two conditions occurring. Although Dover

presented evidence from its local manager, the manager conceded

that he had no knowledge of the negotiations between Dover and

Galloway.

Because Dover was in the position of having made the final

offer, and thus technically having control over the drafting of

the contract, we are required to construe the contract in favor

of Galloway. See Baird v. Dodson Bros. Exterminating, 217 Va.

745, 749, 232 S.E.2d 770, 773 (1977); Graham v. Commonwealth, 206

Va. 431, 434-35, 143 S.E.2d 831, 834 (1965). Moreover, Dover's

modification of Article 12 would indicate an understanding of the

effect of Galloway's prior modification of paragraph 12.1, and,

by extension, the identical modification of paragraph 11.3.

Accordingly, we hold that the evidence adequately supports

Galloway's contention that the parties had the intent of

providing a "pay when paid" defense in circumstances other than

those covered by the amendment to Article 12. The trial court's

award to Dover for breach of contract was thus in error and will

be reversed.
Cape Henry Mechanical, Empire Granite, and Sprinkle Masonry

William A. Etheridge, Jr., Cape Henry's president, testified

that he understood that Galloway's intent in altering the AIA

contract was "to not be obligated to pay [Cape Henry] until

[Galloway] got paid." (Emphasis added.) Etheridge further

conceded that subcontractors did not favor such terms, but that

he understood that he had to accept "pay when paid" terms in
order to be awarded the subcontract.

Apparently through an oversight, Stephen C. Broocks,

Empire's president, failed to sign the final contract proposed by

Galloway. As Empire undertook to perform the contract according

to its terms, an acceptance by performance resulted. The absence

of an authorized signature does not defeat the existence of the

contract and does not impact our analysis of the parties'

awareness of and intention concerning the ambiguity.
Broocks testified that he "thought the language . . . as

drafted . . . [meant that] if something should go wrong with the

job it would make it hard to get my money." He further testified

that he understood "Empire [would not] get paid until Galloway

[was] paid." (Emphasis added.)

Robert Hedrick, Sprinkle's vice-president, testified that

his "understanding of this contract . . . is that when [Galloway]

received payment from the owner [Sprinkle] would receive [payment

from Galloway]." He further testified that being familiar with

Galloway and its relationship with Rowe, Sprinkle assented to

these terms without concern that Rowe would not be able to

fulfill its contract with Galloway.

The testimony of the representatives of these subcontractors

shows that, even though the terms of their contracts were legally

ambiguous, each had a mutuality of understanding with Galloway in

regard to the ambiguous terms. A plaintiff's case can rise no

higher than his own testimony. Massie v. Firmstone, 134 Va. 450,

462, 114 S.E. 652, 655-56 (1922). Accordingly, since the

evidence shows that the parties, by their negotiations and prior
dealings, understood and intended their contracts to give

Galloway an absolute "pay when paid" defense, the trial court's

awards for breach of contract to these subcontractors were in

error and will be reversed.

In summary, we hold that in the absence of a clear and

unambiguous statement of the parties' intent as to the meaning of

the time of payment provision in a construction subcontract, an

absolute "pay when paid" defense is available to a general

contractor only if it can establish by parol evidence that the

parties mutually intended the contract to create such a defense.

Here, the evidence shows that such a defense was contemplated by

each of the subcontractors and was agreed to by each

subcontractor with the exception of Ballard. With respect to

Ballard, the evidence shows express efforts to avoid such a

defense. Accordingly, we will affirm the award to Ballard for

breach of contract and will reverse the awards to Dover Elevator,

Cape Henry Mechanical, Empire Granite, and Sprinkle Masonry.
Record No. 942077 - Affirmed in part,
reversed in part,
and final judgment.

Record No. 950529 - Reversed and final judgment.