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.