Is “Pay When Paid” article valid?

The “Pay When Paid” (hereinafter referred to as the “PWP”) clause usually applied in the chain contracts. The typical feature of PWP is that there are two contracts, a party sets the payment of the upstream party as the precondition for the payment to the downstream party. Such clause could help the party to reduce risks related to the payment, which is widely used in contracts such as construction, advertising, technical services, bulk cargo transactions and so on. However, the validity of such clause is not clearly defined in the current laws, so it is impossible to affirm such clause is valid to not in individual cases.

In judicial practice, the “PWP” clause would be deemed as invalid due to four specific reasons.

First, some courts held that the “PWP” clause breaks the principle of privity of contract, and violates the principle of fairness, so it should be invalid. For example, in the case of (2020) Xin Min Zhong No. 45, the court held that, “According to the principle of privity of contract, whether Company A had received the payment from Company C, the owner, in accordance with the contract signed with Company C, would not affect the payment by Company A to Company B.“ The first-instance court found that such clause was unfair, and rejected Company A’s defense.

Second, some courts held that the “PWP” clause is a standard clause, which violates the principle of fairness, so it should be invalid. For example, in the case of (2018) Jing 01 Min Zhong No. 5491, the court held that, “According to the contract, after company A received the installment payment from the end user, it should pay company B proportionally. However, it is impossible for Company B to know whether the end user pays Company A and when, Company B was obviously in a disadvantageous position when signing the contract, so such clause had violated the principle of fairness.”

Third, the “PWP” clause is invalid due to the invalidity of the contract. For example, in the case of (2020) Chuan 01 Min Zhong No. 7194, the court held that, “Even if Company A believed that it should only pay B for construction works after it received the project payment from its counterparty according to the principle of the “PWP” clause, however, since the “Labor Service Subcontract for the Construction of Hydropower Installation Projects” is an invalid contract as explained in the beginning, Company A has no basis for this defense.”

Fourth, the “PWP” clause is invalid due to the fuzzy demonstration. In the case of (2019) Jing 03 Min Zhong No. 6724, the second-instance court held that, “First of all, the contract only stipulates the due time and amount of the payment between Company A and Company B, which failed to demonstrate the “PWP” clause, and did not disclose Company C. Secondly, the evidence submitted by Company A could not prove that it had informed Company B about the “PWP” clause, if Company A’s explanation should be applied, then Company B would undertake the risk of the uncertainty of the payment, which violated the principle of fairness and the legislative spirit of contract law.”

In view of the above reasons, in order to reduce the risk of the “PWP” clause being invalidated, the intermediary party should pay attention to the following aspects:

First, to ensure the validity of the relevant contracts. If the main contract is found to be invalid, it may directly lead to the invalidity of the “PWP” clause. If such occasion does happen, the intermediary party may consider to defense from the perspective of Article 567 of the Contract Volume of the “Civil Code”, which stipulates that the termination of the contract’s rights and obligations does not affect the validity of the settlement and liquidation clauses in the contract.

Second, the “PWP” clause should be clear and specific. Generally speaking, the “PWP” clause should at least contain the payment time (e.g. specific payment time node, payment term), amount, method, ratio, terms, etc. For example, in a construction contract, the payment node of the contract signed by the general contractor and the owner shall correspond to the payment node agreed by the general contractor and the subcontractor, and the necessary information of the owner shall be disclosed to the subcontractor.

Third, to avoid being identified as a standard clause. The party that provides the “PWP” clause shall highlight such clause by special fonts, colors, etc., and draw the counterparty’s attention, which can prove the party has fulfilled the obligation of prompting and explaining. In addition, it is recommended to keep the emails, WeChat history during the negotiation regarding such clause.

Fourth, to well manage the contract during the performance. The Beijing High People’s Court clearly affirmed the validity of the “PWP” clause in the construction contract of the construction project in item 22 of the “Answer to Several Difficult Problems Regarding the Trial of Construction Contract Dispute Cases”. The court also requires the intermediary party to make the settlement timely, claim for due payments timely, and bear the burden of proof for the facts of the progress of the settlement. Therefore, the intermediary party should pay attention to retaining evidence, such as the relevant evidence which could prove it has actively organized the project acceptance, followed up the project progress, claimed creditor’s rights to the upstream party, and informed the downstream party of the relevant situation.