From Deadly to Dead Letter: The Rise and Fall of the Constitution’s Contract Clause

Erik Koltun

 

Under the US Constitution, the Contract Clause provides that “No state shall… pass any… Law impairing the Obligation of Contracts….”[1] Though once “perhaps the strongest single constitutional check on state legislation”,[2] it has largely disappeared from legal education.[3] This post explains how a powerful restraint on state legislation turned into a mostly dead letter.

One motivation behind the Clause was to protect creditors from state debtor relief statutes passed in the 1780’s which resulted from the majority debtor population taking advantage of the lack of strict limitations upon state legislatures in order to shirk debt.[4] The measure is among the Constitutional provisions which protect a minority against majority expropriation. Indeed, it functions to protect the majority debtor population from legislating against the minority creditor population.[5] Based on its language, however, the Clause broadly protects contractual obligations. James Madison said that the Clause intended to create security in private expectations,[6] a protection deemed essential to a young republic seeking to establish investor confidence and attract funding.[7]

The 19th century saw a powerful Contract Clause. The Supreme Court consistently applied the Clause to invalidate state legislation that impaired contracts, whether between private parties or between private parties and state governments.[8] Private parties successfully cited the Clause’s prohibition in challenges to impairments of land grants, corporate charters, and private debts.[9] The Supreme Court used the Clause to invalidate state laws which caused a material change in a contract’s obligations – such as when New Hampshire altered Dartmouth’s charter to add nine state-appointed trustees.[10]

However, the Court of the 19th century also placed limitations on the Clause that would later foreshadow its abrogation. First, the Court found in Ogden that the Clause can only be triggered when a law is applied to contracts formed before the law’s passage.[11] This finding was in spite of the dissent of Chief Justice Marshall, who believed that the Clause should apply prospectively and retroactively.[12] If Marshall had won out, the Contract Clause could have turned into an early version of economic due process, wherein a constitutional freedom to contract would endanger any state law which may impinge upon that freedom.[13] Ogden’s holding places the Clause’s focus on contracting parties’ reasonable expectations; because parties can expect impairment of obligations from laws passed prior to contract formation but not after, the latter can violate the Clause while the former cannot.

In Stone, the Court imposed a further restriction on the Clause, holding that a state may retroactively impair the obligations of contracts without violating the Clause when using its police power.[14] The Court limited police power to matters of public health or morals.[15] Additionally, the Court grounded its decision in an expectations-based model of the Clause. The case centered on the revocation of a charter granted to a corporation to run Mississippi’s lottery. The Court reasoned that because lotteries are a species of gambling which “disturb[s] the checks and balances of a well-ordered community”, any entity granted such a charter is on notice that the charter may be revoked when the public good requires.[16] This interpretation of the Clause offers a protection of reasonable expectations surrounding obligations rather than the obligations themselves, therefore suggesting that the Clause does not shield against the exercise of police power. It hints how future courts could expand these two concepts – reasonable expectations and police power – to eviscerate the Clause.

In the 20th century, the Court did exactly that. In Blaisdell, the appellant challenged a Minnesota law which extended the redemption period for mortgages entered into prior to passage of the law.[17] Though not a literal repudiation of debt, the situation is oddly reminiscent of a motivation behind the Clause – retroactive forgiveness of debt obligation by a state.[18] The Court found that the law did not violate the Clause because of emergency power.[19] In effect, the holding expanded the concept of police power in Stone to not only include public health and morals, but any economic emergency.[20] Though some have decried Blaisdell as marking the death of the Clause, the holding required that the law be limited to the duration of the emergency so that the Clause retained some vitality in the case of otherwise identical but permanent legislation.[21] This is evidenced by the fact that later in the same year, the Court used the Clause to strike down an Arkansas law because the legislature did not limit the law to the declared emergency.[22]

However, the Court’s subsequent readings of Blaisdell removed the holding’s limitations. In Veix, the Court found that although permanent state legislation aimed at addressing a crisis related to home loan associations was not limited to the emergency, it did not need to be, as it exposed a weakness in the financial system that the state’s police power had authority to regulate.[23] In East N.Y. Sav. Bank, the Court interpreted Blaisdell to mean that the protective power of the state is an implied condition of every contract, so when the state validly exercises its police power, there is no impairment.[24] Twenty years later, the Court upheld a state law significantly changing land forfeiture proceedings for land sold prior to the law’s passage without even mentioning emergency, emphasizing that the legislature had wide discretion to determine what is necessary to protect the general welfare.[25]

In the 1970s, two decisions breathed life into the Clause, though the power granted was limited in scope and short lived. In U.S. Trust Co., the Court struck down a move by the New Jersey government to invalidate a covenant that provided security to state bondholders.[26] The holding provided that when a state impairs its own obligations, a court must apply heightened scrutiny.[27] The Court found that complete deference to a legislature on questions of reasonableness and necessity was inappropriate where the State’s self-interest is at stake, because otherwise the State could reduce its financial obligations for whatever it regarded as an important public purpose.[28] The Court later struck down in Allied Structural Steel a Minnesota law that significantly and retroactively altered a company’s pension obligations to its employees.[29] Declaring that “the Contract Clause remains part of the Constitution”[30], the Court stated that a severe impairment of a contract’s obligation must lead to careful examination of the nature and purpose of the legislation[31].

Nonetheless, two subsequent decisions have allowed state legislatures to sidestep these decisions. In Energy Reserves Gro., the Court allowed a state to retroactively alter a public utility’s price obligation in a natural gas contract because the two parties operated in a heavily regulated industry, so parties could reasonably expect future price regulation.[32] In Eagerton, the Court allowed Alabama to shift the tax incidence of an increase from both the royalty owners and producer of an oil well to solely the producer.[33] The Court upheld the legislation because it was a generally applicable rule of conduct, rather than a statute with the sole effect of altering contractual duties.[34] Taken together, these cases suggest that state legislatures can sidestep the Clause as long as it regulates a heavily-regulated industry or bundles the retroactive contract alteration into a “generally applicable rule of conduct.” Ironically, this implies that the more broadly a statute retroactively alters obligations, the less likely it is to violate the Contract Clause. Unsurprisingly, since Allied Structural Steel, the Supreme Court has not voided any law under the Contract Clause.[35] For now, the Contract Clause is mostly dead.

 

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[1] U.S. Const. Art. 1, § 10, cl. 6.

[2] Tommy Tobin, Far from A "Dead Letter": The Contract Clause and North Carolina Association of Educators v. State, 96 N.C. L. Rev. 1681, 1681 (2018).

[3] James W. Ely Jr., Whatever Happened to the Contract Clause?, 4 Charleston L. Rev. 371, 371 (2010) (“Just how far the Contract Clause has fallen was made painfully clear to me last spring when a good Vanderbilt student asked about serving as a research assistant. When I explained the nature of my project, he pointed out that he was not familiar with the Contract Clause since the subject had not been covered in his constitutional law course”).

[4] Michael B. Rappaport, A Procedural Approach to the Contract Clause, 93 Yale L.J. 918, 931 (1984)

[5] Id. at 932

[6] Robert A. Graham, The Constitution, the Legislature, and Unfair Surprise: Toward A Reliance-Based Approach to the Contract Clause, 92 Mich. L. Rev. 398, 403 (1993)

[7] David Crump, The Economic Purpose of the Contract Clause, 66 SMU L. Rev. 687, 689 (2013).

[8] Fletcher v. Peck, 10 U.S. 87, 137-38 (1810); Tobin, supra note 2, at 1684 (“According to one estimate, the Clause had been considered by the Court in approximately forty percent of its cases involving the validity of state legislation prior to 1889.”).

[9] Graham, supra note 6, at 398.

[10] Trustees of Dartmouth College v. Woodward, 17 U.S. 518, 652-53 (1819).

[11] Ogden v. Saunders, 25 U.S. 213, 269 (1827).

[12] Leo Clarke, The Contract Clause: A Basis for Limited Judicial Review of State Economic Regulation, 39 U. Miami L. Rev. 183, 190 (1985)

[13] Id.

[14] Stone v. Mississippi, 101 U.S. 814, 819 (1879).

[15] Id.

[16] Id. at 820-21.

[17] Home Building & Loans Ass’n v. Blaisdell, 290 U.S. 398, 415-16 (1934).

[18] Rappaport, supra note 4 at 931.

[19] Blaisdell, 290 U.S. at 439.

[20] Id. at 420-22.

[21] Id. at 443-48

[22] W.B. Worthen Co. v. Thomas, 292 U.S. 426, 433-34 (1934).

[23] Veix v. Sixth Ward Building & Loan Ass’n of Newark, 310 U.S. 32, 39 (1940).

[24] East N.Y. Sav. Bank v. Hahn, 326 U.S. 230, 232 (1945).

[25] City of El Paso v. Simmons, 39 U.S. 497, 508-09 (1965).

[26] U.S. Trust Co. of New York v. New Jersey, 431 U.S. 1, 26 (1977).

[27] Id. at 23.

[28] Id. at 26.

[29] Allied Structural Steel v. Spannaus, 438 U.S. 234, 249 (1978).

[30] Id. at 241.

[31] Id. at 245.

[32] Energy Reserves Gro., Inc. v. Kansas Power & Light, 459 U.S. 400, 413 & 416 (1983).

[33] Exxon Corp. v. Eagerton, 462 U.S. 176, 194 (1983).

[34] Id. at 192

[35] David F. Forte, Forgotten Cases: Worthen v. Thomas and the Contract Clause, 18 Federalist Soc' Rev. 48, 55 (2017)