The Obligation of Contracts Clause

No State shall . . . pass any . . . Law impairing the Obligation of Contracts. . . .

—Richard A. Epstein

Introduction

Article I, Section 10 contains a list of prohibitions concerning the role of the states in political, monetary, and economic affairs. This section prohibits the states from “pass[ing] any . . . Law impairing the Obligation of Contracts.” This provision’s interpretation by the U.S. Supreme Court, both before and after the Civil War, has been filled with odd turns and surprises.

History Before 1787

The protection of contracts was a prime objective of Roman and English law before the Founding period, but contracts were not constitutionally protected. The Roman system held that the constitutional dictates were those that pleased the king (quod principi placuit legis habet vigorem). Much constitutional theorizing sought to explain why the king normally would protect these arrangements. The English Bill of Rights (1689) again ignored contractual protection. This issue also was not taken up separately by the English colonies before the Revolutionary War. Instead, contractual protection came in silently through the back door. Natural law writings in the spirit of John Locke spoke of the protection of life, liberty, and property.¹

In 1787, the Articles of Confederation Congress had adopted the Northwest Ordinance. Article II provided an express protection for the rights of contract: “In the just preservation of rights and property . . . no law . . . shall, in any manner whatever, interfere with or affect private contracts or engagements, bona fide, and without fraud, previously formed.”²

The Constitutional Convention

On August 28, 1787, the delegates debated the Constitution’s prohibition on states issuing paper money as legal tender. Rufus King of Massachusetts proposed “a prohibition on the States to interfere in private contracts.”³ King hoped to extend the provision from the Northwest Ordinance to the states. A brief debate followed. George Mason of Virginia feared the prohibition would prevent the states from establishing time limits with respect to lawsuits involving state-issued bonds.⁴ James Wilson of Pennsylvania responded that the clause would prevent “retrospective interferences only”—that is, impair contracts already made.⁵ Wilson may have intended to limit the clause to retroactive impairment of contracts. The text, however, is not limited to contracts that were previously formed; it also could be read to prohibit the prospective impairment of future contracts.

The scope of the clause is also quite broad. It is not limited to the debtor-relief laws that were common in the states. Rather, it covers all types of contracts between private persons, including partnerships and corporations.⁶ This text was consistent with the Roman tradition.⁷ The term “obligation” was long understood to protect the debtor or obligor, but it also protects the full interests of the creditor. Both sides could seek the clause’s protection, whether the “impairment” be partial or total. Moreover, the Obligation of Contracts Clause applies to contracts with interstate connections as well as to local contracts.

The clause also reads as a stern imperative: Obligations of contracts cannot be violated under any circumstances, and Congress cannot waive that prohibition. By contrast, Congress can override other prohibitions on the states in Article I, Section 10, including the Import-Export Clause and the Compact Clause. (See Essay Nos. 84 and 86.)

The Ratification Debates

The Obligation of Contracts Clause appears in Article I, Section 10 alongside the section prohibiting the states from issuing paper money. (See Essay No. 79.) The Anti-Federalists feared that the two clauses operating in tandem would prevent the states from assisting the debtor classes: The states could not debase the currency with new issues of paper tender and could not invalidate contracts to wipe out unpaid debts. Luther Martin of Maryland had voted against the clause at the Constitutional Convention, arguing that the states would no longer be able “to prevent the wealthy creditor and the monied man from totally destroying the poor though even industrious debtor.”⁸

In Federalist No. 44, James Madison argued that the Obligation of Contracts Clause would “banish speculations on public measures, inspire a general prudence and industry, and give a regular course to the business of society.” Madison seemed to fear that debtor relief would undermine the long-term stability of commercial operations.

In the South Carolina ratifying convention, Charles Pinckney contended that the prohibitions on contractual impairment and state currency would help to cement the Union by barring the states from discriminating against out-of-state commercial interests.⁹ In the Virginia convention, Edmund Randolph declared that the Obligation of Contracts Clause was essential for enforcement of the peace treaty with Great Britain, which guaranteed private British debts.¹⁰ The clause therefore afforded both a protection to individuals against their states and a limitation on the states that prevented them from intruding on essential federal interests.

Judicial Precedent

In the antebellum period, the Obligation of Contracts Clause was the only general federal constitutional guarantee that imposed limitations on the state governments. The clause soon became the focus of efforts to protect economic liberties against state intervention.

The first seminal case on the clause was Fletcher v. Peck (1810).¹¹ The Georgia legislature had passed a law that transferred land to private parties, and the recipients had transferred the property to innocent purchasers. However, that initial grant of the property from the government was tainted by bribery. The next state legislature passed a statute that purported to repeal the legislation and thus to void the transfers to the innocent purchasers. The Supreme Court held that revoking these transfers violated the Obligation of Contracts Clause but did not fully address the fraudulent nature of the initial grant.

Nine years later, Chief Justice John Marshall wrote the majority decision in Trustees of Dartmouth College v. Woodward (1819).¹² This case held that the clause also prohibited state governments from violating contracts between the state and private parties. New Hampshire, acting through Woodward, tried to stack the Dartmouth Board of Trustees with its own trustees to convert the college into a public institution. The Court held that Dartmouth could invoke the clause to block the state’s legislation. Here, the obligation stretched back to Dartmouth’s royal charter. Marshall’s broad reading of the Obligation of Contracts Clause fits well with the Framers’ antipathy to corrupt self-dealing and unlimited state powers. Dartmouth College remains unchallenged to this day.

That same year, the Court decided Sturges v. Crowninshield (1819), which recognized that the Obligation of Contracts Clause protects rights that were already vested in private contracts.¹³ Specifically, state insolvency laws could not order the discharge of contracts that were already formed before the state statute was passed. This retrospective principle was not controversial. The clause must apply to preexisting contracts; otherwise, it would effectively be a dead letter. The legislature could not flip the background rules of the legal system to prejudice individuals who had advanced money on the faith of earlier arrangements.

Does the clause impose limitations on the power of the state to regulate contracts that are not yet formed? Ogden v. Saunders (1827), in which a divided Court upheld a prospective state bankruptcy statute, provided something of a mixed answer. Justice Bushrod Washington, writing for the majority, held that the clause’s original design does not block any improvements in the administration of commercial justice, but the Court also recognized limits on this holding. For example, the state could not nullify, individually and at-will, any contracts that were thereafter formed.¹⁴ The net effect of this legislation would be to nullify entirely the force of the clause. In short, the state may alter the rules governing future contracts in ways that offer greater security and stability to contractual obligations. In this regard, the Court disagreed with James Wilson, who had stated that the clause was purely retroactive. As a practical matter, however, Ogden left all general state economic regulation outside the scope of constitutional prohibition.

Over time, the yawning gap left by Ogden was filled by other constitutional provisions. The Court held that some future contracts were protected from state interference by the so-called Dormant Commerce Clause. (See Essay No. 44.) The Court has also invoked the doctrine of liberty of contract under both Due Process Clauses, and the Equal Protection Clause.

The Police Power

In the American legal system, there is a concept known as the police power. Under the police power, the state can override private rights of property to protect the public “safety, health, morals, and the general welfare.” (See Essay No. 173.) Actions taken pursuant to this power do not require just compensation under the Takings Clause of the Fifth Amendment. Limits on the police power are nowhere mentioned explicitly in the Constitution, but they are read into every substantive guarantee that limits the exercise of state power. For example, laws stopping contracts to pollute, to bribe, or to fix prices have always been permissible under the police power.

Beginning in the 1930s, the Supreme Court expanded the scope of the police power beyond these limited objectives. Home Building & Loan Association v. Blaisdell (1934) significantly multiplied the police-power exceptions to the Obligation of Contracts Clause even when no compensation was supplied. During the Great Depression, Minnesota imposed a mortgage moratorium to prohibit home foreclosures. The moratorium was challenged as a violation of the Obligation of Contracts Clause. But the Court upheld the mortarium as a proper exercise of the police power to deal with the exigencies of the fiscal crisis, despite the traditional police-power limitations relating to health and safety.¹⁵ This decision also unleashed many other legislative initiatives that sought to neutralize the protections secured by individual contracts. After Blaisdell, it was no longer possible to distinguish between the general welfare and special-interest laws benefiting certain groups.

Under modern doctrine, it is virtually certain that the Supreme Court will find a police-power justification for special legislation with interest-group support. For example, Exxon Corp. v. Eagerton (1983) found that a “broad societal interest” was sufficient to justify preventing a company from asserting its explicit contractual rights.¹⁶ The Court has effectively gutted the clause insofar as it applies to broad classes of existing contracts.

While the Supreme Court is largely deferential when the state voids contracts between private parties, it has remained more suspicious when the state voids a contract between the state and private parties. There is an obvious risk of self-dealing when the government uses legislation to extricate the state from its own covenants. The Court declared unconstitutional a law that nullified bond covenants that prohibited the government from using bond proceeds to support mass transit.¹⁷ It also refused to allow Minnesota to impose retroactively more stringent financial obligations on an employer in the winding up of the state’s pension plan.¹⁸ But in another case, the Court allowed Minnesota to apply retroactively a law revoking a spouse’s life insurance beneficiary status upon divorce.¹⁹

By contrast, when dealing with private contracts, the modern age often affords little intellectual respect for freedom of contract or for the sanctity of contracts validly formed.

Open Questions

• Can state and local governments unilaterally restrict pension benefits for public employees, both union and nonunion?²⁰
• Does the Obligation of Contracts Clause apply to a state’s subdivisions and administrative agencies?²¹
• What is the relationship between the Obligation of Contracts Clause and the Takings Clause of the Fifth Amendment? Does the state’s impairment of a contract require the payment of just compensation?²²

1. 2 The Writings of Samuel Adams 350–59 (Harry Alonzo Cushing ed., 1904–08), https://perma.cc/9ZBK-ESQB. ↩︎
2. Ordinance for the government of the territory of the United States, North West of the river Ohio, 32 J. Cont. Cong. 334 (July 13, 1787). ↩︎
3. 2 Farrand’s 439; James W. Ely Jr., Whatever Happened to the Contract Clause?, 4 Charleston L. Rev. 371, 372–73 (2010). ↩︎
4. 2 Farrand’s 440. ↩︎
5. Id. ↩︎
6. Thomas W. Merrill, Public Contracts, Private Contracts and the Transformation of the Constitutional Order, 37 Case W. Rsrv. L. Rev. 597, 597–98 (1987). ↩︎
7. Barry Nicholas, Introduction to Roman Law (1976). ↩︎
8. Storing 2.4.75–78. ↩︎
9. 4 Elliot’s 333–36. ↩︎
10. 3 Elliot’s 478. ↩︎
11. 10 U.S. 87 (1810). ↩︎
12. 17 U.S. 518 (1819). ↩︎
13. 17 U.S. 122 (1819). ↩︎
14. 25 U.S. 213, 266–268 (1827). ↩︎
15. 290 U.S. 398 (1934). ↩︎
16. 462 U.S. 176 (1983). ↩︎
17. United States Trust Co. v. New Jersey, 431 U.S. 1 (1977). ↩︎
18. Allied Structural Steel Co. v. Spannaus, 438 U.S. 234 (1978). ↩︎
19. Sveen v. Melin, 584 U.S. 811 (2018). ↩︎
20. In re Pension Reform Litigation, 32 N.E. 3d 1 (Ill. 2015). ↩︎
21. Rodney W. Harrell, The Contract Clause of the Constitution and the Need for “Pass Any . . . Law” Rehabilitation in the Age of Delegation, 22 Geo. Mason L. Rev. 1317 (2015). ↩︎
22. Richard A. Epstein, Toward the Revitalization of the Contract Clause, 51 U. Chi. L. Rev. 703 (1984). ↩︎