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ArtI.S10.C1.6.4.3 Modern Doctrine on State Changes to State Contracts

Article I, Section 10, Clause 1:

No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility.

The Court revived the Contract Clause in the context of public contracts in the late twentieth century. A major case from this time period, in which the Supreme Court confirmed it would thoroughly scrutinize state legislation that modified the state’s own contracts, is United States Trust Co. v. New Jersey.1 In that case, holders of bonds issued by the Port Authority of New York and New Jersey challenged a New Jersey statute as violative of the Contract Clause.2 The law, along with a parallel New York enactment, repealed a prior statutory covenant that limited the Port Authority’s discretion to use revenue and reserve funds pledged as security for the bonds in order to subsidize passenger rail transportation.3 The bondholders argued that in repealing the covenant, which sought to promote investors’ confidence in the bonds, the state impaired a contractual obligation in violation of the Contract Clause.4

The Supreme Court agreed with the New Jersey trial court that the state legislature’s statutory covenant was a contract among New Jersey, New York, and the bondholders that fell within the Contract Clause’s protection.5 The Court further determined that repeal of the covenant impaired the obligation of the states’ contract with the bondholders because the covenant had limited the Port Authority’s deficits, which in turn protected bondholders from depletion of the Authority’s general reserve fund, and the state had not replaced it with a comparable provision.6 Moreover, the impairment violated the Contract Clause because it modified the express terms of the parties’ agreement by repealing the covenant retroactively without being justified by a legitimate public purpose.7 The state legislature’s interests in protecting its citizens’ welfare by financing new mass transit projects, conserving energy, and protecting the environment could not justify the repeal,8 and the Court refused to defer to the state legislature’s judgment when balancing the alleged benefits that would result from impairment of the covenant against the private financial loss that the private bondholders would incur from impairment of the covenant.9 Instead, the Court considered whether the impairment was reasonable and necessary to serve the public purposes for which the State had accomplished it.10

In this vein, the Supreme Court determined that “a less drastic modification” of the covenant would have achieved the state’s purposes, such as amending the covenant to exclude new revenues from the limitation in order to subsidize mass transit.11 The repeal was also unreasonable because the original covenant had been made with full knowledge that the public might demand increased options for mass transit in the future.12 In other words, the Court was not reviewing a case in which a contract had been made a long time ago and circumstances had changed significantly.

Notably, in United States Trust Co., the Court declined to defer to the state’s characterization of the public interests affected by the challenged state legislation and refused to weigh these public interests against private contract rights.13 Consequently, the Court established a heightened standard of review for state laws that modify a state’s own obligations as opposed to laws that simply interfere with contracts between private parties.14 The Court justified this “dual standard of review” on the grounds that the state was a self-interested party.15

431 U.S. 1 (1977). back
See id. at 3. back
Id. “In general, a statute is itself treated as a contract when the language and circumstances evince a legislative intent to create private rights of a contractual nature enforceable against the State.” Id. at 17 n.14. State law addressing interpretation and enforcement of contracts may be deemed a part of the obligation of the contract as well. See id. back
Id. at 17. back
See 431 U.S. 1, 17–18 (1977). back
Id. at 19. back
See id. at 19–32. back
Id. at 21–32. The Supreme Court also examined whether the state could properly enter into the covenant without giving up an essential element of its sovereign powers. Id. at 23 & n.20, 28–29 (discussing the example of a state’s revocation of a twenty-five-year charter to operate a lottery as an illustration of the Contract Clause’s limits on a state’s power to bind itself not to exercise its police powers in the future). However, the Court determined the states could properly bind themselves to financial restrictions regarding use of revenues and reserves securing bonds to finance passenger railroads through the exercise of their spending (and, perhaps, taxing) powers, and thus the states could not argue that the 1962 covenant was invalid when it was adopted. Id. at 24–26. The Court listed a few examples of state powers that could not be contracted away, including its power of eminent domain and its police power. Id. at 24 n.21. back
See id. at 21–32. back
Id. at 29 ( “[A] State cannot refuse to meets its legitimate financial obligations simply because it would prefer to spend the money to promote the public good rather than the private welfare of its creditors. We can only sustain the repeal of the 1962 covenant if that impairment was both reasonable and necessary to serve the admittedly important purposes claimed by the State.” ). back
Id. at 29–31 & 30 n.28. back
Id. at 31–32. back
See id. at 25–28. back
See id. back
Id. at 26 & n.25 ( “As with laws impairing the obligations of private contracts, an impairment may be constitutional if it is reasonable and necessary to serve an important public purpose. In applying this standard, however, complete deference to a legislative assessment of reasonableness and necessity is not appropriate because the State’s self-interest is at stake.” ). back