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How the Contracts Clause was gutted—and how SCOTUS’ early efforts to correct this have been ignored

Rob in Murano, Italy

The Constitution lists several things states may not do. Article I, Section 10 provides that “No State shall . . . pass any . . . law impairing the Obligation of Contracts.” This clause was inserted to curb state “debtor relief” laws that the Framers believed were immoral and rendered bad economic conditions worse.

Founding-Era debtor relief laws included, but were not limited to, measures permitting debtors to enjoy complete moratoria on payment (“stay laws”) or to repay in installments amounts actually due in full (“installment laws.”) To be sure, the constitutional ban extended beyond stay and installment laws, but they were the ban’s clearest targets.

The Contracts Clause did not prevent judges from relieving debtors from fraud or other creditor overreaching. Nor did it prevent courts from applying the particular remedy fairest to all concerned. And debtors could still declare bankruptcy if they chose. The Clause was designed only to prevent demagogic politicians from meddling, ad hoc, with honest bargains.

The Framers believed that stay and installment laws were immoral, because they allowed favored people to receive money or value from disfavored people on a promise of payment—and then break their promises. The Framers also believed such measures were bad for the economy. This was because they created uncertainty in the credit markets, which in turn led to higher interest rates and more arduous loan conditions. They also prevented debtors (and creditors) from proceeding to an orderly bankruptcy or loan restructuring so all parties could cut their losses and make a new start.

Were the Founders right about the bad economic effects of such laws? Recent evidence suggests they were. Our own recovery from the Great Recession has been painfully slow, and one reason seems to be constant federal interference with mortgage loans and other obligations. (The Contracts Clause does not apply to the federal government.)

For most of our constitutional history, the Supreme Court enforced the Contracts Clause. During the Depression of the 1930s, however, states once again began to adopt stay and installment laws as a way to “help” debtors.

A Minnesota stay law came before the Supreme Court in 1934 in the case of Home Building and Loan Assn. v. Blaisdell. Once the Court failed to take advantage of an easy way to avoid the constitutional issue,* the case should have been an easy one: The Minnesota statute was precisely the kind of measure the Contracts Clause was adopted to prohibit. Yet the Court upheld it by a 5-4 margin. The five justices in the majority included the Court’s four progressives, and its centrist, Justice Owen Roberts. (The claim, based on the invalidation of a few New Deal measures, that the 1930s Supreme Court had a conservative majority is inaccurate.)

The Blaisdell opinion, a long and confused production by Chief Justice Charles Evans Hughes, did what “progressive” justices have so often done: It replaced clear constitutional language with judge-made and judge-administered “balancing tests.” In the Blaisdell case, the “test” boiled down to whether or not the justices themselves (not the Founders!) thought the law was sufficiently targeted at what the justices themselves (not the Founders!) thought was an emergency.

Most of the foregoing is widely understood among constitutional writers. What is much less known is that the Court seemed to have second thoughts almost immediately. Later the same year, in W.B. Worthen Co. v. Thomas, the Court tossed out an Arkansas law essentially barring creditors from seizing life insurance proceeds. The Court’s excuse for not following Blaisdell was that the law was not targeted at the economic emergency—although it clearly was adopted in response to the Depression.

Similarly, in 1935 in W.B. Worthen Co. v. Commissioners, the Court voided another Depression-era Arkansas law that re-wrote a contract between a municipal improvement district and its bondholders.  Again, the Court held that the law was not sufficiently targeted, disregarding that it clearly was a response to hard times. Yet again, in 1936, the Court in Treigle v. Acme Homestead Assn voided a 1932 Louisiana statute designed to shore up threatened savings and loans associations.

Several things are striking about the three post-Blaisell cases.

1. They all involved enactments that, as in Blaisdell, were adopted to address the emergency created by the Great Depression.

2. The Court had to strain to show how they were different from Blaisdell—so much, in fact, that one could argue that they either overruled or severely limited Blaisdell.

3. All three subsequent cases were unanimous.  The Treigle opinion was written by Justice Roberts, a centrist. The Thomas and Commissioners opinions were written by Chief Justice Hughes and Benjamin Cardozo, both progressives.

Was the Court really having second thoughts? In her recent best-seller, The Forgotten Man, Amity Shlaes argues that much New Deal-era legislation actually prolonged the Great Depression by creating an arbitrary, unpredictable business environment.  Perhaps the justices on the U.S. Supreme Court were coming to the same conclusion—at least as to state-based “debtor relief” legislation.

Whatever the reason for the Court’s pull-back, you’d think that academic writers would realize that the authority of Blaisdell had been badly impaired. Yet academic writers are overwhelmingly left-of-center. Their treatises, therefore, tend to emphasize Blaisdell and omit or minimize the later decisions. The Supreme Court, which eventually did get a “progressive” majority, conformed to this pattern of emphasis and omission.  It has cited Blaisdell nearly 70 times, while only rarely citing the cases that limited or overruled it.

* Arguably the Minnesota law only wrote into statute tools for avoiding injustices that judges could use in mortgage foreclosure cases from before the Founding Era. If this was so (and Chief Justice Hughes strongly suggested it was), then the statute was valid under the Contracts Clause as originally understood. In other words, the Court could have upheld the statute without disregarding the Founders’ understanding and without creating a jurisprudential mess.

Rob Natelson