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Yes, the Supreme Court’s Medicaid Decision was Good Contract Law

061712  RGN Thirlmere In NFIB v. Sebelius (the Obamacare decision) a 7-2 majority voided that part of the law that required states to join the Medicaid expansion or lose all (not just a part) of their Medicaid funds. The court treated the federal-state Medicaid relationship as a contract. It essentially held that while the states had granted the federal government power to make changes in the program, any changes the feds imposed had to be reasonable and foreseeable.

Former Solicitor-General Charles Fried has attacked this part of the decision on Scotus Blog, referring to it as“The Court’s Bad Contract Law:” He compares the states’ position to

“a commercial tenant who has a lease in commercial premises in which he has invested heavily and where he has lots of good will (e.g., a neighborhood restaurant). The lease is terminable after five years on sixty days’ notice and the lessor insists on a greatly increased rent. I submit that the tenant’s complaint that this constituted duress would get nowhere.”

But this is a bad analogy and the court’s reasoning was actually very good contract law.

There are certain principles that cut across the field of contracts and other “private law” subjects—subjects such as property, mineral law, associations, and partnership. These principles govern relationships where (1) the parties are locked together in a common enterprise for mutual benefit, and (2) some of the participants have granted to others the authority to make decisions affecting all. Examples include:

* The partnership or joint venture, where some of the partners or venturers have given one of their number authority to make business decisions.

* The homeowners association or mutual benefit association that receives power to make rules for the members.

* Joint landowners, where one holds the “executive right”—that is, authority to sign oil and gas leases on behalf of all.

* The relationship between a landowner and the company pumping oil from his land (the operator), where the landowner has authorized the operator to make decisions affecting the landowner’s royalties.

Now, the state-federal Medicaid program is clearly a common enterprise of this kind. It is jointly funded and jointly operated for a common purpose, and as part of the deal the states granted the federal government power to make program changes.

Early in my legal career, I practiced, wrote, and taught mostly private law subjects like contracts, property, real estate transactions, commercial law, and trusts. (Necessary knowledge for understanding the Founders’ Constitution, by the way.) One of my legal treatises, Modern Law of Deeds to Real Property (Little, Brown and Co., 1992) contains a theoretical chapter that summarizes the law of common enterprises.

In a common enterprise, the grantee of a power affecting the enterprise does not have authority to use the power however he wishes, even if the literal terms of the grant seem to permit it. The courts impose limitations. Depending on the specific area of the law being applied (contracts, oil and gas, partnership, agency, etc.), sometimes these limitations are referred to as “fiduciary,” sometimes as duties of “utmost good faith,” and sometimes as limiting the power to what is foreseeable or reasonable. But whatever called, they amount to pretty much the same thing.

The restrictions on a common enterprise power-holder fall short of true fiduciary duties, but are more exacting than what is required of an arms-length relationship, such as most commercial leases.

A primary restriction is that the power-holder must use his authority so as to preserve the essential bargain for all parties. He may not radically change what the parties bargained for initially (or would have bargained for, given the chance). This standard is precisely what the court applied in NFIB v. Sebelius.

There is another aspect of contract and property law that, while not at all necessary to the Supreme Court’s position, justifies it further: Power grants from sovereigns (in this case the states) are strictly construed in favor of the sovereign grantor. See Proprietors of Charles River Bridge v. Proprietors of Warren Bridge, 36 U.S. 420 (1837); United States v. Brown, 552 F.2d 817 (8th Cir.), cert. denied, 431 U.S. 949 (1977). Thus, doubts about the scope of the power granted by the states to the federal government are properly resolved in favor of the states.

Rob Natelson