King’s X

Can a state, county or city government enter a contract with a private business and then call a “King’s X” by passing a law that changes the deal. Fairness says this cannot be right. The answer is not that simple.The United States Constitution limits the ability of state and local governments to impair contractual obligations.  In United States Trust v. New Jersey, the United States Supreme Court said “[c]ontract rights are a form of property and as such may be taken for a public purpose provided that just compensation is paid,” and thus “[t]he States remain free to abrogate such rights upon payment of just compensation.”

The purpose of this “Contract Clause” is to protect the legitimate expectations that arise from contractual relationships from unreasonable legislative interference.  As observed in Allied Structural Steel Co. v. Spannaus, “[c]ontracts enable individuals to order their personal and business affairs according to their particular needs and interests.  Once arranged, those rights and obligations are binding under the law, and the parties are entitled to rely on them.”

Although this prohibition on impairment must be balanced against the power of governmental authorities to regulate matters of public concern, courts have recognized that “a higher level of scrutiny is required” when the legislative interference touches on the government’s own contractual obligations.  Thus, when legislation substantially impairs a contract right, it may violate the Commerce Clause. 

Legislation may rise to the level of a “substantial impairment,” even absent total destruction of the contract.  With respect to public contracts involving a governmental entity, a federal court has said impairment is substantial if it “deprives a private party of an important right, thwarts performance of an essential term, defeats the expectations of the parties, or alters a financial term.”  Moreover, the fact that an ordinance relates to areas that are frequently the subject of municipal supervision, for example zoning or business licensing, does not immunize it from the Contract Clause.  Notably, other federal courts have determined that a contract is “impaired” in violation of the Contract Clause where the government uses its legislative authority “not merely to breach its contractual obligations, but to create a defense to the breach that purports to prevent the recovery of damages.”

A law or ordinance that substantially impairs a public contract cannot survive unless the impairment is “both reasonable and necessary to fulfill an important public purpose.”  In the Energy Reserves Group case, the Court explained that the requirement of a legitimate public purpose “guarantees that the state is exercising its police power, rather than providing a benefit to special interests.”  Where the government has impaired its own contract it bears the burden of establishing that each aspect of the ordinance is reasonable and necessary to fulfill an important public purpose and the municipality is not entitled to deference given the government’s self-interest is at issue.

As the court observed in the Cayetano decision, “[i]mpairment is not reasonable if the problem sought to be resolved by an impairment of the contract existed at the time the contractual obligation was incurred.” Changed circumstances and important government goals do not make an impairment reasonable if the changed circumstances are “of degree and not kind.”

References

United States Constitution Art. I, § 10; United States Trust v. New Jersey, 431 U.S. 1 (1978); Southern California Gas Co. v. City of Santa Ana, 336 F.3d 885 (9th Cir. 2003); Allied Structural Steel Co. v. Spannaus, 438 U.S. 234 (1978); Univ. of Haw. Prof’l Assembly v. Cayetano, 183 F.3d 1096 (9th Cir. 1999); Crosby v. City of Gastonia, 635 F.3d 634 (4th Cir. 2011); Pure Wafer Inc. v. City of Prescott, 845 F.3d 943 (9th Cir. 2017); Seltzer v. Cochrane, 104 F.3d 234 (9th Cir. 1996); St. Paul Gaslight Co. v. City of St. Paul, 181 U.S. 142, 148 (1901).