Constitutional Problems: the Contract Clause

Peter Namtvedt's picture

A great many books have been written about the U.S. constitution. We have enjoyed some, particularly those which have pointed out problematic areas, clauses that the authors either regretted or wish could be fixed or just would prefer to be understood as they were when they were written.

Here we pull together the best thoughts, in our opinion, of various authorities on the U.S. constitution who have found clauses in it that have been ignored or misunderstood. Some of the authors merely want the correct meaning to be restored by educating the judiciary, others wish to amend the constitution so as to correct the way the constitution is applied (so as to repeal or correct the problem clauses), and yet others would like an entirely new constitution.

The focus here will be on one of the 10 troubling constitutional clauses:

  1. The commerce clause
  2. The contracts clause
  3. The due process clause (amend 5 and 14)
  4. The privileges or immunities clause
  5. The equal protection of the laws clause
  6. The general welfare clause
  7. The necessary and proper clause
  8. The supremacy clause
  9. The takings and tax clauses
  10. The enumeration of rights clause (amend 9)

The enumeration of rights clause (amend 9) We started with the commerce clause , which was expanded from regulating transportation between states to cover the expansion of many government powers over the economy and private activity. We continue now with the next troubling clause: #2, The Contracts Clause. This clause, which was once the principal protection of property rights, is rarely mentioned in our times; it is virtually repealed, as it is no longer the protection of our property rights that it once was, but rather, protection of contracts between citizens, while at times allowing the terms of loans to be broken and allowing government changes to its own contracts with us.



Article 1, section 10, clause 1 of the U.S. Constitution says: “No State shall . . . pass any . . . ex post facto Law or Law impairing the Obligation of Contracts.”

This was not meant to regulate all contracts, but to still allow laws which regulate how contracts are created, which improve or impair what a party to a contract could expect, as long as such regulation is prospective (applying to the future). This clause does not prohibit many laws and regulations which might restrict new contracts, but laws with a retroactive effect.

While the focus is on prohibiting impairment of the obligations of contracts, it will soon become apparent that the preceding words are also important. While ex post facto laws are often seen as attempts to suddenly prohibit past actions that were regarded as legal at the time they were done, the implications of such other law-making is tightly intertwined with government impairments of contracts.

Many impairments of the right of contracts have a retroactive characteristic, i.e., they harm part of your property in a promissory agreement made in the past. Benefits you may be receiving or have received, justly, in return for promising to perform some act or having already performed some acts, may be revoked. In the case of mortgage contracts, this often affects both borrowers and lenders. This is once again in 2007 a hot issue.

This latter effect is discussed again in the section later dealing with evaluation of the clause today, since the credit crunch of 2007 is likely to bring forth federal and/or state laws affecting financial contracts such as mortgages. This is already being considered in the United Kingdom .


As will often be necessary, we must first delve into the reason the constitution would have such a clause or clauses added. The background immediately becomes illuminating in that this was inserted late in the writing of the constitution as it was voted on. The writers were no doubt going back over weaknesses in the laws among the colonies several times, and the issues raised by other laws which may or may not need some constraints imposed. The language of the clause is not entirely new, having as recently as 8 weeks prior to the constitutional convention been added to the Articles of Confederation. The need for it was fresh on the minds of many participants and did not cause much discussion.

Criticism of this clause at the convention that it would limit the states ability to act in times of emergency, James Madison admitted this “inconvenience,” but saw the usefulness as outweighing these concerns. His wisdom prevailed.

The Confederation tolerated many a state law that steered the benefit of actions between people toward one party or the other. The affected interpretations of contractual obligations which after the fact were deemed unfair by one of the parties. Relief was often sought by people on the brink of bankruptcy. Such parties then petitioned for relief, and sometimes lawmakers were happy to help out. This no doubt began earlier in colonial times and was allowed to continue under the Confederation.


From the background information you can gather that arbitrary breaking of contract by the bound parties was not the issue, but rather the retroactive alteration of already existing contracts by state laws which would harm one of the parties to a contract. Debtor relief was one of several excuses. But the concept behind the contract clause was basically the rich concept of “property” in Enlightenment thinking. Each person has “property in” things, including persons, papers and effects, real estate, as well as abstract things that are usually protected by copyrights and patents. Both parties have “property in” (an ownership stake) in a loan contract as well as the listed items. One party has a right to collect repayments of principal plus interest at preset times. The other party has a right to possess and use the proceeds to buy land or capital equipment. It is no light matter to allow either party to renege on his obligation to honor the other party's “property” in the items exchanged and all terms of the contract.

Property, where mentioned elsewhere in the U.S. Constitution (article V and amendment XIV) are not firm guardians of property right. They were attempts at controlling the “taking” of what individuals owned by government or part of a short statement of human rights (“life, liberty and the pursuit of happiness” in the Declaration of Liberty is here “life, liberty and property”). These were not regarded early in our history as the real protection of property, as was the contract clause. Unfortunately they have all, one by one, been weakened by court decisions.


In the following is discussed the high points of U.S. Supreme Court decisions which have affected the interpretation or application of the contract clause. Some of this summarizes the expert narrative of Douglas W. Kmiec at Answers.Com .

While the clause might seem to have targeted debtor relief (allowing cancellation of debts through bankruptcy), early application by the Supreme Court refutes this. Chief Justice John Marshall would lead the court to apply the clause to public as well as private contracts; in Georgia 's attempt to cancel previous public land grants. In Sturges v. Crowninshield (1819) they rejected social welfare arguments for allowing escapes from their debts. Other cases went the same way except for Ogden v. Saunders (1827). As late as 1880 the Court dug deep to resolve difficult issues, sometimes hanging on whether a state could contract away its police powers (which primarily concerned public health and safety), in Stone v. Mississippi , where the state was prohibiting the sale of lottery tickets to a party whom the state had chartered to allow lotteries.

There was then a long lull in contract clause history, as from the Civil War until the 1930s the closest similar issues were economic problems with which due process rules dealt.

Due process rights began falling into disuse during the Great Depression, when debtor relief began to bubble up as a frequently occurring problem. States enacted laws to postpone foreclosures in the name of economic emergency.

The rule became, in regard to contracts, to balancing the older, declining power with “public needs” and “reasonable judgment.” Gradually the same “public purpose” intentions of government interference weakened the contract clause in the same way as the “takings clause.” See United States Trus v. New Jersey (1977) and Keystone Bituminus Coal Association v. DeBenedictis (1987). The contract clause was clearly no longer to be taken literally.


The topic of debtor relief is now very much once again in the forefront, as the USA struggles with its new credit crunch. The causes are not all clear, but the low interest rates of a few years enticed many home-buyers into mortgages which allowed interest-only payments for a few years, or very low payments, and adjustable rate mortgages (ARMS) and mortgages at higher rates which required no income documentation, which began to change to higher rates and to full payments in 2006. In 2007 some lenders found their holdings to be over-loaded with such mortgages, or sub-prime loans.

We should expect, into 2008, a hue and cry for relief and protection against foreclosures and freezing of loan rates.

This is not confined to this country. The problem spreads as problem loans are bundled and sold to investors who are motivated by the high rates that many of the loans get adjusted up to and by the discounts that sellers offer. Such investors are in places such as southeast pacific countries and China, as well as in Europe .

Now even as loans go into default and properties are seized, the foreclosures come to the notice of one more party: the IRS! Having lost one's home and some equity in it, insult is added to injury by the IRS when they claim you owe taxes on the difference between the market value and the forgiven part of the loan (which is carelessly computed for the IRS by the lenders). See the New York Times story .


It is time to stop the hollowing out of the U.S. Constitution! Not only the Commerce Clause, but also the Contract Clause, discussed above, have been emaciated. It is not just “history has . . .” but real people have been at work to undermine the wisdom of the Constitution. I would not take any blind trip to the past and opine that no law shall be passed that affected all contracts already in force. But all parties to contracts, individuals and states alike, must be allowed to retain their property or stake in such contracts. The corrective to the current problem situation would be a sound Libertarian conception of contracts and returning to the original meaning of the constitution's contracts clause as people then understood it.

Randy E. Barnett, Law Professor at Georgetown University, in his book The Structure of Liberty: Justice and the Rule of Law describes the Libertarian concept of the Freedom of Contract [p. 65]. It actually consists of two freedoms, the freedom from contract and the freedom to contract.

Freedom to contract means you should be free to agree to anything by contract, obliging you to do or pay anything that is alienable and entitling you to what the other party agrees to do for you or give you. This excludes enslaving and killing yourself (freedom to contract).

The freedom from contract means that you cannot become a party to a contract without your consent. It is not a valid contract unless you agree and sign it. A contract requiring your property or work is not valid unless you consent to it. No law can override your not consenting. No law can alter the terms of or cancel a valid contract.


Contract Clause Vs.US Congress

Can the U.S.Congress break the contract between AIG and it's retreive the $165 million in retention bonuses paid to them.



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Peter says:

The road to hell is paved with good intentions...

Peter also writes for Ada Byron's Blog.