By: Donald L Swanson
“No State shall . . . pass any . . . Law impairing the Obligation of Contracts.”
–Art. I, Sec. 10, U.S. Constitution
Increasingly, states are expanding their laws on debtor/creditor relationships, such as receiverships and assignments for benefit of creditors.
Some of these expansions look suspiciously like a Bankruptcy Code Lite—e.g., adding “stay” provisions.
And that can be a constitutional problem, according to long-standing (and recent) opinions of the U.S. Supreme Court.
What follows is a brief summary of three such opinions.
One: Bankruptcy Stay is Valid—Due to Constitution’s Bankruptcy Clause
The U.S. Supreme Court declares a bankruptcy stay, enacted by Congress, to be valid under the U.S. Constitution—because of the Constitution’s Bankruptcy Clause.
The Supreme Court’s bankruptcy stay opinion is Continental Illinois National Bank v. Chicago, Rock Island & Pacific Railway, 294 U.S. 648 (1935).
Here are portions of the Supreme Court’s rationale, from Continental v. Chicago, on why Congress can create a bankruptcy stay impairing private contract rights.
- “The Constitution . . . does not in terms prohibit Congress from impairing the obligation of contracts as it does the states” (emphasis added).
- “As far back as Calder v. Bull, 3 Dall. 386, 3 U.S. 388, it was said that . . . Congress could not pass without exceeding its authority . . . ‘a law that destroys or impairs the lawful private contracts of citizens.’ The broad reach of that statement has been restricted . . . but the principle which it includes has never been repudiated.”
- “Speaking generally, it may be said that Congress, while without power to impair the obligation of contracts by laws acting directly and independently to that end, undeniably, has authority to pass legislation pertinent to any of the powers conferred by the Constitution, however it may operate collaterally or incidentally to impair or destroy the obligation of private contracts.”
- “And, under the express power to pass uniform laws on the subject of bankruptcies, the legislation is valid though drawn with the direct aim and effect of relieving insolvent persons in whole or in part from the payment of their debts.”
- A bankruptcy stay “must have been within the contemplation of the framers of the Constitution when the [bankruptcy] power was granted.”
294 U.S. at 680-81.
Notably, states do not have a bankruptcy-like clause under the U.S. Constitution for authority to create bankruptcy-like laws that impair private contract rights.
Two: States Cannot Discharge Debts—But Can Discharge Debtors from Debtors’ Prison
An ancient dividing line on acceptable vs. unacceptable state action is this: discharging debts v. discharging debtors.
The ancient opinion on this dividing line is Sturges v. Crowninshield, 17 U.S. 122 (1819).
In Sturges, the U.S. Supreme Court declares:
- “The insolvent laws of many . . . states . . . discharge the person of the debtor [from debtors’ prison], but leave his obligation to pay in full force. To this the Constitution is not opposed” (17 U.S. at 203); and
- “the act of the State of New York, . . . so far as it attempts to discharge this defendant from the debt . . . , is contrary to the Constitution of the United States.” (Id. at 208).
Other state laws, argued in Sturges as examples of permissible contract impairments, don’t actually “impair” contract rights at all. For example:
- statutes of limitations “amount to evidence that a contract has been performed” and do not impair a contract obligation (id. at 206-07); and
- a contract created in violation of an existing law against usury “would have no obligation in its commencement” (id. at 207).
What other types of state debtor/creditor laws are permissible legislation (like statutes of limitations and usury laws)?
And what types of state debtor/creditor laws are an impermissible impairments of contract?
These questions are difficult to answer. That’s because the law is not well-developed on what constitutes an impermissible “impairment” and what does not.
Three: Constitution’s “Laws on the Subject of Bankruptcies”—Very Broad Meaning
Railway Labor Executives’ Assn. v. Gibbons, 455 U.S. 457 (1982), applies Article I, § 8, cl. 4, of the United States Constitution, which provides that Congress shall have power to “establish . . . uniform Laws on the subject of Bankruptcies throughout the United States.”
In doing so, the Supreme Court overturns, as not-uniform, a bankruptcy law that “applies only to one debtor and can be enforced only by the one bankruptcy court having jurisdiction over that debtor.” Id. at 471.
The Supreme Court’s observations, in Railway v. Gibbons, on what qualifies as a bankruptcy law include:
- The subject of bankruptcies, though “incapable of final definition,” applies to “the relations between an insolvent or nonpaying or fraudulent debtor and his creditors, extending to his and their relief”;
- Congress’s power under the Bankruptcy Clause:
- “contemplates an adjustment of a failing debtor’s obligations”;
- “extends to all cases where the law causes to be distributed the property of the debtor among his creditors”;
- “includes the power to discharge the debtor from his contracts and legal liabilities, as well as to distribute his property”; and
- “involves the power to impair the obligation of contracts,” which “the States were forbidden to do.” Id. at 465-66.
Such language suggests that state laws on debtor creditor relations might easily qualify as bankruptcy laws, over which only Congress—and not the states—has authority.
[Note: The Railway v. Gibbons opinion is cited, earlier this week, as authoritative in Siegel v. Fitzgerald, Supreme Court Case No. 21-441, at 8 (decided 6/6/2022).]
States are expanding their debtor/creditor laws with provisions that make such laws look more-and-more like a Bankruptcy Code Lite.
Such expansions are probably pushing toward show-downs on where the lines actually lie, between constitutional and unconstitutional impairments of contract obligations.
In other words, trouble is brewing.
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