COVID-19, Debt and the Constitution
Despite recent reopening efforts, state economies are sinking under the combined weight of COVID-19 and state-imposed economic suppression. Without income to pay the bills, businesses and workers will soon be overwhelmed with debt. States therefore owe it to their residents to pass debt relief legislation that provides affected borrowers with deferral and the ability to refinance missed payments.
Indeed, several states – including New York, Ohio and California – have law projects borrowers promising mortgage and auto debt relief. The banking sector, in response, has interrogates whether these bills are constitutional.
It is true that, unlike Congress, the Constitution prohibits states from adopting laws “affecting the obligation of contracts.” But decades of Supreme Court rulings force the conclusion that COVID-19 debt relief bills would not violate this clause. Key Depression-era cases uphold debt relief, and Supreme Court did not strike down state law under contract since 1978.
Nonetheless, a conservative court could push its way through these rulings and find a constitutional violation. Therefore, states should protect their autonomy and pass legislation authorizing governors to order debt relief in the event of a future pandemic. By legislating prospectively, states can virtually eliminate the risk of violating Contract clause.
When does a state law violate the Contractual clause? To answer this question, the courts first ask whether the law imposes a material interference with contractual obligations. If so, they then ask whether the law reasonably promotes an important and legitimate public objective.
Behind this simple test lies a complex story. After the War of Independence, many states passed laws granting debt relief, and the drafters included the contracts clause in the Constitution to limit this practice. Throughout the 19th and early 20th centuries, courts routinely struck down state laws favorable to debtors.
Everything changed during the Great Depression. In Home Building & Loan Association v. Blaisdell (1934), the Supreme Court ruled that a Minnesota statute extending the period during which borrowers could occupy and redeem property after foreclosure did not violate the contractual term. During the extension period, the principal remained, the interest accrued, and the borrower was required to pay rent. Accordingly, the court held that the law was a temporary and legitimate response to an emergency that imposed reasonable terms on borrowers and lenders.
Under Blaisdell, COVID-19 debt relief bills would be constitutional if passed. While undermining contractual obligations, the bills would advance two key public objectives. First, as in Blaisdell, they would reduce defaults on consumer debt, which unfairly and inefficiently concentrates risk on borrowers during downturns. Second, by reducing auto seizures and repossessions, the bills would mitigate the health risks associated with COVID-19, and the state’s police powers are at their height in public health and safety. Third, courts have traditionally relied on legislative expertise in contractual clause cases involving private contracts. Here, the provisions of the bills are presumed reasonable because they closely follow the relief provisions for federally insured mortgages in the recent CARES Law.
The provisions of the bills are also similar to those of the Blaisdell. The two main differences are that the status in Blaisdell judicial oversight and payment required during the extension period. However, it is reasonable for a state to deviate from these requirements.
First, loan managers are in a better position than the courts to deal with thousands or millions of requests for relief. Second, the purpose of the relief is to delay payments until the COVID-19 emergency is over. It would be wrong for states to demand continued payments as a condition of debt relief when their own social distancing policies have deprived so many borrowers of their livelihoods. Finally, in Blaisdell the court emphasized that state laws should only provide reasonable protection for investments by large corporate lenders, and the provisions of the bills do so by refinancing missed payments on terms more or less the same as the original loan.
Nevertheless, the courts could stubbornly read Blaisdell to demand continued payments or judicial oversight and find laws based on COVID-19 debt relief bills unconstitutional. Therefore, states should also pass enabling legislation that allows governors to declare debt relief in the event of a future pandemic. In such a pandemic, a governor’s statement would cover all contracts entered into from enabling legislation regardless of the contractual clause.
The reason is once again historical. Since Ogden v. Saunders (1827), it was established that the prohibitions of the contractual clause only apply retroactively to contracts in progress at the time of the enactment of a law. Subsequent contracts are not affected because, at the time of their formation, they are meant to incorporate all existing laws as implied conditions.
Yet few issues are truly settled in constitutional law. The Supreme Court may decide to resurrect Chief Justice John Marshall’s dissenting opinion in Ogden v. Saunders (1827) that the contractual clause applies prospectively. But that would reverse nearly 200 years of judicial precedent. Until then, the Constitution does not prohibit states from enacting reasonable debt relief in response to COVID-19. And that certainly doesn’t stop states from planning ahead for the next pandemic.
Prasad Krishnamurthy is Professor of Law at UC Berkeley School of Law, where he teaches and writes in the area of financial regulation and contracts.