Public Interest and State Modifications to Private Contracts

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Article I, Section 10, Clause 1:

No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility.

In the 1980s, the Supreme Court upheld generally applicable state laws regulating private contracts, which it determined were intended to serve a broad public interest, against Contract Clause challenges. For example, in Exxon Corp. v. Eagerton, the Court considered the constitutionality of an Alabama law that increased the severance tax on oil and gas extracted from wells located in the state, which the state imposed on producers at the time of severance.1 The law, which amended a statute that imposed a tax on oil and gas extracted from Alabama wells, exempted the owners of royalty interests from the tax increase and forbid producers from passing the tax increase on to purchasers or consumers.2 Oil and gas producers argued the law impaired the obligations of their contracts with royalty owners and consumers in violation of the Contract Clause.3

The Supreme Court determined the royalty owner exemption did not violate the Contract Clause because it did not impair contractual obligations benefiting the producers.4 The Alabama law merely provided that the royalty owners were not legally responsible for paying the tax to the state, and did not prevent the producers from shifting the burden of the tax to the royalty owners through contractual stipulations.5

With regard to the state law’s prohibition on passing through the severance tax to consumers, the Supreme Court confronted a more difficult question.6 The Court determined the prohibition interfered with producers’ existing contracts that required consumers to absorb increases in severance taxes.7 However, the Court noted the Contract Clause leaves some room for state regulation to protect the public welfare, even when such regulation would interfere with existing contracts.8 The Court deemed the pass-through prohibition to be similar to state laws setting rates in heavily regulated industries, like the electricity industry or oil transportation sector, which were consistent with the Contract Clause despite their incidental effect on existing contracts.9 Comparing the pass-through prohibition to a rate-setting scheme that displaced contractual rates, the Court determined the prohibition applied broadly, had a legitimate public interest justification (i.e., safeguarding consumers from high prices), and was not targeted specifically at contracts of oil and gas producers.10 Thus, there was no violation of the Contract Clause.11

Another case in which the Supreme Court determined that a state’s sovereign power to protect public interests justified the impairment of private contracts is Keystone Bituminous Coal Ass’n v. DeBenedictis.12 In that case, the Pennsylvania legislature, concerned about public safety, land conservation, and other issues, enacted a law prohibiting mining that would damage existing structures, such as public buildings and homes, by eliminating underground support.13 Petitioners, including a coal industry association and companies that controlled subsurface coal reserves, sued to enjoin a state environmental agency from enforcing the act and regulations promulgated thereunder.14 One of the petitioners’ challenges was that the Act on its face violated the Contract Clause by nullifying the surface owner’s contractual waiver of liability for damage to the surface estate from coal mining.15 The Court agreed with the lower courts that “the Commonwealth’s strong public interests in the legislation [were] more than adequate to justify the impact of the statute on petitioners’ contractual agreements.” 16

The Court determined that a contract right had been impaired because the coal companies secured waivers of liability from property owners for damages from mining to surface structures and much of the land affected by the Subsidence Act.17 The Act impaired this right by nullifying the surface owners’ contractual waiver obligations.18 However, the Court found that Pennsylvania’s interest in preventing environmental damage and hazards to people and property outweighed this contract right.19 Because the state was not a party to the contracts at issue, the court deferred to the state’s judgment that the legislation was appropriately tailored to the public purpose justifying it.20

In a subsequent case, Sveen v. Melin, the Supreme Court examined state regulation of private contracts in the context of a life insurance policy.21 In that case, the Court upheld against a Contract Clause challenge a Minnesota law that revoked any revocable beneficiary designation an individual made to his or her spouse (e.g., in a life insurance policy) if their marriage was dissolved or annulled.22 The law operated on the theory that the policyholder would have supported the revocation, and it allowed the policyholder to redesignate the ex-spouse as the beneficiary at any time.23

In Sveen, the life insurance policyholder designated his wife as the primary beneficiary prior to the state’s passage of the law, which operated retroactively.24 The policyholder and his wife subsequently divorced, and the divorce decree did not mention the insurance policy.25 After the policyholder passed away, his wife, who would have been the primary beneficiary under the policy if the legislature had not enacted the law, and his children, who were the contingent beneficiaries, claimed a right to the insurance proceeds.26 The Court examined whether retroactive application of the revocation-on-divorce law to the policyholder’s designation violated the Contract Clause.27

The Supreme Court, in an opinion authored by Justice Elena Kagan, rejected the Contract Clause challenge to the Minnesota statute.28 Although the Court determined that a life insurance policy was a contract subject to the Contract Clause,29 its holding recognized that not all laws that retroactively alter contracts in existence at the time of their passage violate the Contract Clause.30 Rather, a violation occurs only when (1) the law substantially impairs a contractual relationship (e.g., by undermining the agreement, interfering with a party’s reasonable expectations, or preventing a party from safeguarding or reinstating its rights); and (2) the law was not a reasonable and appropriate means of furthering a “significant and legitimate public purpose.” 31

In Sveen, the Court determined the Minnesota law did not substantially impair the life insurance contract for three reasons.32 First, the law supported the general objectives of life insurance contracts by attempting “to reflect a policyholder’s intent.” 33 Second, the law would not undermine the policyholder’s expectations regarding his or her beneficiary designation because the policyholder could not significantly rely upon that designation; a divorce court could revoke the beneficiary designation.34 Finally, the law provided a default rule the policyholder could modify simply by submitting paperwork.35

1: 462 U.S. 176, 178 (1983).
2: Id. at 178–79.
3: Cf. id. at 178–80. The producers were parties to contracts that allocated the tax among themselves, royalty owners, and nonworking interests “in proportion to each party’s share of the sale proceeds.” Id. at 180. They also were party to sales contracts that made purchasers responsible for reimbursing them for the severance tax on products sold. Id.
4: Id. at 187–88.
5: Id. at 188–89.
6: See id. at 189.
7: Id.
8: Id. at 190–91.
9: See id. at 192–94. In a separate section of its opinion, the Court determined that federal law preempted the pass-through prohibition as applied to sales of natural gas in interstate commerce. Id. at 187.
10: See id. at 191–94 ( “If a party that has entered into a contract to transport oil is not immune from subsequently enacted state regulation of the rates that may be charged for such transportation, parties that have entered into contracts to sell oil and gas likewise are not immune from state regulation of the prices that may be charged for those commodities.” ).
11: Id. at 196.
12: 480 U.S. 470 (1987).
13: Id. at 474, 476.
14: Id. at 478.
15: Id. at 502.
16: Id.
17: Id. at 504.
18: Id.
19: Id. at 505 ( “[T]he Commonwealth has a strong public interest in preventing this type of harm, the environmental effect of which transcends any private agreement between contracting parties.” ).
20: Id. at 505–06.
21: No. 16-1432, slip op. at 1 (U.S. June 11, 2018).
22: Id. at 1.
23: Id.
24: Id. at 5–6.
25: Id. at 5.
26: Id. at 5–6.
27: Id. at 6.
28: Id. at 1.
29: Id. at 7.
30: Id.
31: Id.
32: Id. at 7–8.
33: Id.
34: See id. at 8–10.
35: Id.