Brewing problem? Expand debtor/creditor laws in relation to the “harmful contracts” clause of the Constitution

“No State shall . . . pass any . . . law affecting the obligation of contracts.

-Art. Me, dry. 10, Constitution of the United States

Increasingly, states are expanding their laws on debtor/creditor relationships, such as receiverships and assignments for the benefit of creditors.

Some of these extensions look suspiciously like Bankruptcy Code Lite—for example., adding “stay” provisions.

And that may be a constitutional issue, according to the long-standing (and recent) opinions of the United States Supreme Court.

What follows is a brief summary of three of these opinions.

One: the stay of bankruptcy is valid – due to the bankruptcy clause of the Constitution

The Supreme Court of the United States declares that a stay of bankruptcy, enacted by Congress, is valid under the Constitution of the United States, because of the bankruptcy clause of the Constitution.

The notice of suspension of bankruptcy from the Supreme Court is Continental Illinois National Bank v. Chicago, Rock Island & Pacific Railway294 US 648 (1935).

Here are excerpts from the Supreme Court’s reasoning, Continental against Chicago, on why Congress can create a stay of bankruptcy that infringes private contract rights.

• “The Constitution . . . does not in any way prohibit Congress from infringing upon the obligation of contracts just like the states(emphasis added).
• “As far as Calder versus Bull, 3 Dal. 386, 3 US 388, it was said that . . . Congress could not pass without overstepping its authority. . . ‘a law which destroys or alters the lawful private contracts of citizens.’ The broad scope of this statement has been restricted. . . but the principle it contains has never been repudiated.
• “Generally it may be said that Congress, though it has no power to infringe the obligation of contracts by laws acting directly and independently for that purpose, undeniably has power to pass laws relevant to any of the powers conferred by the Constitution, but it may operate incidentally or incidentally to alter or destroy the obligation of private contracts.
• “And, by virtue of the express power to enact uniform bankruptcy laws, the legislation is valid though drafted for the direct purpose and effect of relieving insolvent persons in whole or in part of the payment of their debts.”
• A stay of bankruptcy “must have been contemplated by the framers of the Constitution when the [bankruptcy] the power was granted.

294 United States at 680-81.

Notably, states do not have a bankruptcy-like clause in the U.S. Constitution for the power to create bankruptcy-like laws that infringe upon private contract rights.

Two: States cannot discharge their debts, but can release debtors from debtors’ prison

An old dividing line between acceptable and unacceptable state action is: paying debts versus paying debtors.

The old opinion on this dividing line is Sturges vs. Crowninshield17 US 122 (1819).

In Sturgesthe U.S. Supreme Court says:

• “The insolvent laws of many. . . States. . . release the debtor’s person [from debtors’ prison], but leave its obligation to pay in full force. The Constitution is not opposed to this” (17 US at 203); and
• “the act of the State of New York, . . . insofar as he tries to release this defendant from the debt. . . , is contrary to the United States Constitution. (ID. at 208).

Other state laws, discussed in Sturges as examples of permitted breaches of contract, do not “impair” any contractual rights. For instance:

• limitation periods “constitute proof that a contract has been performed” and do not affect a contractual obligation (identifier. at 206-07); and
• a contract created in violation of an existing law against usury “would have no obligation at its commencement” (identifier. at 207).

-Questions

What other types of state debtor/creditor laws are permissible laws (such as statutes of limitations and usury laws)?

And what types of state debtor/creditor laws constitute impermissible breaches of contract?

These questions are difficult to answer. This is because the law is not well developed on what constitutes an inadmissible “impairment” and what does not.

Three: The “Bankruptcy Laws” of the Constitution: A Very Broad Meaning

Association of Railway Trade Union Officials. against Gibbons, 455 US 457 (1982), applies Article I, § 8, cl. 4, of the United States Constitution, which provides that Congress shall have the power “to establish[LoisuniformessurlesujetdesfaillitesàtraverslesÉtats-Unis

Ce faisant, la Cour suprême annule, comme non uniforme, une loi sur la faillite qui “ne s’applique qu’à un seul débiteur et ne peut être appliquée que par le seul tribunal de la faillite ayant compétence sur ce débiteur”. Identifiant. au 471.

Les observations de la Cour suprême, en Chemin de fer contre Gibbonssur ce qui est considéré comme une loi sur la faillite comprennent :

• Le sujet des faillites, quoique « insusceptible de définition définitive », s’applique aux « relations entre un débiteur insolvable ou impayé ou frauduleux et ses créanciers, s’étendant à son et à leur secours » ;
• Pouvoir du Congrès en vertu de la clause de faillite :
  • « envisage un ajustement des obligations d’un débiteur défaillant » ;
  • « s’étend à tous les cas où la loi fait répartir les biens du débiteur entre ses créanciers » ;
  • « comprend le pouvoir de décharger le débiteur de ses contrats et de ses obligations légales, ainsi que de distribuer ses biens » ; et
  • “implique le pouvoir de porter atteinte à l’obligation des contrats”, ce que “les États étaient interdits de faire”. Identifiant. à 465-66.

Un tel langage suggère que les lois des États sur les relations débiteurs créanciers pourraient facilement être qualifiées de lois sur la faillite, sur lesquelles seul le Congrès – et non les États – a autorité.

[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).]

Conclusion

States are expanding their debtor/creditor laws with provisions that make those laws look more and more like a Bankruptcy Code Lite.

Such expansions likely push toward clashes over where the lines really lie, between constitutional and unconstitutional encroachments on contractual obligations.

In other words, trouble is brewing.