COVID-19, debt and the Constitution

COVID-19, debt and the Constitution
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Despite recent efforts to reopen, state economies are sinking under the combined weight of COVID-19 and state-mandated economic suppression. With no income to pay the bills, businesses and workers will soon be submerged in debt. States thus owe it to their residents to enact debt-relief legislation that provides affected borrowers with payment deferral and the opportunity to refinance missed payments.

Indeed, several states – including New York, Ohio and California – have proposed bills promising borrowers relief from mortgage and auto debt. The banking industry, in response, has questioned whether these bills are constitutional.

It is true that, unlike Congress, states are prohibited by the Constitution from passing laws “impairing the obligation of contracts.” But decades of Supreme Court decisions compel the conclusion that the COVID-19 debt-relief bills would not violate this clause. The key Depression-era cases uphold debt relief, and the Supreme Court has not invalidated a state law under the Contracts Clause since 1978.

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Nevertheless, a conservative court could maneuver its way through these decisions and find a constitutional violation. Therefore, states should protect their autonomy and pass legislation that authorizes governors to enact debt relief in the event of a future pandemic. By legislating prospectively, states can practically eliminate the risk of violating the Contracts Clause.

When does a state law violate the Contracts Clause? To answer this question, courts first ask whether the law imposes a substantial impairment on contractual obligations. If it does, they next ask whether the law reasonably advances a significant and legitimate public purpose.

Behind this simple test lies a complex history. After the Revolutionary War, many states passed laws granting debt relief, and the Framers included the Contracts Clause in the Constitution to limit this practice. Throughout the nineteenth and early twentieth centuries, courts routinely struck down debtor-friendly state laws.

This all changed during the Great Depression. In Home Building & Loan Association v. Blaisdell (1934), the Supreme Court held that a Minnesota statute extending the time that borrowers could occupy and repurchase property after foreclosure did not violate the Contracts Clause. During the extension period, the principal remained, interest accumulated, and the borrower was required to pay rent. Accordingly, the court found the statute to be a temporary and legitimate response to an emergency that imposed reasonable conditions on borrowers and lenders.

Under Blaisdell, the COVID-19 debt-relief bills would be constitutional if enacted. Despite impairing contractual obligations, the bills would advance two key public purposes. First, as in Blaisdell, they would reduce defaults on consumer debt, which unfairly and inefficiently concentrates risk on borrowers during a downturn. Second, by reducing foreclosures and automobile repossessions, the bills would mitigate COVID-19 health risks, and the state’s police powers are at their height in matters of public health and safety. Third, courts traditionally defer to legislative expertise in Contracts Clause cases involving private contracts. Here, the bills’ provisions are presumptively reasonable because they closely track the relief provisions for federally-insured mortgages in the recent CARES Act.

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The bills’ provisions are also similar to those in Blaisdell. The two main differences are that the statute in Blaisdell required court supervision and payment during the extension period. It is reasonable, however, for a state to depart from these requirements.

First, loan servicers are better positioned than courts to handle thousands or millions of requests for relief. Second, the whole point of relief is to delay payments until after the COVID-19 emergency ends. It would be perverse for states to require ongoing 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 need only provide reasonable protection to the investments of large, corporate lenders, and the bills' provisions do so by refinancing missed payments on terms more-or-less identical to those of the original loan.  

Nevertheless, courts could obstinately read Blaisdell to require ongoing payments or judicial supervision and find laws based on the COVID-19 debt-relief bills to be unconstitutional. Therefore, states should also pass enabling legislation that authorizes governors to declare debt relief in the event of a future pandemic. In such a pandemic, a governor’s declaration would cover all contracts formed since the enabling legislation without regard to the Contracts Clause.

The reason why is again historical. Since Ogden v. Saunders (1827), it has been settled that the Contracts Clause’s prohibitions only apply retrospectively to contracts in existence at the time a law is passed. Subsequent contracts are unaffected because, at the time of formation, they are said to incorporate all existing laws as implied terms.

Still, few matters are truly settled in constitutional law. The Supreme Court could decide to resurrect Chief Justice John Marshall’s dissenting view in Ogden v. Saunders (1827) that the Contracts Clause applies prospectively. But this would overturn 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 it certainly does not prevent states from planning ahead for the next pandemic.

Prasad Krishnamurthy is professor of law at U.C. Berkeley School of Law, where he teaches and writes in the area of financial regulation and contracts.