You asked whether the state could pass a law that alters an existing commercial contract between a state government entity and a private company. Our office is not authorized to give legal opinions and this report should not be considered one.

SUMMARY

Legislation to alter an existing contract between the state and a private business could face a serious challenge under the contract clause of the U. S. constitution. The contract clause bars states from passing any law that impairs the obligation of contracts.

The U. S. Supreme Court has held that claims of a contract clause violation must first undergo a three-step analysis. Courts must determine whether (1) there is a contractual relationship, (2) a change in a law has impaired that relationship, and (3) the impairment is substantial (General Motors Corp. v. Romein, 503 U. S. 181 (1992)). If the court determines that the contract has been substantially impaired, it must then determine whether the law at issue has a legitimate and important public purpose and whether the adjustment of the rights of the parties to the contractual relationship was reasonable and appropriate in light of that purpose. A challenged law will not be held to impair the contract clause if the impairment, although substantial, is reasonable and necessary to fulfill an important public purpose (Energy Reserves Group v. Kansas Power & Light, 459 U. S. 400, 411-412 (1983)).

Contract clause jurisprudence is fact specific. Thus, it is impossible to provide a definitive answer in the abstract. Important considerations include the precise language of the legislation, the nature of the contract, the extent to which the contract is affected, and the nature and significance of the public purpose advanced by the law.

STANDARD FOR DETERMINING CONTRACT CLAUSE VIOLATIONS

Article I, § 10 of the United States Constitution provides that “[n]o State shall . . . pass any law. . . impairing the Obligation of Contracts. ” According to the U. S. Supreme Court, “Although the language of the contract clause is facially absolute, its prohibition must be accommodated to the inherent police power of the State to safeguard the vital interests of its people” (Energy Reserves Group, Inc. v. Kansas Power & Light Co. , 103 S. Ct. 697, 704 (1983); Keystone Bituminous Coal Ass'n v. DeBenedictis, 107 S. Ct. 1232, 1251 (1987)).

To determine whether a change in state law violates the clause, the threshold inquiry is whether the change has operated as a substantial impairment of a contractual relationship (Allied Structural Steel Co. v. Spannaus, 98 S. Ct. 2716, 1722 (1978)). This consists of a three-part inquiry: (1) whether there is a contract relating to the statute's subject matter, (2) whether the change in the law impairs the contract, and (3) whether the impairment is substantial (General Motors Corp. v. Romein, 112 S. Ct. 1105, 1109-10 (1992)).

If the impairment is substantial, it may nonetheless be constitutional if the state has a significant and legitimate public purpose behind the change, such as to remedy a broad and general social or economic problem. The public purpose need not be directed to an emergency or temporary situation. For example, it might be to eliminate unforeseen windfall profits. “The requirement of a legitimate public purpose guarantees that the state is exercising its police power, rather than providing a benefit to special interests” (Energy Reserves Group, 103 S. Ct. at 704-05).

Once a legitimate public purpose is identified, the final inquiry is whether the adjustment of the rights and responsibilities of contracting parties is based upon reasonable conditions and is of a character appropriate to the public purpose justifying the legislature's adoption of the legislation. Unless the state is a party to the affected contract, the courts defer to legislative judgment as to the necessity and reasonableness of the measure (id. at 705 (quoting United States Trust Co. , 97 S. Ct. at 1518)).

STATE IMPAIRMENT OF ITS OWN CONTRACTUAL OBLIGATIONS

The contract clause does not absolutely bar the legislature from subsequently modifying the state's own contractual obligations. For both private and state contracts, an impairment may be constitutional if it is reasonable and necessary to serve an important public purpose. But, according to the Court, when the state is a party to the affected contract, it is inappropriate to defer to the legislature's judgment of reasonableness and necessity, because the state's self-interest is at stake (id. at 1519; compare Keystone Bituminous Coal Ass'n, 107 S. Ct. at 1252-53 (refusing to “second-guess” Pennsylvania's determination of necessity because state was not a party to the contracts)). If a state could reduce its financial obligations whenever it wanted to spend money for what it regarded as an important public purpose, that would provide no contract clause protection at all “(id. at 1519). In its 1983 decision in the Energy Reserves Group case, the Court noted that” [w]hen a State itself enters into a contract, it cannot simply walk away from its financial obligations. In virtually every case, the Court observed, it has held a governmental unit to its contractual obligations when it enters the financial arena (103 S. Ct. at 705 n. 14).

A Supreme Court case demonstrates the heightened scrutiny applicable to state modifications of its own contractual obligations. (United States Trust Co. of New York v. New Jersey, 97 S. Ct. 1505, 1518 (1977)).

In that case, the Court held unconstitutional a repeal of a statutory covenant between New Jersey and New York that limited the ability of the Port Authority of New York and New Jersey to subsidize rail passenger transportation from revenues and reserves pledged as security for consolidated bonds issued by the authority. A bond holder challenged the repeal, claiming that it impaired the states' contractual obligations with bond holders. The states argued that the repeal was necessary to encourage private automobile users to shift to public transportation-it intended to discourage automobile use by raising bridge and tunnel tolls and using the extra revenue to subsidize commuter railroad service. Furthermore, the states argued, the new mass transit facilities could not be self-supporting. The Court rejected this justification, concluding that the repeal was neither necessary to achieve the objective nor reasonable in light of the circumstances.

Regarding the repeal's necessity, the Court observed that a total repeal was not essential: a less drastic modification would have served the states' plan without entirely removing the covenant's limitation on the use of Port Authority revenues and reserves to subsidize commuter railroads. Moreover, the states could have adopted alternative means to achieve their goal without modifying the covenant at all. The Court rejected the states' argument that choosing among the alternatives is a matter for legislative discretion. According to the Court, a state is not completely free to consider impairing its own contractual obligations on a par with other policy choices, and may not impose a drastic impairment when a more moderate approach would serve equally as well.

Regarding the repeal's reasonableness, the Court observed that the concerns it purported to address were not unknown at the time the covenant was adopted, and changes in the public perception of mass transit's importance “were of degree and not of kind. ” The Court stated that it was unable to conclude that the repeal was reasonable in the light of changed circumstances (id. at 1521-23).

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