United States Trust Co. v. New Jersey-state Promises and the Contract Clause: an Untimely Resurrection

• Publication year: 1978

UNIVERSITY OF PUGET SOUND LAW REVIEWVolume 1, No.1FALL 1977

COMMENTS

United States Trust Co. v. New Jersey-State Promises and the Contract Clause: An Untimely Resurrection

Clifford D. Foster Jr.

The contract clause of the Federal Constitution provides: "No state shall . . . pass any . . . Law impairing the Obligation of Contracts. . . ."(fn1) As the only direct restraint on state actions affecting private property until the adoption of the fourteenth amendment,(fn2) the contract clause was once fertile ground for constitutional litigation.(fn3) But in the early twentieth century the growing importance of substantive due process as a check on state economic regulation obscured the provision's role.(fn4) By the Depression era, the Supreme Court's eventual recognition of broad governmental powers to regulate economic activity had rendered the contract clause, along with substantive due process, "virtually moribund" in the constitutional scheme.(fn5) The recent decision in United States Trust Co. v. New Jersey,(fn6) however, subjects alleged impairments of state contracts to rigorous scrutiny under the contract clause and resurrects the provision as a powerful tool of judicial review.

This comment examines the impact of United States Trust on traditional contract clause doctrines and policies. After an initial discussion of the factual and legal background, a historical survey will show the decision employs a new approach to contract clause analysis. Next, this comment will analyze the Court's new approach, especially the Court's treatment of impairments when a state is a contractual party, its willingness to make policy judgments formerly left to legislative discretion, and the decision's probable effect on any future municipal debt crises. Finally, in accord with Justice Brennan's dissent in United States Trust, this comment will conclude that the Court's former approach to contract clause issues was superior because the Court recognized the need for broad state powers to regulate governmental obligations.

I. Background of United States Trust

In 1962 the New York and New Jersey legislatures enacted legislation restricting the Port Authority of New York's operation of deficit producing commuter railraods.(fn7) Although the legislation authorized the Port Authority to acquire and operate the bankrupt Hudson and Manhattan mass transit system,(fn8) the legislatures also created a statutory covenant between the states and Port Authority bondholders as an additional security measure for private investors.(fn9) By the covenant's terms, the states promised bondholders that the Port Authority would not apply any revenues or reserve funds for commuter railroad operations, except the Hudson and Manhattan or the "permitted railroad purposes" defined in the agreement.(fn10) The covenant's "permitted purposes" allowed only self-supporting future rail projects or projects that could operate within "permitted deficits." (fn11)

In practice, however, the covenant effectively barred the Port Authority from new rail transit operations.(fn12) The legislatures prospectively repealed the covenant in 1972 to allow increased Port Authority participation in solving the Manhattan area's transportation problems.(fn13) Yet prospective repeal failed to solve funding problems for new projects; the covenant still protected outstanding bonds until the year 2007(fn14) In the interim, the legislatures confronted mounting public concern over transit, energy, and pollution problems.

In 1974, during a national energy crisis, the legislatures retroactively repealed the 1962 covenant.(fn15) The repeal was part of a general plan to meet the Manhattan area's transit problems and to bring the region's air quality into compliance with federal air pollution standards.(fn16) The legislatures sought to discourage automobile traffic through higher tolls on Port Authority bridges and tunnels and to employ the increased revenue for improving and expanding commuter rail services.(fn17) A congressional declaration of a national energy emergency also prompted the retroactive repeal.(fn18) The United States Trust Company of New York, however, a holder and trustee of affected bonds, brought suit against both states contending the repeal impaired the obligation of Port Authority bond contracts.

The New Jersey trial court held the repeal constitutional.(fn19) It found that the repeal neither materially impaired the bondholders' security(fn20) nor adversely affected the bonds' secondary market value, except for a short term fall-off.(fn21) The court held that the contract clause does not prohibit reasonable exercises of the state's police power.(fn22) Relying on Justice Cardozo's opinion in W.B. Worthen Co. v. Kavanaugh,(fn23) the court found the repeal reasonable because it did not destroy the bonds' quality as an acceptable investment for a rational investor.(fn24) Most significantly, the trial court stated that parties who contract with a state deal with a sovereign entity; thus, the sovereign's power to alter obligations in the public interest inheres in the contract.(fn25) Accordingly, the court rejected plaintiffs argument that impairments of state contracts require more stringent judicial scrutiny than those of private contracts.(fn26) The New Jersey Supreme Court affirmed the judgment without discussing the constitutional issue.(fn27)

The United States Supreme Court, however, emphasized New Jersey's role as a party to the contract and held the law unconstitutional.(fn28) Justice Blackmun's majority opinion(fn29) noted a state cannot contract away an essential attribute of its sovereignty, such as its police power or power of eminent domain; if a state attempts to do so, the contract is void ab initio.(fn30) Yet a state does have the power to enter into binding financial contracts. The Court found the 1962 covenant a "purely financial" obligation not within the inalienable state power doctrine.(fn31) The repeal affected an operative contract and the crucial question was whether the impairment was permissible.

The opinion stressed that special judicial scrutiny is appropriate when a state impairs its own contract. The Court stated that although courts usually give wide deference to legislative discretion when state actions affect private contracts, complete deference to legislative judgments is inappropriate when legislation affects a state's own financial interest.(fn32) Justice Blackmun reasoned that if states could reduce their financial obligations to spend money in the public interest at will, the contract clause would not protect the rights of state creditors.(fn33) Thus, the Court refused to defer to the legislature's assessment of the repeal's "reasonableness" and "necessity" because the state was a contractual party.(fn34)

The Court formulated a conjunctive standard of "reasonableness" and "necessity" to test the repeal's constitutionality.(fn35) The Court analyzed the legislation's reasonableness by contrasting the circumstances surrounding the covenant's adoption and subsequent repeal. The Court found that the earlier legislature foresaw and intended the covenant's restrictions on mass transit operations.(fn36) Despite a mounting transit and energy crisis,(fn37) and extensive federal environmental legislation,(fn38) the Court also found that the new circumstances prompting the repeal were merely changes in degree, not of kind, from problems known to the legislature in 1962.(fn39) Consequently, under the Court's changed circumstances standard, the covenant's repeal was not "reasonable" because the state failed to show the contract had unforeseen and unintended effects on state policy.

The repeal also failed to satisfy the Court's "necessity" criterion. First, the Court inquired whether total repeal of the covenant was necessary.(fn40) It then suggested hypothetical alternatives for achieving the state's goals through limited modifications of the covenant and concluded such measures would be equally effective.(fn41) Second, the Court found that the state had alternative measures available to attain the repeal's objectives without modifying the covenant at all.(fn42) Accordingly, the repeal was not "necessary" because the Court found the state could have pursued its goals through less drastic means than total abrogation of the covenant.(fn43) Although the Court recognized the state action served important public purposes,(fn44) it held the repeal unconstitutional.

Justice Brennan's vigorous dissent, however, argued that the contract clause cannot bind states to contracts limiting the authority of successor legislatures to enact laws in the public interest.(fn45) The dissent stressed that a fundamental premise of popular democracy is that legislatures must remain responsive to the will of the electorate.(fn46) Accordingly, a rigid application of the contract clause threatens the functioning of the political system by binding legislatures to the policies inherent in their predecessor's contracts.(fn47) Justice Brennan argued that one hundred years of precedent demonstrated the need for judicial deference to legislative actions challenged under the contract clause,(fn48) and that the trial court's constitutional standard correctly resolved the litigation.(fn49) The dissent warned that the Court not only departed from the policy values of previous decisions, but also fundamentally misconceived the nature of the contract clause...