The U.S. Constitution’s prohibition against states passing laws impairing contractual obligations (the Contracts Clause) does not mean states cannot pass any laws impairing contracts. Far from it. This article explains that in the main, the Contracts Clause bars state legislation materially reducing the value of a contractual obligation, when the legislation is not justified by a state’s police power to protect the public health, safety, and welfare. Thus, without violating the Contracts Clause, states can even enact legislation restructuring debt of entities ineligible for federal bankruptcy such as banks and insurance companies, as long as the legislation preserves for creditors the values they can obtain enforcing such entities’ obligations.
The Contracts Clause is contained in Article I, §10, clause 1 of the U.S. Constitution. It provides: “No State shall…pass any … law … Impairing the Obligation of Contracts …” The impetus for the Contracts Clause was that after the Revolutionary War, the state legislatures passed a host of schemes enabling debtors to avoid paying their creditors, and the people lost faith in the value of contracts. The Contracts Clause was crafted to guard the credit of the United States.1
