Supreme Court and contract law - Business in United States of America

Definition: Decisions by the nation’s highest court regarding the constitutionality and interpretation of the laws governing legally binding agreements between individuals or corporations
Significance: Contract law lies at the heart of business and financial dealings among private entities. For more than a century, the U.S. Supreme Court had a significant impact on the nation’s contract laws, but since the 1930’s, the Court’s impact on that branch of the law has been limited.
Contact law in the United States is primarily made by state legislatures and adjudicated in state courts. Because most aspects of contract law do not have a direct relationship to the U.S. Constitution or to federal legislation, the state courts are usually the final arbiters of the law in each state. The U.S. Supreme Court, nevertheless, has played a significant role in shaping four major aspects of contract law: It has interpreted the contract clause of the Constitution, determined the proper application of the freedom of contract doctrine from 1897 to 1937, recognized a relevant national general common law from 1842 to 1938, and adjudicated questions of federal contract law relating to purchases by the federal government.

Contract Clause

The Constitution, in Article I, section 10, prohibits states from passing “any law impairing the Obligation of Contracts.” The framers apparently drafted the clause out of concern that state legislatures might help the debtor class at the expense of property interests. In Fletcher v. Peck (1810), the Supreme Court held that the Constitution prohibited Georgia’s legislature from revoking land contracts, even though the contracts had their origins in a public land grant tainted by bribery and fraud. In Sturges v. Crowninshield (1819), the Court held that the contract clause prohibited state legislatures from passing bankruptcy laws that relieved insolvent debtors of their contractual obligations. In Ogden v. Saunders (1827), however, the justices voted 4 to 3 to uphold a New York state bankruptcy law that applied only to contracts made subsequent to the passage of the law.
Beginning during the late nineteenth century, the Supreme Court gradually allowed the states to exercise greater flexibility in regulating contracts. In the case of Stone v. Mississippi (1880), the Court held that the contract clause could not be used to limit a state’s police power in protecting the public’s health, safety, and morality. During the Great Depression, in Home Building and Loan Association v. Blaisdell (1934), the justices by a 4 to 3 vote upheld a Minnesota statute that attempted to limit farm and home foreclosures by temporarily extending the period for repaying loans. In addition to accepting the pragmatic justification for the law, the Court’s majority reasoned that the legislature had not altered the basic integrity of the contractual obligation.
The Court appeared to return to favoring stricter enforcement of the contract clause in United States Trust v. New Jersey (1977): It invalidated a state law that abrogated a public bond covenant on the use of revenues. Writing for the majority, however, Associate Justice Harry A. Blackmun wrote that contractual impairments might not be unconstitutional if they were “reasonable and necessary to serve an important public purpose.” In subsequent decisions, the Court tended to subordinate the contract clause to economic judgments of state legislatures. In Keystone Bituminous Coal Association v. DeBenedictis (1987), Associate Justice John Paul Stevens wrote, “It is well settled that the prohibition against impairing the obligation of contracts is not to be read literally.”

Freedom of Contract Doctrine

From 1897 until 1937, the Supreme Court held that the due process clauses provided substantive protection for the right of employers and employees freely to negotiate employment agreements and placed strict limits on governmental interference. The Court’s best-known application of the doctrine was in Lochner v. New York (1905), which overturned a state law limiting the number of hours that bakery employees might work. In other applications of the freedom of contract doctrine, the Court struck down a federal minimum wage law as well as a federal law prohibiting employers from firing employees who engaged in union activities.
The Court, however, upheld restrictions on contracts that could clearly be justified by the states’ interest in protecting public safety and health. In 1937, it reversed the Lochner v. New York line of cases with West Coast Hotel v. Parrish, which upheld Washington State’s minimum wage law. The Court’s decision in West Coast Hotel v. Parrish terminated its tradition of applying special scrutiny to governmental regulation of employment agreements. Encouraged by this landmark decision, Congress enacted the Fair Labor Standards Act of 1938, which established a national minimum wage.

National Common Law and Contracts

The Judiciary Act of 1789 required the federal courts to follow applicable state laws. In Swift v. Tyson (1842), however, the Supreme Court held that this requirement did not extend to state courts’ decisions on “contracts and other instruments of a commercial nature.” The Swift v. Tyson decision initiated the establishment of a national general common law in commercial transactions, although the Supreme Court only rarely chose to review contract cases. After almost a century of controversy, in Erie Railroad v. Tompkins (1938), the Court reversed Swift v. Tyson and repudiated the doctrine of a national common law. Subsequent to the Erie Railroad v. Tompkins ruling, the Court has almost always declined to hear cases dealing with contract law, unless the federal government is a party to a dispute.

Federal Contract Law

As the world’s largest purchaser of goods and services, the U.S. government annually awards billions of dollars in contracts for the procurement of everything from office supplies to complex weapons systems. These government expenditures are governed by a body of federal contract law that is based on the Constitution, federal statutes, regulations of the Office of Federal Procurement Policy, federal court decisions, and executive orders. Although the government’s right to make procurement contracts is not expressly authorized in the Constitution, the Supreme Court in United States v. Tingey (1831) acknowledged that it is an inherent aspect of national sovereignty.
Other noteworthy decisions of the Court include Cooke v. United States (1875), recognizing that when the federal government is a party to a commercial transaction, it incurs all the responsibilities of a private person in the same circumstances. A federal statute of 1917 empowers the president to modify or cancel contracts for ships or materials, while requiring just compensation for such canceled contracts as determined by the president. In DeLaval Steam Turbine Co. v. United States (1931), the Court held that a company was entitled to compensation for the value of the contract at the date of cancellation, but not for anticipated profits. If contracting officers exceed the authority conferred on them by statute or regulation, the Court held in Federal Crop Insurance Corp. v. Merrill (1947), the government has no obligation to honor the resulting contracts.

Further Reading
Ely, James W. Contract Clause in American History. New York: Taylor & Francis, 1997. Scholarly examination of the creation, interpretation, and enforcement of the U.S. Constitution’s contract clause.
_______. The Guardian of Every Other Right: A Constitutional History of Property Rights. New York: Oxford University Press, 2007. Includes a good introductory treatment of the contract clause and the freedom of contract doctrine; favorable toward the laissez-faire tradition.
Epstein, Lee, and Thomas Walker. Constitutional Law for a Changing America: Institutional Powers and Constraints. Washington, D.C.: CQ Press, 2007. Includes clear treatments of Supreme Court’s decisions on the contract clause and the freedom of contracts doctrine.
Massengale, Eugene. Fundamentals of Federal Contract Law. New York: Quorum Books, 1991. The standard work on the complex body of laws relating to federal purchases of goods and services, with summaries of hundreds of court decisions.
Wilmott, Lindy, and Des Butler. Contract Law. New York: Oxford University Press, 2005. A standard textbook providing a good summary of most aspects of the topic.
See also: U.S. Congress; government spending; U.S. Presidency; Supreme Court and banking law; Supreme Court and commerce; Supreme Court and labor law.

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