You might be surprised to learn that the U.S. and California Constitutions both contain clauses that unequivocally prohibit any law – whether state, local or administrative – from “impairing” contract rights between two parties. This clause is called the “Contract Clause,” and it is supposed to protect contract rights – including in private contracts – like, for example, lease agreements. 

Now, if you are a landlord in Los Angeles, (and many other places) you could be forgiven for jumping out of your seat in consternation at this point. Something clearly is not right, since the simple explanation of the Contract Clause I offered above seems completely at odds with the world as we recently have witnessed it. Laws “impair” parties’ contract rights all the time and, indeed, landlords in Los Angeles have watched – aghast – as the State and City have stripped them during this COVID-19 pandemic of their most fundamental rights as property owners — including the right to collect rent and evict tenants. 

As an aside, Rep. Ilhan Omar, D-Minn., introduced a bill (the “Rent and Mortgage Cancellation Act”) in April that would simply wipe out rent obligations altogether until after the national emergency. This bill illustrates the siege many property owners face. 

Simply put, there seems to exist a wide chasm between our Constitutional rights to be free of laws that would impair our private contracts and the numerous recent laws that plainly do so. 

In fact, lawsuits have been and are being filed – based in part on the Contract Clause – challenging the City of Los Angeles’ rent moratorium and other, similar laws. This article explains the legal issues involved. How does this all work? Or, put another way, can the government actually do this? 

 

History of the Contract Clause

Because I am a bit of an American history geek, I start with a slight digression to explain the Contract Clause’s history. It arose from the post-Revolutionary War period when states started passing a variety of laws to defeat creditors. Legislative interference with creditor’s rights became so extreme that Chief Justice John Marshall described it in 1827 as “so great, so alarming, as not only to impair commercial intercourse … but to sap the morals of the people, and destroy the sanctity of private faith.” Thus was born the Contract Clause – a constitutional protection to prevent states from altering or eliminating existing contractual relationships. The clause as written was straightforward, simple and absolute.

However, courts have steadily eroded the Contract Clause’s “facially absolute” language. The Contract Clause now is far from absolute; rather, in the words of our highest court, it must bow “to the inherent police power of the State ‘to safeguard the vital interests of its people.” Energy Reserves Group, Inc. v. Kan. Power & Light Co., 459 U.S. 400, 410 (1983)

Unsurprisingly, therefore, many legal decisions about the Contract Clause have arisen from times of national crisis, when government has stepped in to try to mitigate the crisis. In fact, one of the main Contract Clause cases arose during the Great Depression after the government placed a moratorium on foreclosures. The U.S. Supreme Court upheld this law because – pay attention here – an emergency existed, and because the law was intended to protect society’s basic interests, was appropriate to the emergency and was temporary. 

 

How Courts Analyze Laws in Light of the Contract Clause 

Courts apply a three-part analysis to determine whether a law violates the Contract Clause. 

The first step asks whether the law substantially impairs a contractual relationship. If the answer is “yes,” then rather than knock out the law, courts proceed to the second step. This step involves determining whether the government has a “significant and legitimate public purpose” such as “the remedying of a broad and general social or economic problem.” If so, the third step involves determining whether “the adjustment of the rights and responsibilities of contracting parties is based upon reasonable conditions and of a character appropriate to the public purpose justifying the law’s adoption” – in other words, whether the law is appropriate to the emergency.  

In addition to this three-step analysis, several broad principles come into play in court decisions about the Contract Clause. One key principle is that courts tend to go easier on laws that only impact contracts between private parties – like private lease agreements – as opposed to when the government is itself one of the contracting parties.

Another theme is that courts consider how heavily regulated an industry has been in the past, because that frames the parties’ expectations. This idea worked against insurance companies after the 1994 Northridge earthquake, because the insurance industry is heavily regulated, and the court felt insurance companies should reasonably have expected the state to pass laws to help insureds. Therefore, in our situation, a court may consider that rent and residential leases have in the past been highly regulated.  

 

Our Analysis

So just for fun – since, alas, a court (and not we) will get to decide the various legal challenges being filed – let’s analyze the factors we discussed above. 

First, does a law forgiving rent and preventing evictions, albeit temporarily, impair existing contractual relationships? Undoubtedly. To a property owner, receipt of rent is the raison d’être of having a lease agreement in the first place. A law that fully negates the rent obligation for any significant period of time certainly impairs that relationship. Is the impairment substantial? The answer to that would appear to be in the eyes of the beholder. But it would seem to be.

Assuming a law requiring landlords to forego rent substantially impairs contract rights, does the law have a “significant and legitimate public purpose” such as “the remedying of a broad and general social or economic problem?” The City’s Ordinance No. 186606 justifies the rent moratorium by explaining that “COVID-19 … threatens to undermine housing security and generate unnecessary displacement of City residents and instability of City businesses” and the “City of Los Angeles … must continue to take measures to protect public health, life, and property.” This appears to be a significant and legitimate public purpose.

The third analytical step may be the most controversial. It involves determining whether the law is appropriate, given the problem the government is trying to solve. There exists a lot of room for argument here. As noted, however, any legal challenges may have to overcome that courts give a lot of deference to laws that only affect private, non-governmental contracts.   

There is no way to predict how a court may decide the issues discussed above. However, because courts have held that the Contract Clause must be narrowly construed so as to allow local governments to effectively exercise their police powers, landlords may not want to completely rely on the judicially-pliant Contract Clause to protect them from tenant-friendly legislation. 

 

Gary Ganchrow is a shareholder at the 107-year old firm of Parker Milliken Clark O’Hara and Samuelian, has served as an Adjunct Professor at the USC School of Law, and is a frequent contributor to AOA Magazine.  He regularly advises on, litigates and writes about a variety of employment, property management, and business matters, and can be reached at 213-683-6535 and gganchrow@pmcos.com. This article is for informational purposes only, and should not be considered legal advice or establishing an attorney-client relationship.