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Law360 (April 29, 2020, 5:05 PM EDT) --
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| Kathleen Sullivan |
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| Derek Shaffer |
The U.S. Constitution prohibits the retroactive impairment of private contracts under the contracts, takings and due process clauses. Despite arguments to the contrary in a recent Law360 guest article, it would be unconstitutional for states to retroactively require insurers to pay for losses related to the virus that they did not insure against — that is, losses that the insured never paid premiums to protect against and that the insurer never bargained to cover.
Governmental efforts to protect small businesses in furtherance of the public interest are well-intentioned, to be sure, but the costs attending any such efforts should be shared fairly and evenly; it is unconstitutional to single out insurers and make them pay the daunting tab by retroactively rewriting insurance policies contrary to their terms.
State Proposals
To take a prominent example of the proposals some states are considering, New Jersey's legislature is contemplating a bill that would retroactively mandate coverage of any pandemic-related losses. New Jersey legislators acknowledge that virus-related closure is not a covered event and is, indeed, expressly excluded from most commercial property insurance policies, which traditionally cover only specified physical loss or damage to property.
If enacted, the New Jersey bill[1] would rewrite existing insurance policies by dictating that they "shall be construed to include among the covered perils under that policy, coverage for business interruption due to global virus transmission."
Insurers should not be forced after the fact to cover a pandemic under the auspices of policies that were written and priced not to cover such events and in most cases to expressly exclude them. Although no law mandating such coverage has been passed as of yet, states like New York,[2] Massachusetts,[3] Pennsylvania,[4] Louisiana,[5] South Carolina,[6] and Ohio[7] are threatening to follow New Jersey's lead in proposing to shift small business' losses to the insurance industry in this fashion and to override contrary exclusions.
These efforts would be profoundly counterproductive. Insurers create reserves to pay claims by carefully evaluating risk and collecting premiums that will enable them to cover those risks according to agreed-upon coverage limitations set forth in their policies.
They cannot readily pool risk for catastrophic events like a pandemic that will be of unlimited scope and duration — and if they did so they would have to charge correspondingly higher premiums (assuming they could price such risk at all). Subjecting insurers, retroactively, to massive new monetary liabilities associated with virus-related losses would wreak havoc with insurance markets, now and prospectively.
Any such law would also be subject to serious constitutional challenge on multiple bases.
Contracts Clause
The contracts clause of Article I of the U.S. Constitution was framed specifically to forbid states from rewriting private contracts retroactively. Although subsequent precedents have qualified that prohibition, they have not gone so far as to question its fundamental vitality.
Contractual "rights and obligations are binding under the law,"[8] and the U.S. Supreme Court has held that a state may not impose "a sudden, totally unanticipated, and substantial retroactive obligation" on private parties — for example by retroactively imposing massive new and unbargained for pension obligations.[9]
The Supreme Court has established a three-step analysis for determining whether retroactive legislation constitutes an unconstitutional impairment of contract. The threshold inquiry is whether the law has operated "as a substantial impairment of a contractual relationship."[10]
Courts will consider "the extent to which the law undermines the contractual bargain, interferes with a party's reasonable expectations, and prevents the party from safeguarding or reinstating his rights,"[11] as well as whether "the industry the complaining party has entered has been regulated in the past."[12]
If the law is found to impose a substantial impairment, the second step is to determine whether the government entity, by way of justification, had a "significant and legitimate public purpose behind the regulation ... such as the remedying of a broad and general social or economic problem."[13]
Finally, once such a legitimate public purpose is identified, the court must determine "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 legislation's] adoption.'"[14]
As to the first step, there can be little dispute that mandating costly coverage for an event that insurers did not agree to cover, in most cases expressly excluded, and in all events never factored into premiums substantially interferes with insurers' expectations under the contracts.
Although the insurance industry is heavily regulated, a retroactive direct intervention into private, bilateral contracting differs vastly from a prospective, regulatory shift in relations across industry participants.
No matter how highly regulated the industry, the government cannot upend bilateral negotiations between contracting parties by going so far as retroactively rewriting core terms of their contracts. If the government could, that would spell the end of insurance markets as we know them and call into question the integrity of innumerable private contracts on which economic relations depend.
As to the second step, the COVID-19 crisis undoubtedly presents a formidable economic challenge for the public and private sectors, but shifting losses from one group of private businesses to another is not a general solution to that societal problem.
And as to the third step, which involves a comparison of means and ends more demanding than ordinary rational basis review, after-the-fact rewriting of private business interruption insurance is not a solution reasonably tailored to the character of the problem. The New Jersey proposal, for example, would not necessarily even serve the limited, immediate purpose of keeping small businesses afloat because it does not require a small business to stay open, to pay employees, or impose any other reasonable conditions upon small businesses.
Nor will small businesses (or anyone else) ultimately benefit to the extent that proposals like New Jersey's threaten to render insurers insolvent and deter them from issuing business interruption coverage in the first place. It seems dubious, therefore, that even the supposed public policy purpose for such legislation will withstand constitutional scrutiny.
Takings Clause
The takings clause presents another obstacle to a state seeking to retroactively rewrite commercial property insurance contracts in a way that diminishes the value of coverage limitations to the insurer.
A laws is invalid as a per se taking when it confiscates an established pool of funds or renders private property altogether worthless, as the proposed legislation arguably would relative to insurance policies (the value of which will not only drop to zero, but become negative for insurers).[15]
Alternatively, laws may be invalid as a regulatory taking when they create a substantial economic impact, interfere with "distinct investment-backed expectations," and do more than simply "adjust[] the benefits and burdens of economic life to promote the common good."[16]
For purposes of a regulatory taking, there should be no doubt that the legislation under consideration imposes a significant — indeed, potentially ruinous — financial burden on insurers, one that could total on the order of many billions of dollars. And, by definition, insurers' distinct investment-backed expectations will be diminished if insurers are forced to pay out claims for perils they never contracted to cover and for which they never received premium payments.
Finally, just compensation is wanting. The Supreme Court has been clear that the takings clause prohibits legislation aimed at "forcing some people alone to bear public burdens which, in all fairness and justice, should be borne by the public as a whole."[17]
Even though the proposed legislation in New Jersey purports to provide for a fund from which insurers can theoretically seek reimbursement for their losses (albeit through an unspecified claims process on indeterminate terms), the state would requires insurers themselves to provide the reimbursement funds. Just compensation that one pays oneself cannot be considered just compensation under the takings clause. Just compensation requires that the costs be spread among the broader benefited public.
Substantive Due Process
Substantive due process is similarly implicated by retroactive revocation of contractual rights and responsibilities. While rarely invoked as a constraint on economic legislation, the substantive aspect of the due process clause does in some instances bar retroactive laws as arbitrary and irrational.
As Justice Anthony Kennedy observed in concurring on due process grounds with a decision invalidating a retroactive alteration of mining companies' benefits obligations to miners, "retroactive laws change the legal consequences of transactions long closed, [and this] change can destroy the reasonable certainty and security which are the very objects of property ownership."[18] Retroactive laws pose a special danger of arbitrariness because they tend to single out preferred groups for particular benefits and unpopular groups for particular burdens.
Just such danger resides in proposals by New Jersey and other states to reorder contractual rights and property ownership so that insurers alone will bear the brunt of COVID-19 losses, without regard for settled expectations and legal rights.
The problems COVID-19 poses for small businesses are real, but so are the constraints of the U.S. Constitution. States should take a broader, more considered approach to advancing their laudable policy objectives while staying faithful to venerable constitutional principles.
Kathleen Sullivan and Derek Shaffer are partners at Quinn Emanuel Urquhart & Sullivan LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] https://www.njleg.state.nj.us/2020/Bills/A4000/3844_I1.HTM.
[2] https://www.njleg.state.nj.us/2020/Bills/A4000/3844_I1.HTM.
[3] https://malegislature.gov/Bills/191/SD2888.
[4] https://www.legis.state.pa.us/cfdocs/billInfo/BillInfo.cfm?syear=2019&sind=0&body=S&type=B&bn=1114.
[5] http://www.legis.la.gov/legis/BillInfo.aspx?s=20RS&b=SB495&sbi=y.
[6] https://www.scstatehouse.gov/sess123_2019-2020/bills/1188.htm.
[7] https://www.legislature.ohio.gov/legislation/legislation-summary?id=GA133-HB-589.
[8] Allied Structural Steel Co. v. Spannaus
, 438 U.S. 234, 245 (1978).[9] Id. at 244.
[10] Energy Reserves Group, Inc. v. Kansas Power & Light Co.
,459 U.S. 400, 411 (1983) (quoting Allied,438 U.S. at 244).[11] Sveen v. Melin
, 138 S. Ct. 1815, 1822 (2018).[12] Energy Reserves, 459 U.S. at 411.
[13] Energy Reserves,459 U.S. at 411–12.
[14] Energy Reserves,459 U.S. at 412, (quoting United States Trust Co. v. New Jersey,
431 U.S. 1, 22 (1977)).[15] Koontz v. St. Johns River Water Management Dist.
, 570 U.S. 595 (2013); Lucas v. South Carolina Coastal Council, 505 U.S. 1003 (1992).[16] Penn Central Transp. Co. v. City of New York
, 438 U.S. 104, 124 (1978).[17] Armstrong v. United States
, 364 U.S. 40, 49 (1960).[18] Eastern Enterprises v. Apfel
, 524 U.S. 498, 548 (1998) (Kennedy, J., concurring in judgment).For a reprint of this article, please contact reprints@law360.com.
