The so-called “contracts clause” appears in Article I, section 10, clause 1 of the United States Constitution:
No State shall … pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts.
In Law in America: A Short History, Lawrence Friedman explains that “the clause was probably intended to make it impossible for states to interfere with the rights of creditors [or] to go too far in helping out debtors” (53). Legislatures had been known to pass laws relieving influential persons of debt, for example, a practice that was both unfair to those less influential and potentially ruinous to the overall economic system:
There was a shortage of hard money in the country, no real banking system in the modern sense; yet the whole structure of enterprise floated on a sea of credit. Businesses sold on credit and bought on credit. … When one link in the chain began to weaken, there was trouble up and down the line. (53)
Aside from the appearance of this clause in 1787, the law of contracts before the nineteenth century was minimal, especially as compared to it’s more developed cousin, the law of property. But the nineteenth century — which Friedman called “the golden age of contract law” — saw contract law in the United States become the pre-eminent form of private law.
The common law before the nineteenth century required contracts to be fair and reasonable: a “sound price warrants a sound commodity.” But by mid-century, William Wetmore Story’s famous treatise on contracts recognized that this basic understanding had radically altered. Contracts now required only “mutual assent of the parties” and “valuable consideration.” Fairness — roughly defined as similar levels of benefit for each party — was now irrelevant. Kermit Hall‘s American Legal History: Cases and Materials puts it this way:
the law of the nineteenth century recognized and supported the belief that unfair bargains were necessary for the commercial and industrial development of the day.
Martin Horwitz, in The Transformation of American Law, 1780-1860, adds that
judges and jurists finally reject[ed] the longstanding belief that the justification of contractual obligation is derived from the inherent justice or fairness of the exchange. In its place, they asserted for the first time that the source of the obligation of contract is the convergence of the wills of the contracting parties.
Put another way, “the law of the nineteenth century recognized and supported the belief that unfair bargains were necessary for the commercial and industrial development of the day” (Hall 197).
Seixas and Seixas v. Woods
The shift to a caveat emptor model of contract — distinct from the earlier common law and also from then-current European civil law — emerged early in the newly formed United States.
In 1804, a court in New York rejected the idea of an “implied warranty” absent intentional fraud, and required that, “without a warrant by the seller, or fraud on his part, the buyer must stand to all losses arising from latent defects.” Judge Kent argued that this was unlike civil law, but was indeed “well and elegantly vindicated … as most happily reconciling the claims of convenience with the duties of good faith.”
The New York court argued — as courts often did (and do) that this articulation was long-standing, and nothing new at all — even though Martin Horwitz explains that this was not the case in the seventeenth country at all:
[A]s late as 1792 Blackstone’s successor in the Vinerian Chair at Oxford, Richard Wooddeson, proclaimed the “sound price” doctrine to be good law (167).
Nonetheless, the trend away from the “sound price” interpretation of contracts continued.
McFarland v. Newman
A Pennsylvania case from 1839, McFarland v. Newman, Watts (Pa.) 55, argued that any adoption of the “civil law maxim … that a sound article is warranted a sound price” by the common law was a mistake:
The [common-law] judges, in pursuit of a phantom in the guise of a principle of impracticable policy and questionable morality, broke away from the common law.”
Instead, Judge Gibson argues, the “maxim caveat emptor, disposes of all,” unless there is “willful misrepresentation.” Gibson goes on to explain the principle:
the naked averment of a fact is neither a warranty itself, nor evidence of it. … [I]t certainly may be taken into consideration … but the jury must be satisfied from the whole that the vendor actually, and not constructively, consented to be bound for the truth of his representation.”
Seymour v. Delancey, et al.
Back in New York, the highest court of appeals rejected a lower-court opinion finding that equity forbid ordering specific performance of contracts with very unequal levels of consideration. The lower-court judge had argued that there was a
“very great weight of authority against enforcing a contract, where the consideration is so inadequate as to render it a hard bargain, and an unequal and an unreasonable bargain.”
On the contrary, wrote the higher-court majority in Seymour v. Delancey, et al., 3 Cow. (N.Y.) 445 (1824), “mere inequality in value” was “not sufficient … in withholding a decree for specific performance.” As in Pennsylvania, contracts had to be enforced, “where thee is no fraud, misrepresentation, imposition, or concealment of facts.”
Kermit Hall suggests that this New York opinion “anticipates a modern marketplace” where “purchases are constantly made upon speculation” (202). The court prefers to support this new marketplace of “risky investments,” even “at the expense of those who might enter into blatantly unfair bargains out of ignorance” (202).
Fletcher v. Peck
As I noted above, unlike most other areas of non-criminal law, contracts have a constitutional component. As a result, state legislatures cannot “impair” existing contracts.
The implications of this clause were felt early in United States history, when the 1795 Georgia legislature sold land for less than market value — benefitting many legislators and other government officials. The 1796 Georgia legislature then attempted to rescind the sale because of the blatant corruption involved, but in Fletcher v. Peck, 10 U.S. 87 (1810), the Supreme Court held this rescission by the legislature unconstitutional:
The state of Georgia was restrained, either by general principles which are common to our free institutions, or by the particular provisions of the constitution of the United States, from passing a law whereby the estate of the plaintiff in the premises so purchased could be constitutionally and legally impaired and rendered null and void.
Justice Marshall added that, if this were not the case, then “[a]ll titles would be insecure, and the intercourse between man and man would be very seriously obstructed.”
(The issue was eventually handled by an act of Congress in 1814 that indemnified purchasers with a buyout, instead of rescinding the contract of sale.)
If it’s fair to say, as Kermit Hall does, that before the nineteenth century “a legally enforceable contract had to be fair,” then it’s also fair to say that caveat emptor — ”let the buyer beware” — triumphed early on the 1900s:
[C]ontract law generally favored sellers over buyers and employers over laborers and served as an instrument that aided the industrial and commercial entrepreneurs of the nineteenth century. This led to the “triumph of contract” over property, tort, and equity, as the law came “to ratify those forms of inequality that the market system produces.” (196-97)
The Civil War did little to change contract law, even if contracts to own persons were no longer enforceable. (Note that the Contracts Clause does not apply to the federal government, so there was no Contracts Clause problem with Abraham Lincoln’s Emancipation Proclamation.)
Modern contract law has added some complexity to the doctrine of caveat emptor. Many states have added statutory provisions that create “implied warrantees of merchantability,” for example, and the United Kingdom has moved away from it for consumer purchases. Still, in general American courts have not strayed too far from the rule (except Louisiana, which continues to follow the civil-law doctrine of “redhibition”: “a sound price warrants a sound commodity”).