U.S. Supreme Court Resolves Issue on Whether State Law Operated as Substantial Impairment of Contract

The contract clause of the United States Constitution restricts the power of states to disrupt contractual arrangements. It provides that “No state shall pass any . . . law impairing the obligation of contracts.” U.S. Const., Art. I, ¶ 10, cl. 1.

This was a case about life insurance proceeds. It generated a single dissent in the U.S. Supreme Court about the Constitution’s contract clause, which prohibits states from enacting laws that impair the obligation of contracts.

Mark Sveen named his wife, Kaye Melin, as the beneficiary of a life insurance policy he purchased in 1998. A 2002 Minnesota statute automatically revoked the designation (as beneficiary) when the couple divorced in 2007. Sveen’s children from a prior marriage claimed the life insurance proceeds as contingent beneficiaries when he died in 2011.

The sole dissenter was Justice Neil M. Gorsuch. The U.S. Supreme Court reversed in favor of Kaye Melin from the decision of the Eighth U.S. Circuit Court of Appeals.

Justice Elena Kagan wrote the majority opinion, which concluded that retroactive application of the revocation-on-divorce law [of Minnesota] did not violate the Constitution’s contracts clause.

Justice Kagan explained. “Here, it may stop after step one because Minnesota’s revocation-on-divorce statute does not substantially impair pre-existing contractual arrangements” for three reasons: “The statute is designed to reflect a policyholder’s intent”; “The law is unlikely to disturb any policyholder’s expectations”; and “The statute supplies a mere default rule, which the policyholder can undo in a moment.”

Justice Gorsuch disagreed, explaining: “Minnesota’s statute automatically alters life insurance policies upon divorce to remove a former spouse as beneficiary. Everyone agrees that the law is valid when applied prospectively to policies purchased after the statute’s enactment. But Minnesota wants to apply its law retroactively to policies purchased before the statute’s application. The court of appeals held that this violated the contract’s clause, which guarantees people the ‘right to rely on the law as it existed when their contracts were made.’ That judgment seems to me exactly right.”

Not all laws affecting pre-existing contracts violate the clause. See El Paso v. Simmons, 379 U.S. 497 (1965). To determine when such a law crosses the constitutional line, this court has long applied a two-step test.

The threshold issue is whether the state law has “operated as a substantial impairment of a contractual relationship.” Allied Structural Steel Co. v. Spannaus, 438 U.S. 234 (1978). In answering that question, the court has considered the extent to which the law undermines the contractual bargain, interferes with a parties’ reasonable expectations and prevents the party from safeguarding or reinstating his rights. If such factor shows a substantial impairment, the inquiry turns to the means and ends of the legislation. In particular, the court has asked whether the state law is drawn in an “appropriate” and “reasonable” way to advance “a significant and legitimate public purpose.” Energy Reserves Group, Inc. v. Kansas Power & Light Co., 459 U.S. 400 (1983).

In this case, the high court found that Minnesota’s revocation-on-divorce statute does not substantially impair pre-existing contractual arrangements.

True enough that in revoking a beneficiary designation, the law makes a significant change. The aspects of Minnesota’s law, taken together, defeat Melin’s argument that the change it effected “severely impair” her ex-husband’s contract.

First, the statute is designed to reflect the policyholder’s intent – and so to support, rather than impair, the contractual scheme. Second, the law is unlikely to disturb any policyholder’s expectations because it does no more than a divorce court could always have done. And third, the statute supplies a mere default rule, which the policyholder can undo in a moment.

The court added that although there are exceptions, most divorcees do not aspire to enrich their former partners. A person would as little want his ex-spouse to benefit from his insurance as to collect under his will. Or said otherwise, the insured’s failure to change the beneficiary after divorce is more likely the result of neglect than choice; that means the Minnesota statute often honors, instead of undermines, the intent of the only contracting party to care about the beneficiary term.

In this case, an insured cannot reasonably rely on a beneficiary designation remaining in place after a divorce. Divorce courts have a wide discretion to divide property between spouses when the marriage ends. The house, the cars, the sporting equipment are all up for grabs. And (what matters here) so too are the spouses’ life insurance policies, with their beneficiary provisions.

When a person ignored a recording obligation, for example, he could forfeit the sum total of his contractual rights. But when a policyholder in Minnesota does not redesignate his ex-spouse as beneficiary, his right to insurance does not lapse; the upshot is just that his contingent beneficiaries (here his children) receive the money.

That redirection of proceeds is not nothing; but under the court’s precedents, it gives the policyholder – who, again, could have easily and entirely escaped the law’s effect – no right to complain of a contract’s clause in violation. For these and other reasons, the U.S. Supreme Court reversed the judgment of the U.S. Court of Appeals.

Sveen v. Melin, No. 16-1432 (June 11, 2018).

Kreisman Law Offices has been handling commercial litigation matters, contract disputes and business-related lawsuits for individuals, families and businesses for more than 40 years in and around Chicago, Cook County and its surrounding areas, including Lemont, LaGrange, Barrington, Flossmoor, Olympia Fields, University Park, Calumet City, Blue Island, Rosemont, Richton Park, Chicago (Rogers Park, Albany Park, Jefferson Park, Wicker Park, Bucktown, West Loop, South Shore, Jackson Park), Wilmette, Winnetka, Waukegan, Gurnee and Cary, Ill.