Letting People Renege on Their Debts is Unconstitutional—and Foolhardy

The Goldwater Institute joined forces with a group of Arizona business owners to file a brief this week urging the Arizona Court of Appeals to declare Proposition 209 unconstitutional. That’s a law that limits the ability of lenders to recover the money they’re owed when borrowers fail to repay. As the brief explains, that initiative is already forcing property owners to charge tenants more, and reducing the willingness of employers to hire employees who might have problematic credit histories—all of which is bad for economic opportunity and growth in Arizona. Not only that—the initiative violates the state’s Constitution, which forbids the government from subsidizing private businesses or nullifying existing contracts.

The economic issues are simple: if lenders can’t be sure that they’ll get their money back, they’re going to be less inclined to lend. That hurts the economy because responsible and conscientious people need to borrow money to start businesses, or to expand a business, or to buy a house or a car, or to do many of the other things that improve our standard of living. When borrowers don’t repay, lenders must have some way to get their money back through a collections process. And when government stops that, and blocks creditors from recovering what they’re owed, they’ll be stingier about credit. That, in turn, punishes responsible people who find it harder to borrow the money they need, and makes it harder for entrepreneurs to start new businesses.

In other words, limiting the ability of creditors to recover what they’re owed encourages lenders to go to other states—and discourages Arizona businesses from cooperating with borrowers who might just need a little more time.

That’s what’s happening now. Take the case of property owners Mark and Virginia Blosser, who rent out residential property in Cochise County. Unfortunately, like all landlords, the Blossers sometimes have renters who damage or destroy property, which they should pay for. But thanks to Prop. 209, the amount that the Blossers can recover in such cases is so drastically reduced that they’ve already been forced to increase the amount of the security deposit they require, and to take other steps to screen renters.

These aren’t minor problems. As the brief explains, Prop. 209 creates a formula that limits how much a creditor can recover, and that formula is written in such a way that a couple who make as much as $1,000 a week—that is, a household income of $100,000 a year—are effectively rendered “judgment proof.” This means that if they destroy the Blossers’ property, the Blossers can’t recover what they’re owed. And $100,000 a year is nearly twice the median household income in Cochise County. It’s no surprise that the Blossers are now looking into selling their properties and getting out of the rental market altogether.

Likewise, the owners of the Ash Management Company used to try to work with new employees who might have bad credit histories and need the opportunity to improve their situations. But Prop. 209 makes it so much harder to recover money when borrowers fail to repay that the company has become more stringent in its credit checks for new hires—making it harder for workers to find jobs.

All of this is bad for the Arizona economy—and that’s one reason why the authors of the state Constitution took steps to prevent things like this. The Arizona Constitution forbids the government from “impairing the obligations of contract” or from giving any kind of “gift” or “subsidy” to any individual or corporation. Laws that limit a creditor’s ability to recover an unpaid debt violate the Contracts Clause because they essentially nullify the borrower’s “obligation” to repay.

True, courts have said that the government can limit the rights of creditors in contracts made after the passage of a certain law—and Prop. 209 says that it only applies to future contracts. But even if that’s enough to avoid violating the Contracts Clause, the initiative still violates the Gift Clause.

That’s because the Gift Clause forbids the state from giving any kind of financial benefit or other subsidy to a private person. Arizona courts have already held that this forbids the state from telling people they don’t have to pay their taxes, for example, because eliminating a debt is basically the same thing as handing them cash—which is what the Gift Clause prohibits. And the same rule applies even to debts that haven’t yet been incurred. For example, in one Texas case, a city tried to subsidize a railroad company by promising to indemnify it for any legal liabilities it might incur for the next 999 years—something Texas courts declared unconstitutional under that state’s Gift Clause.

Simply put, promising to cover someone else’s future debts—or to eliminate that person’s obligation to repay—is a kind of subsidy prohibited by the Arizona Constitution. Prop. 209 is clearly illegal—and it hurts hardworking Arizonans.

You can learn more about the case here, and read the brief here.

Timothy Sandefur is the Vice President for Legal Affairs at the Goldwater Institute.