Chapter 14 THE IMPAIRMENT CLAUSE

"No law impairing the obligation of contracts shall be passed."

THE PURPOSE OF THE IMPAIRMENT CLAUSE: to safeguard the integrity of valid contractual
agreements against unwarranted interference by the State.

AS A RULE: they should be respected by the legislature and not tampered with by subsequent
laws that will change the intention of the parties or modify their rights and obligations. The will of
the obligor and the obligee must be observed; the obligation of their contract must not be
impaired.

 protection of the impairment clause is not absolute. There are instances, as will
appear later, when contracts valid at the time of their conclusion may become
invalid, or some of their provisions may be rendered inoperative or illegal, by
virtue of supervening legislation.
CONTRACT
 refers to any lawful agreement on property or property rights, whether real or personal,
tangible or intangible. The agreement may be executed or executory.

 The parties may be private persons only, natural or artificial, or private persons on the
one hand and the government or its agencies on the other hand.

 It includes franchises or charters granted to private persons or entities, like an authorization to

operate a public utility.

 BUT IT DOES NOT COVER licenses, say for operation of a liquor store or a cockpit, as
these involve grants of privileges only that are essentially revocable. Neither does it
include the marriage contract, which, more than a mere agreement between the
spouses, is regarded as a social institution subject at all times to regulation by the
legislature and to change of the original conditions. Thus, a subsequent law allowing
divorce would be applicable to marriages previously solemnized under a law prohibiting
their dissolution.

 a public office is not a property right and therefore cannot be the subject of a contract
between the incumbent and the government.
LAW
- includes statutes enacted by the national legislature, executive orders and administrative
regulations promulgated under a valid delegation of power, and municipal ordinances
passed by the local legislative bodies.

- DOES NOT INCLUDE judicial decisions or adjudications made by ad ministrative bodies

in the exercise of their quasi-judicial powers.

To impair, the law must retroact so as to affect existing contracts concluded before its
enactment. There will be no impairment if the law is made to operate prospectively only, to
cover contracts entered into after its enactment.
 OBLIGATION
 is the vinculum juris, i.e., the tie that binds the parties to each other.
 "The obligation of a contract is the law or duty which binds the parties to perform their
undertaking or agreement according to its terms and intent."
 In a contract of loan, for example, the obligation is the duty of the lender to extend the
loan and of the borrower to repay it, according to their stipulations.
IMPAIRMENT
 is anything that diminishes the efficacy of the contract.

 EXAMPLE: In contract of loan, there will be an impairment of its obligation if by

subsequent law the principal of the loan is reduced or increased, or the period of
payment is shortened or lengthened, or conditions are added or removed, or the
remedies for the enforcement of the rights of the parties are completely withdrawn.

The degree of the diminution is immaterial. As long as the original rights of either
of the parties are changed to his prejudice, there is an impairment of the
obligation of the contract.
NOTE: But IN THE CASE OF REMEDIES, there will be impairment only if all of them are
withdrawn, with the result that either of the parties will be unable to enforce his rights under the
original agreement.
There will be no impairment, in other words, as long as a substantial and efficacious remedy
remains. And this rule holds true even if the remedy retained is the most difficult to employ and
it is the easier ones that are withdrawn.

LIMITATIONS
- Despite the impairment clause, a contract valid at the time of its execution may be
legally modified or even completely invalidated by a subsequent law.

- If the law is a proper exercise of the police power, it will prevail over the contract.

Stone v. Mississippi: a franchise granted by the government in exchange for valuable

consideration, for the operation of a lottery by a private corporation, was in effect revoked when the
legislature subsequently imposed a prohibition on all kinds of gambling within the state. The
measure was sustained although the term of the franchise had not yet expired.

Gold Clause Cases: the creditors in many contracts of loan, anticipating a change in the legal
tender from gold to silver, stipulated with the borrowers that their loans would be repaid in gold
currency even if the conversion did take place. As expected, the United States ultimately converted
to the silver standard, the law providing for the discharge of existing money obligations through
payment in the new legal tender dollar for dollar. The creditors objected, claiming an impairment of
the obligation of their contracts. The U.S. Supreme Court sustained the law, holding that the
subject of the contract being currency, which was within the exclusive power of the legislature to
control, the agreement was subject to modification by the State in the exercise of the police power.
Rutter v. Esteban: the Philippine government declared, first by executive order of the
President and later by congressional enactment, a moratorium on the payment of pre-war
debts until after eight years from the settlement of the war damage claims of the debtors. The
law was annulled by the Supreme Court as violative of the impairment clause. The Court
declared that, to begin with, the emergency caused by the war that earlier had justified the
moratorium was no longer existing. Secondly, the period was oppressively long, extending over
a period of four years, when the executive order was in force, and another eight years as
provided under the law, during which the creditor could not enforce his claim. Finally, during the
moratorium, all the rights of the creditors were suspended, including the right to collect interest
on the principal of the loan as long as it remained unpaid. The Court noted that in the United
States, the usual period of moratorium did not extend beyond two years and during this period
all the rights of the creditor, except only the right to collect the principal of the loan, were
continued in force.

Ortigas & Co. v. Feati Bank: two lots sold by the petitioners on condition that they were to be
used only for residential purposes were subsequently acquired by the respondent, which started
erection of a commercial building thereon. The petitioner sought to restrain such construction on
the strength of the stipulated condition but the respondent invoked a resolution adopted by the
municipal council of Mandaluyong declaring the area in which the lots were located a
commercial and industrial zone. The Supreme Court upheld the respondent, ruling that the
zoning resolution had been adopted in the exercise of the police power, which was superior to
the impairment clause and so could modify the provisions of the contract of sale.

Tiro v. Hontanosas: The Supreme Court declared that a government directive which in effect
discontinued the assignment of the salaries of public school teachers to their creditor was not
offensive to the impairment clause because the latter could still collect its loans after the
salaries had been drawn by the employees themselves.

In Ganzon v. Inserto: however, it was held that the clause would be violated by the
substitution of a mortgage with a surety bond as security for the payment of a loan as this
would change the terms and conditions of the original mortgage contract over the mortgagee's
objection. Re markably, the change was made by a decision of the trial court, which is not
supposed to be covered by the term "law" as used in the impairment clause.

 In Article XII, Section 11, of the Constitution, it is provided that no franchise to

operate a public utility shall be granted except under the condition that it shall be
subject to "amendment, alteration or repeal by the Congress when the common
good so requires".
  It is submitted that this reservation is not at all necessary inasmuch as the
subject of the franchise is necessarily connected with the public welfare and so is
embraced in the police power of the State.
NOTE: Like the police power, the other inherent powers of eminent domain and
taxation may validly limit the impairment clause.

In LONG ISLAND WATER SUPPLY CO. V. BROOKLYN: a private corporation contracted to

supply the town of New Lots with water for a period of 25 years. The town was later annexed to
the City of Brooklyn, which then sought to expropriate the properties and franchises of the plain
tiff. In sustaining the expropriation, the U.S. Supreme Court declared that "a contract is property
and, like any other property, may be taken for public use . . . subject to the rule of just
compensation. The true view is that the condemnation proceedings do not impair the contract,
do not break its obligations, but appropriate it, as they do the tangible property of the company,
to public use.

This power, denominated 'eminent domain' of the State, is, as its name imports, paramount to
all private rights vested under the government, and these last are, by necessary implication,
held in subordination to this power, and must yield in every instance to its proper exercise.

NOTE: This right does not operate to impair the contract affected by it, but recognizes
its obligation in the fullest extent, claiming only the fulfillment of an essential and in
separable condition.

It has also been held that a lawful tax on a new subject, or an increased tax on an old
one, does not interfere with a contract or impair its obligation within the meaning of the
Constitution. Even though such taxation may affect particular contracts, as it may
increase the debt of one person and lessen the security of another, or may impose
additional burdens upon one class and release the burdens of another, still the tax must
be paid unless prohibited by the Constitution, nor can it be said that it impairs the
obligation of any existing contract in its true legal sense.

On the other hand, where a law grants a tax exemption in exchange for valuable consideration,
such exemption is considered a contract and cannot be repealed because of the impairment
clause. All other tax exemptions are not contractual and so may be revoked at will by the
legislature.