Would a Tennessee bill limiting when insurers can change open-ended payment contracts with doctors violate the Contract Clause?

Subject

Opinion No. 14-34, Constitutionality of Legislation Restricting Changes to Health Care Contracts, March 18, 2014

Plain-English summary

Senator Douglas Henry asked whether Senate Bill 2427, which would restrict how third-party payers (health insurers and similar payers) can change contracts with health care providers, would violate the Tennessee Constitution's Contract Clause (Article I, Section 20) when applied to open-ended contracts that had indefinite initial terms or no stipulated renewal date.

The bill would add a new Part 34 to the Tennessee Insurance Law (Title 56, Chapter 7) to regulate "material changes" to provider payment contracts. A "material change" is defined as any change in fees or payment methodologies that a reasonable person would consider in deciding what action to take, including changes to fee schedules, coding guidelines, edits, payment rules, claim payment procedures, or other elements affecting reimbursement amounts. The bill would prohibit a third-party payer from making a material change during the first year of the contract (or the initial term, whichever is longer); after that period, material changes would only be permitted on the stipulated renewal date or the anniversary of the effective date. The bill would also require the payer to provide a calculation estimating the cumulative impact on the provider before making the change, and would make any contractual waiver of these rules void.

The Contract Clause concern is real. If applied to an existing open-ended contract, the bill would substantively reduce the third-party payer's right to change the deal, tipping the contract in the provider's favor. That is the textbook description of contract impairment under Estate of Bell v. Shelby County Health Care Corp., 318 S.W.3d 823, 829 (Tenn. 2010), and the older cases (Lake County v. Morris, Hannum v. McInturf). Even though the legislature can sometimes impair contracts when exercising the police power for general welfare (Home Building & Loan Ass'n v. Blaisdell), United States Trust Co. v. New Jersey demands that the impairment be reasonable and necessary to a legitimate public purpose. A retroactive application to existing open-ended contracts would likely fail that test.

The bill avoided the constitutional problem by including Section 3, which made the rules apply only "to all policies, contracts, and health benefit plans issued, delivered, or renewed in the state on or after October 1, 2014." Prospective application is the saving feature. Since Ogden v. Saunders (1827), federal Contract Clause doctrine has limited the clause to retrospective legislation. The Tennessee Supreme Court has long affirmed that the legislature has power "to declare the force and effect of future contracts" (West v. Jefferson Woolen Mills, 147 Tenn. 100 (1922)). Parties writing new contracts after October 1, 2014, would do so against the backdrop of the new statute; no vested right would be disturbed.

The AG also applied the constitutional-avoidance canon. Even if Section 3 might be read more broadly, courts should read it to be prospective only (Freeman Industries v. Eastman Chemical), which is what its text says anyway. The AG made clear that if the bill were applied to existing open-ended contracts, it would impair contracts in a way that would likely fail the Blaisdell/United States Trust standard.

Currency note

This opinion was issued in 2014. Subsequent statutory amendments, court decisions, or later AG opinions may have changed the analysis. Treat this page as historical context, not current legal advice. Verify current law before relying on any specific rule, deadline, or remedy mentioned here.

Common questions

What did SB 2427 try to do?

It would have regulated how third-party payers (health insurers, third-party administrators, similar entities) can change payment contracts with health care providers. During the first year (or initial term) of a contract, no material change would be allowed. After that, material changes would only be allowed on the renewal date or the anniversary of the effective date, and only with a calculation showing the cumulative impact on the provider. Contracting around these rules would be void.

What was the Contract Clause concern?

If applied to existing open-ended contracts (contracts with no defined initial term), the bill could lock the third-party payer into the original terms permanently, since "first year of the contract or the initial term, whichever is longer" never expires when the initial term is indefinite. That is a substantial reduction in the payer's contractual rights, transferring value to the provider.

Why doesn't a prospective-only application raise the same problem?

Because the Contract Clause prohibits laws "impairing the obligation of contracts," and that means existing contracts. When parties enter a new contract after the law takes effect, they are negotiating against the backdrop of the law. No previously vested right is impaired; the law is just part of the regulatory environment. Ogden v. Saunders made that distinction in 1827 and it has held up ever since.

Could the legislature still apply the rules to existing contracts as an exercise of police power?

Theoretically yes, but it would have to clear a high bar. Blaisdell, Pace, and United States Trust v. New Jersey establish that contract impairment under the police power must be reasonable and necessary to a legitimate public purpose. The AG concluded that imposing this regime on existing open-ended contracts would likely be seen as an "unnecessary and unreasonable means" to address general-welfare concerns and would fail under Article I, Section 20.

What is a "material change" under the bill?

"A change in fees or payment methodologies that a reasonable person would attach in determining the action to be taken upon the change." The definition then enumerates examples: changes to fee schedules, coding guidelines, edits, payment rules, claim payment procedures, or any other elements used to determine payment amounts. The list is broad and would have captured most of what insurers do to update reimbursement structures.

Did the bill let providers and payers waive these rules by contract?

No. The bill expressly voided any contractual waiver. The AG did not analyze that anti-waiver provision separately, but treated it as part of the regulatory package that, applied prospectively, does not raise Contract Clause concerns.

Why is the constitutional-avoidance canon relevant?

The AG cited Freeman Industries and Davis-Kidd Booksellers for the rule that Tennessee courts should construe statutes to avoid constitutional conflict when possible. SB 2427's Section 3 text already supported prospective application, but the avoidance canon reinforced that reading. If a future court faced an ambiguity, it should resolve it in favor of prospective effect.

Did the AG say SB 2427 was bulletproof?

No, only that the bill as written did not implicate Article I, Section 20 because Section 3 made it prospective. The AG explicitly flagged that retrospective application to existing open-ended contracts would likely violate the Contract Clause, an implicit warning that any later amendment removing the prospective limitation would face constitutional challenge.

Background and statutory framework

The Tennessee Contract Clause (Article I, Section 20) and the federal Contract Clause (Article I, Section 10) are read identically by Tennessee courts (First Utility District of Carter County v. Clark). They both bar state laws that impair the obligation of existing contracts. The "main tests" for impairment, listed in the older cases, ask whether the value of the contract has been lessened (Lake County v. Morris) and whether the right existing at execution has been diminished (Hannum v. McInturf).

Modern Contract Clause analysis layers a police-power exception on top, originating in Home Building & Loan Ass'n v. Blaisdell, 290 U.S. 398 (1934). That doctrine allows states to impair existing contracts when necessary to address a public emergency or general welfare concern, but the impairment must be reasonable and tailored to the public purpose. United States Trust Co. v. New Jersey, 431 U.S. 1 (1978), tightened the reasonableness requirement for state laws impairing the state's own contractual obligations and informed the more general doctrine.

The prospective-versus-retrospective distinction is the simplest way out of Contract Clause problems and has been doctrinally clean since Ogden v. Saunders (1827). Future contracts are negotiated against the existing legal background. Tennessee's First Circuit citation (Local Div. 589 v. Massachusetts) recognizes the same principle.

The constitutional-avoidance canon is a standard interpretive tool in Tennessee courts, reaffirmed in Freeman Industries and Davis-Kidd Booksellers. Where one reading of a statute would raise a constitutional problem and another would not, courts choose the second.

Citations

• Tenn. Const. art. I, § 20 (no retrospective law or law impairing the obligation of contracts)
• U.S. Const. art. I, § 10 (Contract Clause)
• Tenn. Code Ann. tit. 56, ch. 7 (Tennessee Insurance Law; bill would add new Part 34)
• First Util. Dist. of Carter County v. Clark, 834 S.W.2d 283 (Tenn. 1992) (Tennessee Supreme Court; federal and state Contract Clauses identical)
• Estate of Bell v. Shelby Cnty. Health Care Corp., 318 S.W.3d 823 (Tenn. 2010) (Tennessee Supreme Court)
• Morris v. Gross, 572 S.W.2d 902 (Tenn. 1978) (Tennessee Supreme Court)
• Lake County v. Morris, 160 Tenn. 619, 28 S.W.2d 351 (1930) (Tennessee Supreme Court)
• Hannum v. McInturf, 65 Tenn. 225 (1873) (Tennessee Supreme Court)
• Home Bldg. & Loan Ass'n v. Blaisdell, 290 U.S. 398 (1934) (U.S. Supreme Court)
• Shields v. Clifton Hill Land Co., 94 Tenn. 123, 28 S.W. 668 (1894) (Tennessee Supreme Court)
• Ford Motor Co. v. Pace, 206 Tenn. 559, 335 S.W.2d 360 (1960) (Tennessee Supreme Court)
• United States Trust Co. v. New Jersey, 431 U.S. 1 (1978) (U.S. Supreme Court)
• City of Paris v. Paris-Henry Cnty. Pub. Util. Dist., 207 Tenn. 388, 340 S.W.2d 885 (1960) (Tennessee Supreme Court)
• Ogden v. Saunders, 25 U.S. (12 Wheat.) 213 (1827) (U.S. Supreme Court)
• Local Div. 589 v. Massachusetts, 666 F.2d 618 (1st Cir. 1981)
• West v. Jefferson Woolen Mills, 147 Tenn. 100, 245 S.W. 542 (1922) (Tennessee Supreme Court)
• Greenfield v. Dorris, 33 Tenn. 548 (1853) (Tennessee Supreme Court)
• Freeman Indus., LLC v. Eastman Chemical Co., 172 S.W.3d 512 (Tenn. 2005) (Tennessee Supreme Court)
• Davis-Kidd Booksellers, Inc. v. McWherter, 866 S.W.2d 520 (Tenn. 1993) (Tennessee Supreme Court)

Source

• Landing page: https://www.tn.gov/attorneygeneral/opinions.html
• Original PDF: https://www.tn.gov/content/dam/tn/attorneygeneral/documents/ops/2014/op14-034.pdf

Original opinion text

STATE OF TENNESSEE
OFFICE OF THE ATTORNEY GENERAL
March 18, 2014
Opinion No. 14-34
Constitutionality of Legislation Restricting Changes to Health Care Contracts

QUESTION

Does Senate Bill 2427/House Bill 2303 of the 108th General Assembly (2014) (hereinafter "SB2427") implicate Article I, § 20, of the Tennessee Constitution if a material change is made to an open-ended contract that has an indefinite initial term or no stipulated renewal date?

OPINION

No. Because Section 3 of SB2427 gives the bill only prospective application (i.e., forecloses its application to existing open-ended contracts), the bill does not implicate Article I, § 20, of the Tennessee Constitution.

ANALYSIS

SB2427 would amend the Tennessee Insurance Law by adding a new Part 34 to Chapter 7 of Title 56 that places restrictions upon a third-party payer who wishes to effect a "material change" to a contract under which a health care provider is paid for services. A "material change" is defined as "a change in fees or payment methodologies that a reasonable person would attach in determining the action to be taken upon the change." SB2427, § 1. Included in the definition of "material change" is a "change to fee schedules, coding guidelines, edits, payment rules, claim payment procedures, or any other elements that the third-party payer utilizes to determine payment of reimbursement amounts." Id.

The bill would restrict a third-party payer from making a material change to such a contract during the first year of the contract or the initial term of the contract, whichever is longer. After the initial term or first year of the contract, SB2427 would permit the third-party payer to make a material change only on the stipulated renewal date of the contract or the anniversary of the effective date of the contract, whichever is longer. If the third-party payer desires to make a material change at that time, SB2427 would require the third-party payer to provide a calculation that estimates any reduction in the health care provider's cumulative allowed amount based on twelve months, or an annualized shorter look back period, of actual data. Under the bill, third-party payers and health care providers are prevented from waiving these provisions by contract, and "any such purported waiver is void." SB2427, § 1.

"Third-party payer" is defined as "a health insurer, third-party administrator, or other person that is obligated pursuant to health insurance coverage or a health benefits plan, to pay for covered health care services rendered to beneficiaries." SB2427, § 1.

Article I, § 20, of the Tennessee Constitution states "that no retrospective law, or law impairing the obligations of contracts, shall be made." Similarly, Article I, § 10, of the United States Constitution provides that "[n]o state shall . . . pass any . . . law impairing the obligation of contracts." The Tennessee Supreme Court has observed that the meaning of these state and federal constitutional provisions is identical. First Util. Dist. of Carter County v. Clark, 834 S.W.2d 283, 287 (Tenn. 1992). Each of these provisions is referred to as the "Contract Clause."

The Contract Clause prohibits laws "which take away or impair vested rights acquired under existing laws or create a new obligation, impose a new duty, or attach a new disability in respect of transactions or considerations already passed." Estate of Bell v. Shelby Cnty. Health Care Corp., 318 S.W.3d 823, 829 (Tenn. 2010) (quoting Morris v. Gross, 572 S.W.2d 902, 907 (Tenn. 1978)). Among the main tests for determining whether the obligation of a contract has been impaired are whether the value of the contract or security has been lessened, Lake County v. Morris, 160 Tenn. 619, 28 S.W.2d 351, 354 (1930), and whether the right in full existing at the time the contract was executed has been diminished. Hannum v. McInturf, 65 Tenn. 225, 1873 WL 4006, at *2 (1873). Accordingly, the obligation of contract is impaired when a legislative enactment changes the obligation in favor of one party against another, either by enlarging or reducing the obligation. 16B Am. Jur. 2d Constitutional Law § 775 (2014).

SB2427 would restrict a third-party payer from making a material change to a contract under which a health-care provider is paid during the first year of the contract or the initial term of the contract, whichever is longer. Open-ended health-care contracts have indefinite initial terms. Therefore, if SB2427 were applied to an existing open-ended contract, the third-party payer would never be able to make a material change to the contract. The legislative change would thus deprive the third-party payer of one of its substantive rights under the contract and change the contract in favor of the health-care provider; consequently, SB2427 would impair the obligation of contracts between third-party payers and health-care providers.

The legislature may impair the obligation of contracts without violating the Contract Clause if such legislation is enacted in the exercise of the police power. Home Bldg. & Loan Ass'n v. Blaisdell, 290 U.S. 398, 437 (1934); Shields v. Clifton Hill Land Co., 94 Tenn. 123, 28 S.W. 668, 674 (Tenn. 1894). The State's police power includes authority to protect the general welfare of the people, Ford Motor Co. v. Pace, 206 Tenn. 559, 335 S.W.2d 360, 370 (1960), and SB2427's stated purpose is to do just that. S.B. 2427, Preamble. But the Contract Clause demands that the exercise of this power "be upon reasonable conditions and of a character appropriate to the public purpose justifying its adoption." United States Trust Co. v. New Jersey, 431 U.S. 1, 22 (1978); see City of Paris v. Paris-Henry Cnty. Pub. Util. Dist., 207 Tenn. 388, 340 S.W.2d 885 (1960). If SB2427 were applied to an existing open-ended contract, the impairment would be substantial, as discussed above; such impairment would likely be seen as an unnecessary and unreasonable means by which to address general-welfare concerns and lead to the conclusion that SB2427 as so applied violates Article I, § 20.

But SB2427 expressly provides that it "shall apply to all policies, contracts, and health benefit plans issued, delivered, or renewed in the state on or after October 1, 2014." SB2427, §3 (emphasis added). Construing this provision to give SB2427 only prospective application (i.e., to foreclose its application to existing open-ended contracts), the bill does not run afoul of Article I, § 20. It has been clear since 1827 that the Contract Clause applies only to laws with retrospective, not prospective, effect, see Local Div. 589, Amalgamated Transit Union v. Massachusetts, 666 F.2d 618, 637 (1st Cir. 1981) (citing Ogden v. Saunders, 6 L.Ed. 606 (1827)), and it is well settled that the legislature has power to declare the force and effect of future contracts made and to be executed in this State, see West v. Jefferson Woolen Mills, 147 Tenn. 100, 245 S.W. 542, 543 (Tenn. 1922); Greenfield v. Dorris, 33 Tenn. 548, 1853 WL 2315, at *3 (1853).

Statutes should be construed so as to avoid any unconstitutionality. Freeman Indus., LLC v. Eastman Chemical Co., 172 S.W.3d 512, 521-22 (Tenn. 2005) (citing Davis-Kidd Booksellers, Inc. v. McWherter, 866 S.W.2d 520, 529 (Tenn. 1993)).

ROBERT E. COOPER, JR.
Attorney General and Reporter

JOSEPH F. WHALEN
Acting Solicitor General

LAURA T. KIDWELL
Senior Counsel

Requested by:
The Honorable Douglas Henry
State Senator
321 War Memorial Building
Nashville, TN 37243-0021