Protecting Against Inflation By Resuscitating The Gold Clause (Part VI)

Limited retroactivity of the gold clause
The gold clause has traveled a long and hard road through the American monetary system. Designed to protect creditors from the debtor-coddling government money monopoly and against the scourge of inflated paper money, the contractual provision served well from the Civil War until gold and its corollaries inconveniently stood in the way of the New Deal’s stranglehold on America’s monetary system.

Then, along with gold itself, the gold clause had to go.

Re-legalization of private gold ownership fueled the hope that the gold clause had, at least by implication, been retroactively resuscitated, but state and federal courts ruled otherwise. (See Chapter Eight of The Gold Clause, entitled "Is the Gold Clause Really Legal?" for one of the more prominent state cases, Aztec Properties, Inc. v. Union Planters National Bank, ruling that the payment of indexed principal runs afoul of anti-usury laws.)

Then the gold clause rose again, with its re-legalization beginning in late 1977.

But what about retroactively?

Maybe.

To explain this tantalizing comment, first I have to explain the legal meaning of the word "novation."

According to Black's Law Dictionary, a novation is the "[s]ubstitution of a new contract, debt, or obligation for an existing one, between the same or different parties. The substitution by mutual agreement of one debtor for another or of one creditor for another, whereby the old debt is extinguished. The requisites of a novation are a previous valid obligation, an agreement of all the parties to a new contract, the extinguishment of the old obligation, and the validity of the new one." (My emphasis.)

In less legal terms, then, a novation is fundamentally the old contract reborn with a new twist or two.

It is through the novation device that only a few pre-New Deal gold clauses have been given effect.

The best explanation of how and why is found in the case of 216 Jamaica Avenue, LLC v. S & R Playhouse Realty Co.(540 F.3d 433), a decision of the United States Court of Appeals for the Sixth Circuit rendered in August 2008. (My annotations within the court's opinion, which appears below in courier font, are bracketed and in bold face. Asterisks signify the omission of at least one entire sentence.)

SUTTON, Circuit Judge

I.

In 1912, Salmon and Samuel Halle leased a parcel of land in downtown Cleveland from its owner, Realty Investment Corporation. The term of the lease was 99 years (through March 31, 2011), and the Halle brothers and their successors in interest retained the option of renewing the lease for another 25, 50 or 99 years (through as late as March 31, 2110).

The lease agreement fixed the annual rent at $10,000 for the first two years, then increased the rent in periodic intervals until it reached $35,000 in the eleventh year, where it remained until the end of the lease.

The lease also contained a "gold clause," which provided that "[a]ll of said rents shall be paid in gold coin of the United States of the present standard of weight and fineness."

At that time and up through the Depression, such clauses commonly appeared in long-term leases "as a sort of price-indexing mechanism to protect a lessor [landlord] from the effects of inflation." [Citing a predecessor case in the United States Court of Appeals for the Eighth Circuit and the Supreme Court of the United States.]

In the early 1930s, as part of a series of measures designed to implement the Roosevelt Administration's overhaul [note the euphemism; "keelhaul" would be a more accurate word] of American monetary policy, Congress withdrew gold from circulation and banned nearly all private ownership of it. * * *

And in 1933, Congress passed a Joint Resolution that declared gold clauses to be "against public policy," barred their inclusion in any future contract and suspended the operation of existing gold clauses by allowing all contract obligations to be paid in paper currency instead. See Joint Resolution of June 5, 1933 . . .(providing that no gold clause "shall be contained in or made with respect to any obligation hereafter incurred" and that "[e]very obligation, heretofore or hereafter incurred, whether or not any such provision is contained therein or made with respect thereto, shall be discharged upon payment, dollar for dollar, in any coin or currency which at the time of payment is legal tender for public and private debts").

Four decades later, Congress changed course. It repealed the ban on private ownership of gold in 1975.

And in 1977, it amended the 1933 Joint Resolution, providing that the resolution "shall not apply to obligations issued on or after" the amendment's date of enactment. * * * Although the amendment made clear that parties could include gold clauses in contracts formed after 1977, Congress's choice of words (authorizing "obligations issued ... after" the amendment) generated a small stream of litigation regarding the amendment's effect on gold clauses contained in contracts made prior to 1977 but transferred after that date. [My emphasis. This is important. The litigation to which Judge Sutton referred was over gold clause contracts made before re-legalization that were renegotiated after that 1977 event. In other words, contracts where there may have been a "novation."]


* * *

In an effort to clarify the matter [and the limbo status of pre-1977 gold clause contracts renegotiated after 1977], Congress passed a law in 1996 providing that owners could enforce pre-1977 gold clauses only if the parties to a new obligation issued after 1977 "specifically agree[d] to include a gold clause" in their new agreement. [My emphasis] * * *

Just over a year later, however, Congress repealed the 1996 statute.


* * *

So far as the record [in this case] is concerned, the gold clause in this contract never attracted anyone's attention or at least never generated any disputes during the first 90 years of its existence.

Since 1982, when the current lessee [tenant], S & R Playhouse Realty, assumed the lease, it has paid annual rent of $35,000 in American currency. And there is no indication in the record that either the original lessees [tenants], the Halle brothers or the other lessees [tenants] prior to S & R paid more than $35,000 in the preceding 70 years. Nor is there any indication that the previous owners ever demanded more than $35,000.

That changed in 2006, when the current owner, 216 Jamaica Avenue, purchased the land for $845,000, then sought to enforce the gold clause, demanding rent equivalent to the value of 35,000 1912 gold dollar coins. [My emphasis.]

The current lessee, S & R, balked at the prospect of paying several multiples of what it had been paying, prompting 216 Jamaica Avenue to file this breach-of-contract action in federal court . . . .

[T]he [trial] district court ruled for the lessee, refusing to enforce the [gold] clause.

II.

The parties share considerable common ground about how to resolve this dispute.

They agree that the question at hand is whether the gold clause constitutes an "obligation issued ... after" October 1977. * * *

And they agree that an assignment combined with a novation, which substitutes a new agreement for a prior one and releases the obligations of the prior lessee, would suffice to satisfy the obligation-issued-after requirement. What the case boils down to, then, is whether the 1982 transfer of the lessee's interest to S & R amounted to a novation.

[Judge Sutton’s concise and thorough recitation of the facts of the case clearly framed the issue to be decided: Congress had OKd gold clauses subject to an “obligation-issued-after” requirement, an assignment/novation could satisfy that requirement—-so was that what happened when S & R took the lease as a new tenant?]

[There followed in the court’s opinion a lengthy discussion of what constituted a contract of novation under Ohio law. Essentially, it is as defined above].

[The parties agreed that the 1982 assignment was a valid new contract, but disagreed about] whether the owner at that time agreed to release the prior lessee (Halle Bros. Co.) from its obligations under the lease and to substitute the new lessee (S & R) in its place.

[Because under Ohio law consent to a novation need not be express, but could be implicit from circumstances or conduct, the court found there had been consent]. * * *

The terms of the 1982 assignment agreement answer another objection raised by S & R: How could the assignment resuscitate the 1912 gold clause, which no party to the lease had been able to enforce since 1933?

In accordance with the express terms of the 1982 assignment agreement, S & R "assume[d] and agree[d] to perform each and all of the covenants, obligations, and engagements of the Assignor and lessee under said Lease and all other terms and provisions thereof on the part of lessee to be observed and performed after the date hereof." [Emphasis in original.]

The agreement also clarifies that the assignment was made "subject ... to the payment of the rents and the observance of all and singular the covenants, conditions, terms and agreements in said Lease contained." [Emphasis in original.]

The assignment agreement, in short, says it all: It explicitly incorporates all of the terms of the 1912 lease, including the gold clause. [My emphasis.] * * *

[T]he 1933 federal statute did not purport to, and did not in effect, delete the gold clause permanently from the lease agreement. The law, sure enough, made existing clauses unenforceable by providing obligors an alternative route for satisfying gold-denominated obligations, by declaring them to be against public policy and by forbidding their inclusion in future contracts. * * * But it stopped short of voiding or invalidating existing gold clauses, and it did nothing to prevent parties from reviving those clauses after the 1977 amendment. As the Eighth Circuit correctly explained [in an earlier case], "[t]he 1933 act did not magically erase the gold clause from the [pre-1933] lease."
As a final matter, it is worth addressing the parties' respective efforts to cast themselves as victims in this nearly century-long saga.

As S & R sees things, it took on a lease obligation of $35,000 a year and now is being asked to pay several multiples of that. As 216 Jamaica sees things, S & R had every reason to know this risk. The 1977 legislation permitted gold clauses to be enforced; the 1912 agreement contained a gold clause; the 1982 assignment required S & R to accept each of these obligations; and S & R chose not to condition acceptance of the assignment on removing the gold clause.

And, what is more, S & R wishes to pay $35,000 per year for space that is worth multiples of that and wants that option not just through 2011 but presumably for 99 more years-through 2110. The record does not say how much comparable space rents for in Cleveland, but one can certainly assume that it is more valuable than it was in 1912 without having to accept the truth of 216 Jamaica's assertion that it is worth more than 75 times what S & R currently pays for it. As a matter of sheer economics, it is hard to say which party has the sharper elbows.

Either way, in light of this ruling, the parties now know one of the effects of the 1982 assignment. * * *

We can speculate about whether one of the parties and their lawyers were brilliant when negotiating the 1982 assignment of the lease, or just lucky—-and whether their adversaries dropped the ball concerning the until-then gold clause.

But either way, in 216 Jamaica Avenue LLC v. S & R Playhouse Realty Co. an old gold clause lived again, albeit under very limited factual circumstances.

Regrettably, the Supreme Court of the United States has not weighed in on the question of resuscitation, and as time goes by it has less and less reason to do so as debt instruments containing gold clauses fade into history.

But that doesn’t mean that new gold clauses should not be, or cannot be, an integral part of any significant debt instrument today especially with massive inflation just below the horizon.

To be continued.