It seems obvious, on the face of it, that paying an employee in IOUs is wrong. I wondered, though, whether it was legal for California to do it. I am pretty sure that I’d be considered in breach of contract if I tried to pay an employee with a promise written on a Post-it note.

Since I am not a normal human being, the first thing I thought of when I heard California was issuing IOUs was Article I, Section 10 of the Constitution. The first paragraph reads as follows:

No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility.

Bringing out the important part, we read that “No State shall emit Bills of Credit.”

It seems pretty obvious that an IOU is a “bill of credit,” but I was curious as to whether the court system would agree. I investigated the Supreme Court rulings pertaining to the “bills of credit” clause. The definition of “bill of credit” as the courts understand it is established mostly in Craig v. Missouri, 29 U.S. 410 (1830). Later rulings refined the Craig ruling somewhat but it has not, as far as I could tell, been overturned.

The key elements in the Craig ruling are:

• There’s a difference between a “bill of credit” and something like a municipal bond. The difference is that “‘bills of credit’ signify a paper medium, intended to circulate between individuals, and between government and individuals, for the ordinary purposes of society.” The ban on “bills of credit” extends to any paper medium issued by a State government, for the purpose of common circulation.
• It doesn’t matter whether or not the “bills of credit” are given legal tender status.
• It is relevant whether the bills can be used to pay taxes or to pay employees, because this gives them currency and makes them likely to circulate as would paper money.
• Several historical examples of the dangers of “bills of credit” are given, including one example from 1690 Massachusetts where the government found itself unable to pay soldiers returning unexpectedly from a failed expedition against Canada and issued “bills of credit” instead of payment.

A later case, Houston & Texas Central R. Co. v. Texas, 177 U.S. 66 (1900), further defined the definition of a bill of credit and a municipality’s obligation with regards to payment when it engages in a contract with the private sector.

• A warrant on a State’s treasury assets isn’t a bill of credit if the money the warrant entitles its holder to is actually in the treasury
• If a municipality contracts for a municipal improvement (e.x. hiring a construction company to build a road) which it has the authority to do, and engages to pay what it owes in a bond which it doesn’t have the authority to issue, the municipality must instead pay in money.

This means that even if there’s a provision in California State employees’ contracts which allows California to pay them in IOUs, California still has to pay in cash, because that part of the contract is null and void.

California’s IOUs seem to pass all the tests for being Constitutionally forbidden “bills of credit.”  About the only argument I could see being made against them is that their denominations make them ill-suited for circulation, but by all accounts they’re circulating anyway, and California clearly intended them to circulate…I don’t know how else they expected their employees to eat.