City attempting to seize underwater mortgages via eminent domain: constitutional objections, potential investor losses

by DLA Piper
Contact

The City of Richmond, California has commenced the process for taking by eminent domain hundreds of notes secured by mortgages on underwater residential properties owned by investors through residential mortgage backed securities (RMBS).

This is the first time a government entity has implemented a novel concept that some law professors1 and a for-profit company2 have been advocating and shopping to many local governments as a solution to the mortgage crisis.

Rather than waiting to defend individual eminent domain actions in state court, last week bank trustees of many RMBS sued in federal court in San Francisco to stop the City’s seizure program.3

The City’s legal strategy is based on California and federal law that allows use of the eminent domain power to condemn intangible property, such as a note secured by deed of trust, if the condemnation is for a valid public use.4

Richmond claims its purpose is to ameliorate the effects of the ongoing financial crisis, particularly home foreclosures and associated urban blight, by seizing and writing down existing mortgages, then refinancing the loans for resale at a lower principal amount to new private investors.  The City attempts to expand on the recent US Supreme Court decision in Kelo v. City of New London, which approved the use of eminent domain even when it directly benefits another private entity.

Richmond’s strategy depends on purported benefits arising from the aggregate of individual private mortgage write-downs rather than a specific need and resulting public benefit for the taking of any particular mortgage.  The City’s plan is to use the eminent domain power to seize underwater residential loans; pay “just compensation” at substantially less than the current sub-par value of the real property security; and then attract private capital to re-issue new loans to the homeowners at greatly decreased principal amounts.

The City has primarily targeted  performing loans because those are the loans most attractive to new investors.  However, some observers have noted that such borrowers are the very people who are most likely to pay off their loans per contract and are least likely to need mortgage relief. 

Scene of the national battle

Because this is the first time a municipality has ever commenced such a legal process and initial lawsuits have now been filed in federal court in San Francisco, the national battle over the constitutionality of seizure programs will take place in the Northern District of California.   Absent  a state or federal legislative solution that says the City’s program is outside the bounds of eminent domain, the legality of the City’s Seizure Program will be determined in federal court.

Bank trustees’ arguments

The federal court lawsuits by three bank trustees (Wells Fargo Bank, Deutsche Bank and BNY Mellon) argue that the City’s plan should be enjoined because it violates:

  • the Takings Clauses of the US and California Constitutions, because it is not a valid “public use” of eminent domain, even under the expansion of “public use” found in Kelo v. City of New London
  • the Takings Clauses of the US and California Constitutions, because it is an attempt to exercise extraterritorial eminent domain jurisdiction by seizure of notes that are not within the City and are owned by out-of-state RMBS
  • the Commerce Clause of the US Constitution, by disrupting interstate commerce in mortgage financing
  • the Contracts Clause of the US Constitution, by wrongfully impairing private contractual obligations between note holders and the homeowner borrowers, most of whom will continue to pay per contract on home mortgages that are temporarily underwater
  • the Just Compensation Clauses of the US and California Constitutions, by not paying the fair market value of the notes (which are performing loans, even though the real property security is currently underwater)
  • the Equal Protection Clauses of the US and California Constitutions by cherry-picking mostly performing (and therefore readily marketable) loans for seizure and targeting only those loans owned by RMBS trusts
  • Cal. Code. Civ. Proc. Section 1240.030 as a matter not in the public interest and necessity, nor planned in a way most compatible with the public good and least public injury, nor necessary, and
  • the California Constitution, by taking a private residence for the purpose of conveying to a private person.

BNY Mellon further argues that the City’s plan constitutes tortious interference with a contract, by interfering with currently performing loans between homeowners and note holders.

The Seizure Program affects investors, title companies, mortgage lenders and many others

Beyond just bank trustees, this program will impact institutional investors such as insurance companies, pension funds and mutual funds, which own significant amounts of RMBS, and which therefore stand to take large losses.

The program also poses huge questions for the FHFA, Fannie Mae, Freddie Mac and title insurance companies.  If the City were successful in seizing and re-writing residential loans secured by mortgages, and if the matter were to remain in legal limbo until resolved on appeal, who would be the owners of the right to be paid on the notes, and of the liens on real property security: the holders of the old notes tied up in litigation, or of the new notes issued pursuant to the Seizure Program? Would title companies issue title insurance on the new loans?

In addition to direct losses to investors in RMBS and chaos for FHFA, Fannie, Freddie and title companies, widespread use of eminent domain to seize residential mortgages could cause significant disruption in the credit markets, including increased costs and/or loss of credit to home purchasers in cities exercising eminent domain to seize underwater mortgage loans.

Taking appropriate steps

Beyond the constitutional questions, there are significant statutory processes applicable to each affected mortgage.  The City has issued offer to purchase letters to 32 holders of RMBS involving over 600 individual mortgages, which is the first step in the eminent domain process.  The letters offer to pay “just compensation” for the mortgages at well below the already below-par “fair market value” of the residential properties that secure the loans.  Recipients of the letters have a short time to respond, and, if the offers are rejected, the City will proceed with condemnation of the affected mortgages.

Investors should take care to ensure that the trustees of the RMBS trusts in which they have invested are taking appropriate steps to challenge the City’s efforts.  In addition to preemptive legal challenges such as the lawsuits described above, trustees can also directly object by appearing at the City Council meetings regarding resolutions of necessity – a prerequisite to the exercise of eminent domain, making writ of mandate challenges to such resolutions if adopted, and defense of eminent domain proceedings on the issues of “right to take,” “just compensation” and numerous statutory requirements.  If the City’s Seizure Program is not enjoined, then investors with actual or potential RMBS exposure, including any investor which received an offer to purchase letter from the City, must object (or cause the RMBS trustee to object) to the eminent domain proceedings to prevent the takings.

Besides direct legal action by their trustees, major investors in RMBS and title companies, mortgage lending and real estate businesses, trade groups or other affected businesses should consider amicus curiae participation now in the pending challenges to the City’s plan at the initial pleading stage of the litigation.  Investors and others should also consider advocacy in support of state and/or federal legislative intervention and also before state and local governments, wherever municipalities are considering following the City’s lead.

If the City’s eminent domain efforts succeed, then other cities are likely to initiate similar proceedings in California and across the country.  Most cities to which this proposal have been pitched have rejected it, including Chicago and, in California, a consortium of San Bernardino and other Inland Empire cities with distressed real estate values.  However, a number of cities, among them Newark, New Jersey; Seattle, Washington; El Monte, California; and North Las Vegas, Nevada, have reportedly engaged Mortgage Resolution Partners or are considering similar programs.


1 See, e.g., Robert Hockett, “Paying Paul and Robbing No One: An Eminent Domain Plan for Underwater Mortgage Debt,” 19(5) Current Issues in Economics and Finance 1 (2013); Ngai Pindell, “Nevada's Residential Real Estate Crisis: Local Governments and the Use of Eminent Domain to Condemn Mortgage Notes,” 13 Nev. L.J. 888 (2013); Robert Hockett, “It Takes a Village: Public-Private Partnerships for Write-Downs of Underwater Mortgage Debt,” 18 Stanford Journal of Law, Business, and Finance 121 (2012).

2 Mortgage Resolution Partners, L.L.C., formed by former lawyers and bankers as a for-profit venture.

3 Wells Fargo Bank, N.A. v. City of Richmond, No. 13-cv-3663 (N.D. Cal.); Bank of New York Mellon v. City of Richmond,  No. 13-cv-3664 (N.D. Cal.). 

4 City of Oakland v. Oakland Raiders, 31 Cal. 3d 656 (1982), Kimball Laundry Co. v. United States, 338 U.S. 1 (1949).

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© DLA Piper | Attorney Advertising

Written by:

DLA Piper
Contact
more
less

DLA Piper on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.
Feedback? Tell us what you think of the new jdsupra.com!