Here is a deeper look at the two lawsuits filed last week in U.S. District Court in San Francisco against the City of Richmond, California, for the city's Mortgage Resolution Partners-backed plan to condemn underwater mortgages, specifically those held by out-of-state securitized bonds, residential mortgage-backed securitization (RMBS) trusts. The first Complaint was brought by Wells Fargo and a number of mortgage holders on behalf of their trusts ("Wells Fargo" suit). The other, filed concurrently, was brought Wednesday by the Bank of New York Mellon for its trusts ("Bank of NYM suit").
My Damon Key colleague Bethany C.K. Ace has digested the complaints and provides us with her thoughts on the cases below. She joined me and Mark M. Murakami as the co-author of Recent Developments in Eminent Domain: Public Use, which is forthcoming in the next edition of the Urban Lawyer.
More On The Two Federal Lawsuits Challenging The Underwater Mortgage Taking Scheme
Bethany C.K. Ace
A review of the program was earlier posted here. In short, Richmond is the furthest along in implementing its partnership with MRP, the investment firm that has aggressively marketed and continues to push its program to various municipalities to acquire underwater mortgages using the power of eminent domain. According to the complaints, Richmond had already contracted with MRP to implement this program.
The suits were filed after the trustees received offers from Richmond to purchase their mortgages, a statutory prerequisite in California to initiating condemnation. The trustees allege that the offers are significantly below the value of the mortgages, particularly given that most of these mortgages are still performing (not in default or foreclosure), and that the offers are a mere formality because (again as the trustees allege) mortgages in private RMBS trusts cannot be sold. The suits are aimed at "nipp[ing] in the bud" the program before the City attempts to take any mortgages.
The two lawsuits raise largely the same allegations and seek the same relief, declaratory and injunctive relief to invalidate the program before the mortgages are condemned as violating a host of U.S. Constitutional, California Constitutional and California statutory provisions. The main thrust of both complaints is the trustees' claims that the program is not for a public use. A municipality has the power to take property by eminent domain, but these powers are not limitless. The United States and California Constitutions require that the condemnation of private property must be for a “public use." The lawsuits claim that Richmond has no public use because the program seeks to move the property (the debts) from one private entity to another (i.e., a private taking) and that the city's purported reasoning (to prevent foreclosures and their attendant economic effects) is mere pretext. The Bank of NYM suit also claims that Richmond's reasoning amounts to a claim for "prevention of future blight or harm" and such reason, even if true, "is not a valid public use."
These arguments put the lawsuit squarely in post-Kelo country, where courts and practitioners continue to try to delineate when a proffered use or purpose is pretext for an impermissible private benefit. Notably, the two lawsuits vary on the depth of their analysis of the statements Richmond has made to demonstrate pretext -- Wells Fargo quoting more of the statements made to support the program (e.g., that the program will create "more stable neighborhoods," add "more money in our local economy to stimulate community wealth," and save homeowners money on their mortgage payments and put that money in "homeowners' pockets" to spend in local businesses). The general rebuttal to these statements is that the natural of the program ipso facto demonstrates pretext because only certain mortgages will be condemned, ones that meet the profitability model of MRP (namely, performing mortgages with owners/borrowers who are good credit risks). At this early stage, it is hard to tell what additional statements will be presented to demonstrate pretext. As takings veterans and frequent readers of this blog well know, proving pretext is easier said than done.
The municipality must also meet any additional constitutional or statutory requirements imposed on the use of that power. For example, eminent domain cannot be invoked to condemn property located outside the jurisdictional limits of the condemning authority. And in condemning property, the municipality can also run afoul of myriad other laws.The trustees also claim that the program violates the following constitutional and statutory provisions (Bank of NYM alleging most of the same):
- Violation of prohibition against extraterritorial seizures under the U.S. Constitution, California Constitution, and the California Code of Civil Procedures because the situs of a debt for eminent domain purposes is the location of the creditor and the creditor of the debts and the promissory notes are located outside of Richmond.
- Violation of the Commerce Clause of the U.S. Constitution, under the "dormant Commerce Clause" doctrine which states and their political subdivisions are prohibited from taking action designed to benefit in-state economic interests by burdening out-of-state interests (claiming that the program "would significantly and directly regulate [the RMSB] market" on a national level and that the "burden imposed on interstate commerce by the Program would be excessive, and would greatly outweigh any purported benefits to the Richmond community").
- Violation of the Contracts Clause of the U.S. Constitution because the program would "severely impair the Trust's contractual rights to receive full payments of unpaid principal from borrowers" (i.e., "abrogate debts of [Richmond's] citizens, ... impair commercial intercourse and threaten the existence of credit").
- Violation of the Just Compensation requirements of the Takings Clause of the U.S. and California Constitutions, claiming not simply unjust compensation for any particular debt, but that unjust compensation (paying less than the fair market of the debts) "is the central premise of the Program itself."
- Violation of the same requirements for a partial taking by "cherry-picking" certain performing mortgages out of the portfolio of the RMBS trusts, leaving a higher concentration of non-performing loans, "thereby diminishing the value of the Trust's remaining, non-condemned assets."
One of the more interesting facets of the arguments concerns the location of the loans and their notes and the role of interstate commerce under the dormant Commerce Clause doctrine. If these arguments win the day, many of these mortgage foreclosure programs would be dead in the water because most debts would be located outside of the jurisdictional limits of the condemning government and an adverse finding in this case would signal that municipalities could not touch these mortgages even if they encumber properties within their jurisdictional limits.
- Violation of the Equal Protection Clause of the U.S. and California Constitutions by discriminating against out-of-state RMBS trusts (which hold the only mortgages targeted by the program) and that "such discrimination is not rationally related to any legitimate purpose."
But a reading of the lawsuits and all this news coverage and commentary shows that the biggest issues with the program is whether under the program “just compensation” is being offered and whether it will actually be paid. The Bank of NYM lawsuit gives an example of an offers being made at 11% of the outstanding principal balance. As required in California, the condemnor must pay the “fair market price” which is statutorily defined ("the highest price" that a willing but economically unpressured buyer would voluntarily pay to and be accepted by a willing but unpressured seller, i.e., arm's length transaction, on the date of value, giving due consideration to the property's features and potential uses, including its highest and best use).
The trustees take issue with how Richmond calculates the value of these loans, noting for example that the valuations do not account for things like consistent payment history. They also claim that the valuations will remain at the "artificially" lower amount if Richmond condemns the mortgages. The trustees point out that for the scheme to work, the mortgages have to be condemned at a price much lower than the current balances or what trustees contend are the "fair market value" of these debts, so that the homeowners can qualify for the new loan and the city and its partners can turn around and sell the securitized loan at a profit. Yet the trustees seek to have these issues vetted before any condemnation occurs, based on a claim of immediate and irreparable harm, as opposed to a challenge raised during a condemnation, requiring the trustees to meet the additional burdens required of those seeking injunctive relief and also raises questions of ripeness, another favorite issue facing those challenging takings.
And the plot continues to thicken… From the looks of it, there will be a battle both in the courtroom and on the street -- Wall Street -- as Richmond and perhaps other municipalities test using their eminent domain powers on underwater mortgages. For its part, Richmond claims to be ready for the fight. "The fact that these threats are being put out there are (sic) very, very disturbing -- but we are not afraid to go to court," said Richmond Major Gayle McLoughlin, as reported in this L.A. Times story. The story also reports that shortly after the lawsuits were filed, the Federal Housing Finance Agency fired a shot across the bow and announced it would instruct Fannie Mae and Freddie Mac to "limit, restrict or cease business activities” in any jurisdiction using eminent domain to seize mortgages.
These cases should be ones to watch, so stay tuned.