Insights

As a result of the foreclosure crisis, many municipal governments have taken action to slow down or prevent foreclosures. Some municipal governments passed ordinances to protect tenants, implement mandatory pre-foreclosure mediation programs, or require registration of vacant or abandoned properties under a notice of default. All of these actions were taken with the goal of preserving communities and property values. Municipal governments are now looking to achieve that goal by using eminent domain to acquire mortgages. Last month, Richmond, California became the first local government to implement a program to acquire mortgages through the use of eminent domain. However, the use of such a plan has not gone without challenge. Here is what is going on.

The Richmond City Council voted to enter into an advisory services agreement with Mortgage Resolution Partners to establish a program to acquire underwater mortgage loans by eminent domain on April 2, 2013. Under the program, Richmond will acquire underwater mortgage loans owned by private mortgage-backed securitization trusts that are performing or in default. Richmond will then refinance the loans for an amount in excess of the acquisition price. The refinanced loan amounts would be for a lower principal balance than the current mortgage loans. The refinanced loans will also be federally insured. The stated purpose of the program is to preserve homeownership, restore homeowner equity, and stabilize the housing market by permitting homeowners to remain in their homes by preventing future defaults and foreclosures.

An Advisory Services Agreement was signed by Richmond and Mortgage Resolution Partners on July 25, 2013 detailing the program duties. Under the agreement, Mortgage Resolution Partners will provide advice on establishing the program and identifying mortgages to acquire, provide legal research on the acquisition and refinancing of mortgage loans, identify and negotiate with financing sources who will provide acquisition funds to the city, negotiate with the owners of the mortgage loans and other parties having a relationship with the owners, and perform additional services. In return for their services, Mortgage Resolution Partners sole compensation will be $4,500 for each loan acquired and restructured or refinanced through the program. Mortgage Resolution Partners also agreed to indemnify the city from damages to persons or property or other claims arising out of the agreement or program, unless the city acts negligently or with willful misconduct.

On July 31, 2013, Richmond sent letters out to bank trustees for 624 mortgage loans offering to purchase the loans for their current fair market value as determined by a June 30, 2013 appraisal. The 624 loans had mortgage balances ranging from $98,000 to $1,120,000. The city offered fair market value purchase prices ranging from 18% to 92% of the mortgage balance to acquire mortgage loans from one trustee. The trustees were given the option to obtain an independent appraisal if they were not satisfied with the fair market value price offered. However, the letter warned that the city would use eminent domain to acquire the mortgage loans if the trustee and city could not agree on the transaction. The recipients of the letter were asked to provide a response by August 13, 2013.

On August 7, 2013, in response to this letter, Wells Fargo Bank, N.A., Deutsche Bank National Trust Company, Deutsche Bank Trust Company Americas, and The Bank of New York Mellon acting as trustees for residential mortgage-backed securitization trusts holding mortgage loans in Richmond sued the city of Richmond and Mortgage Resolution Partners. The suit seeks a declaratory judgment that the program is unconstitutional and a temporary and permanent injunction to stop its implementation.

The bank trustees allege that the program has numerous constitutional pitfalls. The first is that it violates the “public use” requirement of the Fifth Amendment’s “Takings Clause” because it transfers the mortgage loans from one private party to another and only benefits a select group of homeowners rather than the public at large. Moreover, because a majority of the loans are performing loans the trustees allege that not only will the program fail to fulfill any meaningful loss mitigation goals, it also violatesthe “just compensation” requirement of the Takings Clause by taking the best performing loans for a price below the fair market value of loans in default. The bank trustees also allege that the program violates the prohibition against extraterritorial seizures because the loans are located outside of Richmond as the creditors are located outside of Richmond and the notes are held outside of Richmond.

In addition to Fifth Amendment eminent domain issues, the bank trustees allege that the program violates the Commerce Clause because it would unduly burden the national residential mortgage-backed securitization trust industry by diminishing investor confidence in the industry which may lead to a reduction in mortgage credit. The suit also alleges the program violates the Contracts Clause because it would impair the Trusts’ contractual rights to receive full payment and lead to a reduction in mortgage credit and the Equal Protection Clause by discriminating against certain mortgage holders and homeowners as the program will only seize loans held by private residential mortgage-backed securitization trusts and thus benefit certain classes of homeowners while the remaining homeowners in Richmond will likely suffer due to reduced mortgage credit in Richmond.

On its website, Mortgage Resolution Partners allege that the program is constitutional. It responds to the Contracts Clause allegation by noting that the Supreme Court stated in dicta in a 1935 court opinion that eminent domain should be used to take property of individual mortgagees when the public interest requires. Mortgage Resolution Partners also relies on a study by Amherst Securities stating that underwater mortgages have a 55% chance of future default to support the assertion that the program will meet its goal of preventing future defaults. Mortgage Resolution Partners asserts that the Program will not affect mortgage credit in communities with an eminent domain program because private lenders want to make a profit and housing prices will stabilize in communities with an eminent domain program. Thus, all homeowners will benefit.

In addition to the lawsuits, potential federal action threatens to stifle implementation of the program. The Federal Housing Finance Agency (FHFA) issued a statement on August 8, 2013 stating that it has serious concerns about the use of eminent domain to restructure mortgages. The FHFA stated that it may take legal action if an eminent domain program affects the FHFA’s regulated entities or cease business in jurisdictions that use eminent domain to restructure mortgages. Such an action would severely hinder the program which plans to provide federally insured refinance loans. In July, the Protecting American Taxpayers and Homeowners Act, H.R. 2767, was also introduced in the House of Representatives. The bill contains provisions prohibiting Fannie Mae, Freddie Mac, and the FHA from purchasing or insuring mortgage loans on properties where a previous mortgage loan was obtained by a local government through eminent domain in the past 10 years.

Richmond may also take action to revise the program. On August 17th, Councilman Nat Bates, who voted to enter into the advisory services agreement with Mortgage Resolution Partners, issued a statement requesting a special council meeting to make corrections to the eminent domain program to offset potential liability and embarrassment to Richmond. Councilman Bates stated that the city does not know the financial ability of Mortgage Resolution Partners to pay damages in a lawsuit. The Councilman also stated that the Council was never advised about the loan criteria and specifics of the program as requested when the agreement was approved. Finally, Councilman Bates stated that Richmond was being negatively impacted by the program because the city was unable to sell $30 million in revenue bonds even though Richmond has a strong A bond rating.

It remains to be seen whether the eminent domain program to acquire mortgage loans will actually get off the ground in Richmond due to the Trustee lawsuits, potential federal restrictions on insuring refinanced mortgage loans after the use of eminent domain, and potential City Council action. However, other municipal governments are waiting in the wings to implement a similar program. On June 19th, the city of North Las Vegas Nevada voted to enter into an advisory services agreement with Mortgage Resolution Partners. The cities of Newark and Irvington in New Jersey, Seattle in Washington, and several other jurisdictions in California are also considering the use of eminent domain to acquire mortgages. Thus, it appears that the use of eminent domain to acquire mortgages may become commonplace, unless court or federal action prevents it.

Shawnielle D. Predeoux is an associate of Hudson Cook, LLP, in the firm’s Hanover, Maryland office. Shawnielle can be reached at 410-865-5425 or by email at spredeoux@hudco.com.