OCA Attorneys Weigh in on the Use of Eminent Domain to Restructure Underwater Mortgages

There has been much discussion in the media recently concerning a proposed plan developed by San Bernadino County, the cities of Fontana and Ontario, California, and a San Francisco venture capital firm, Mortgage Resolution Partners which seeks to condemn underwater mortgage loans for the purpose of restructuring debt.  For those who may not be following this story closely, below is a recap of the basic ideas.

The municipalities’ plan, and much of the discussion about it, centers around the use of the sovereign’s power of eminent domain, which we know is the power to take private property for a public purpose.  The “Home Protection Plan” creates a public-private partnership between the municipalities and Mortgage Resolution Partners. If the plan follows the proposal suggested by Mortgage Resolution Partners, the local governments will use the power of eminent domain to seize upside down mortgages from the financial institutions and investors who currently hold them using capital raised by Mortgage Resolution Partners from other banks and private investors.  The intent of the plan is to restructure underwater mortgages in an area of California that was hit hard by the drop in the housing market.  By restructuring the mortgage loans to be more in line with property values, the municipalities seek to improve the local economy and housing market.  The idea to use the eminent domain power to seize mortgages for the purpose of restructuring has spread to other municipalities including  Berkeley, CA and Chicago, IL.

The proposed use of eminent domain to bail out distressed mortgagees raise questions as to whether such use constitutes a permissible public purpose under the Fifth Amendment of the U.S. Constitution as well as will mortgage holders receive just compensation as required by the Fifth Amendment.   The Securities Industry and Financial Markets Association, the National Association of Home Builders and other trade groups have expressed strong objection to the “Homeownership Protection Plan” and have tried to instruct council members in these California municipalities as to the potential negative ramifications that may befall local homeowners as well as property owners nationally.

Recently, the Federal Housing Finance Agency (FHFA) spoke out against the plan and threatened yesterday that it would take action against municipalities that attempt to use eminent domain to refinance upside down mortgages.  In an article entitled “FHFA’s Stand Against Eminent Domain Plans Likely To Prevail” in American Banker, eminent domain attorneys affiliated with Owners’ Counsel weigh in on the federal agency’s announcement and the plan overall.

Donna Borak and Kate Berry write, “While it stopped short of specifying what moves it would make, experts said the federal agency is likely to prevail, noting it has jurisdiction to stop local governments like San Bernardino County and the cities of Fontana and Ontario in California from seizing mortgages.”

“San Bernardino County cannot condemn federal property,” said Gideon Kanner, OCA Member, appellate and eminent domain attorney as well as professor of law emeritus at Loyola Law School in Los Angeles. In the article he explains that the FHFA is “a federal agency and the Feds can take the property of a state or city but the state or a local entity cannot take federal property.”

Robert Thomas, OCA Hawaii Member and author of the eminent domain law blog inversecondemnation, was also quoted in the article and referred to FHFA’s response as “a pretty strong shot across the bow,” warning municipalities to rethink the idea of seizing mortgages.

He explained that, “federal property is immune from state and local condemnation so FHFA is trying to nip this before it gets to the courthouse door.” Thomas also said, “This idea to seize performing but underwater mortgages has always been more smoke because the proposal is based on a couple of assumptions that may not be true.”

Anthony Della Pelle, New Jersey Member of Owners’ Counsel and editor of the blog New Jersey Condemnation Law, also shared his insight in the article and agreed that municipalities may have difficulty condemning loans owned by a federal agency.  Della Pelle explained that loans owned by a private bank would have to satisfy the two primary requirements for condemnation – having a public purpose and providing just compensation to the owner of the mortgage.

FHFA issued a notice and has asked for input on the proposed use of eminent domain to restructure home loans.  We’ll be following this story as it continues.

For more discussion about this topic, below is a selection of blog posts commenting on the use of eminent domain to restructure mortgages and on media reports about this story.

• Will the Mortgage Securitization Eminent Domain Plan Succeed
• Should Governments Use Eminent Domain to Acquire Underwater Mortgages?
• The Latest in Eminent Domain: They’re Coming After the Banks
• Whats with All the Chatter about Eminent Domain Takings of “Underwater” Mortgages? and Condemnation of Underwater Mortgages (cont.)

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