Eminent Domain Mortgage Seizures Down But Not Out

The city of Richmond, Calif., was the first municipality to approve the use of eminent domain to acquire underwater mortgages in an effort to reduce foreclosures. But because the city council has been unable to muster the supermajority five out of seven votes necessary to actually use eminent domain, it will need to partner with another community to form a joint powers authority and carry out the plan. To date, it has not had any takers. 

There are two major reasons why other municipalities are likely hesitant to partner with the city of Richmond and Mortgage Resolution Partners, a private company which developed the eminent domain program. The first is the threat of litigation from the banks and trusts that hold the rights to underwater mortgages. The second is the threat of the withdrawal of support from the Federal Housing Finance Agency, the bedrock of residential mortgage lending in America.

The city of Richmond emerged victorious in the lawsuits that were filed against it by the trustees for hundreds of residential mortgage-backed securities trusts after the city approved the eminent domain plan. However, those lawsuits were dismissed without prejudice to the trustees’ right to file again. The trustees are likely to file more lawsuits upon implementation of the plan. This possibility is deterring municipalities from partnering with Richmond, as they fear both their potential liability (the trustees in the initial lawsuits estimated $200 million or more in losses) and the associated legal costs. 

The FHFA's stance on eminent domain is another important deterrent. The agency has stated in no uncertain terms that it is against the use of eminent domain.  The FHFA’s position is that the losses stemming from the use of eminent domain to modify mortgage loans would ultimately be borne by taxpayers and have a potentially chilling effect on the extension of credit to borrowers seeking to become homeowners. The FHFA has stated that it may initiate legal challenges against any local or state government that sanctions the use of eminent domain to restructure mortgage loan contracts in a way that affects FHFA’s regulated entities, Fannie Mae and Freddie Mac. It has also said that it may act by order or regulation to “direct the regulated entities to limit, restrict or cease business activities within the jurisdiction of any state or local authority employing eminent domain to restructure mortgage loan contracts.” This amounts to a death sentence for residential mortgage lending in any municipality in which the FHFA limits, restricts or ceases business activities. 

The serious impact of the FHFA’s position on the viability of the eminent domain option has not been lost on pro-eminent domain stakeholders.  The American Civil Liberties Union has sued the FHFA in Federal Court, seeking information about its position on the use of eminent domain to address underwater mortgages. ACLU staff attorney Linda Lye has said that the “FHFA has taken an aggressive stance on this issue in a way that has harmed minority communities” and that the “public deserves to know why.”

Although the concept of using eminent domain as a tool to address the continuing widespread issue of underwater mortgages is facing serious headwinds as a result of the above factors, the concept is not dead.  Irvington, N.J., recently became the second community in the United States to adopt the use of eminent domain to address the issue of underwater mortgages, indicating that there is more to come on this topic.

Michael E. Reyen, an attorney in Hodgson Russ’s real estate & finance practice group, represents financial institutions, developers, landlords, tenants, corporate trustees, municipalities, and nonprofit organizations in a wide range of commercial real estate and finance matters. He can be reached at mreyen@hodgsonruss.com.