The threshold question for MBS trustees’ new eminent domain suits

August 8, 2013

The long-anticipated fight over the constitutionality of using eminent domain to seize mortgages from mortgage-backed securities trusts is upon us. On Wednesday night, three MBS trustees filed complaints in federal district court in San Francisco, seeking declaratory judgments that Richmond, California, may not deploy its power of eminent domain to take over about 624 mortgages that belong to MBS noteholders. The suits, one brought on behalf of MBS trustees Wells Fargo and Deutsche Bank and the other on behalf of Bank of New York Mellon, raise overlapping though not identical arguments for why Richmond’s eminent domain plan violates the Takings, Contract, Equal Protection and Commerce Clauses of the U.S. Constitution as well as various state constitutional protections. The complaints introduce some new wrinkles in the eminent domain debate, such as an argument by BNY Mellon’s lawyers at Mayer Brown that the seizure of securitized mortgages will endanger the tax status of the MBS trusts that contain the loans, subjecting noteholders to a 35 percent tax on trust income. The trustees have also quantified the harm they face: The takeover of just the 624 loans Richmond has already proposed buying from MBS trusts for 80 percent of the current value of each house that’s collateral on the loan will cost noteholders as much as $200 million, according to Wells Fargo and Deutsche Bank lawyers at Ropes & Gray.

But before the MBS trustees can block Richmond and its eminent domain enabler, the private firm Mortgage Resolution Partners, from seizing securitized loans, they will have to show that they’re in danger of immediate, concrete harm from the plan. U.S. courts cannot issue advisory opinions, in the form of declaratory judgments, unless an actual controversy is before them, not just an abstract or hypothetical question of law. The test, as most recently articulated by the U.S. Supreme Court in the 2007 case of MedImmune v. Genentech, is whether a declaratory judgment case presents “sufficient immediacy and reality to warrant relief.”

Is the supposed harm to MBS trusts from Richmond’s eminent domain plan sufficiently concrete and nearby to present an actual controversy? The city has not actually snatched any securitized loans out of MBS trusts. It hasn’t even held a condemnation hearing on any of the loans it has proposed buying from trusts. It has just signed an agreement with MRP, sent notices to MBS trusts that it wants to buy the 624 loans, given the trusts an August 13 deadline to respond to its offer and announced that it reserves the right to use eminent domain to take over the loans if its offers are rejected. The new suits contend that the trustees’ case is ripe because Richmond has the ability, under California’s “quick take” law, to grab the mortgages with minimal notice. Then MRP can act quickly to arrange new financing for homeowners and bundle their new mortgages into new securities. Once that happens, the trustees assert, it will be nearly impossible to unwind the transactions and restore loans to MBS trusts if the seizures are later deemed unconstitutional.

They say the danger they face is so pressing that Richmond must be enjoined from acting now, in advance of actual eminent domain seizures. Richmond and MRP “have taken substantial steps towards seizing loans under the seizure programs, and such seizures are imminent,” the BNY Mellon complaint said. “If those seizures occur, the trusts will be irreparably harmed.” And money damages, the trustees assert, can’t adequately address the injury Richmond’s plan will inflict not just upon the particular MBS trusts they oversee, but on the whole securitization business and, by extension, the entire housing market.

MRP and Richmond, of course, disagree. “There’s just no evidence that there’s significant harm afoot,” said Robert Hockett, a Cornell law professor who has served as a paid consultant (and unpaid adviser) to MRP. If the danger to MBS trusts from Richmond’s eminent domain plan were as grave as the trustee complaints make it out to be, Hockett said, the secondary market for the securities would already have tanked, but it hasn’t. “This is just a spurious attempt to get their suit going before it’s ripe,” he said. “It’s part of their strategy to frighten small cities, making it look as though they’ll be locked in endless litigation.”

In case you’ve forgotten, here’s a quick refresher on the eminent domain plan. Richmond and MRP want to buy up mortgages on so-called underwater homes that are worth less than the outstanding principal on homeowners’ mortgages. They claim that underwater homeowners are at high risk of defaulting on their mortgages, sending their loans into default and their houses into foreclosure. Richmond and MRP propose paying 80 percent of the current value of the underwater homes to the trusts that hold mortgages on them. If the trusts don’t agree, the city has said it has the right to exercise eminent domain and seize the mortgages in order to accomplish the public good of staving off foreclosures.

Opponents of the eminent domain plan – which include just about the entire financial community, members of the U.S. House Financial Services Committee and the Federal Housing Finance Agency – argue that seizing individual mortgages does not meet the public use requirement for a government taking under the Fifth Amendment. They also say that Richmond’s proposed just compensation for the taking, 80 percent of the current value of the home, isn’t fair at all because the city wants to seize mostly performing loans that are generating a steady income stream to the trusts. That income stream is based on the remaining principal of the mortgage, not the home’s current value. Indeed, as the new trustee complaints point out, the eminent domain scheme wouldn’t make any sense for MRP if Richmond were really going to pay fair value for the mortgages it wants to seize: MRP’s involvement depends on the private company’s ability to resell the loans for more than Richmond is paying (with MRP’s capital). MRP is in this game to make a profit, after all. That’s why Richmond has targeted performing loans for seizure, according to the trustees. Those homeowners, who have already weathered five years of economic crisis, aren’t likely to default now, the trustees say. So there’s no real public use justification for the eminent domain plan, which is therefore a violation of the Takings and Contracts Clauses.

Moreover, they argue, Richmond’s plan gives selected homeowners (and MRP) a windfall at the expense of out-of-state MBS noteholders. By agreeing to refinance the mortgages of one particular group of homeowners, the trustee complaints argue, Richmond is violating the Equal Protection Clause – and harming all of its other residents, who will subsequently face higher mortgage costs from lenders and MBS investors reluctant to bear the increased risk of mortgages on property in Richmond. The city is also violating the Commerce Clause, the trustees argue, by protecting local interests and impairing out-of-state MBS trusts, thus interfering with the nationwide housing market. If Richmond is permitted to proceed with its test-case eminent domain seizures, the Wells Fargo complaint said, other cities will follow Richmond’s lead, damaging MBS trusts to the collective tune of billions of dollars and inflicting harm on the whole residential real estate market.

“This wealth transfer from the RMBS trusts and their beneficiaries to MRP, local governments and select homeowners would seriously adversely impact the national housing market,” the Wells complaint argued.

MRP has been hearing these or similar constitutional arguments for more than a year, and legal advisor Hockett told me Thursday that the company has responses to all of them. (Hockett said he didn’t know if he’d be representing MRP in court and MRP didn’t answer my query about who its outside counsel would be in the trustee cases, simply emailing a comment that the complaints are without merit and a waste of MBS trust assets.) MRP will have a nearly impossible time persuading any of the big firms with marquee appellate groups to represent it, considering the broad opposition to its eminent domain plan from the financial institutions in the Am Law 100’s client base. It’s a much better bet that we’ll see additional big firms enter this fight on behalf of other MBS trustees, such as U.S. Bank and Wilmington Trust, or with amicus briefs for industry groups that oppose eminent domain.

Before we get to the constitutional questions, though, a federal judge in California will have to decide if now is the time to hear them. And just when I thought MBS litigation was winding down!

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This is easily a declaratory judgement case looking for a permanent injunction.

Once the city sent the letters making the demand – and setting a very short deadline for response and made the threat of eminent domain, the threatened harm is imminent enough for the declaratory judgment. To tell the plaintiffs to wait until the city tries to seize the loans under the ‘quick take’ provision of CA law would

(1) put the jurisdiction of the Federal Ct in conflict with the state courts which would be hearing the eminent domain case; and

(2) force the plaintiffs to litigate 624 cases (as of now) vs one — a huge burden on the plaintiffs.

And the city’s legal theory is based upon the drivel from Hockett as Cornell (the guy really needs to go to some small town and jsut do divorce law – he is embarassing as a legal scholar.)

8:42 pm UTCI read Hockett’s articles.

Now I’m a retired litigator – specialized in fed lit and am very well-versed in land use law and con law.

Hockett’s work relies upon some string citations that do NOT in anyway support his theory. Every case he cites claiming that eminent domain was used to solely seize some personal property has NOTHING to do with what he claims it does.

NOT one case he cites has anything to do with solely seizing personal property through eminent domain. The cases all involve (a) stockholder and corporate law or (b) the interpetation of a contract and whether mechanics liens remained in place or (c) changing a statue underwhich bondholders or policy holders purcashe a bond or policy from the government or (d) the seizure (temporary or permanent) of land and extinguishing any collateral claims on the land (easements.)

If a young associate lawyer had handed me such a bogus piece of work, he/she would have been put to merely filling in standard document forms for transactions. Piece of total incompetency – the kind of thing that lands one with sanctions from the court and the other side’s attorney fees.

Posted by onthelake | Report as abusive

onthelake …

Perhaps you need a legal refresher having been retired a while:

“(1) put the jurisdiction of the Federal Ct in conflict with the state courts which would be hearing the eminent domain case” Conflicts between state laws and Federal laws are common bases of actions. If it is a Constitutional issue, the federal court ruling prevails. If the MBS holders lose in state court, they can appeal in federal court if they can show a federal issue. However, I would see them filing their suit in federal court based on the Constitutional issue they seem to raise. In the state court, they would be respondents and in that court only to avoid a default judgment (and to establish points of appeal).

“(2) force the plaintiffs to litigate 624 cases (as of now) vs one — a huge burden on the plaintiffs.” Several US Supreme Court rulings say that is not germane regarding whether it is one case or 624. The criteria to sort that out based on Supreme Court rulings are the same as with the rulings regarding requirements for class action status … is each situation sufficiently the same so as to constitute in total a single issue or is each mortgage/property sufficiently unique as to raise different resolutions (e.g., amount of damages). The former argues for a unified case; the latter argues for 624 cases. The practicality of litigating 624 cases or their cost is not a relevant factor per the Supreme Court.

The Supreme Court already has ruled that eminent domain can be used where the “public purpose” primarily benefits a private party and the government/public benefits only indirectly.

I’m not saying the case suggested by Hockett would prevail … I gave up long ago predicting court rulings … but it has enough merit to go to trial if the MBS holders want to fight the action. I’d be surprised if the federal district court granted a declaratory judgment at this stage. Clearly there is more to come in this matter; I doubt the city and the MRP were bluffing in their threat to use eminent domain if their offer were not accepted or some other resolution attained (I’d counter with the outstanding mortgage balances with a settlement goal of not less than 100% of the fair market value of the properties).

The tax effect on the investors is not germane (and one could argue that the offer includes a notional gross-up for any tax effects). Most of these funds pass on gains/losses to the investors for personal income tax reporting. If the properties are seized, the investors likely have a tax loss that can offset other income.

You may disagree with Hockett (and the idea of using eminent domain in this circumstance), but the arguments on both sides are based on law and precedent and, should eminent domain action occur, are appropriate for trial. They are not on either side spurious as this will probably be a case of first impression; I am not aware of this situation being litigated previously.

Posted by griinincat | Report as abusive