Saturday, July 14, 2012

San Bernardino County's Proposal to Use Eminent Domain to Acquire and Restructure Private Loans

The controversial plan to rescue the real estate market in San Bernardino County, California, has gained national attention. The dispute is centered on the use of the power of eminent domain to acquire mortgage loans on homes that are underwater (loan balance greater than market value of the property.)  Since the real estate bubble burst, the County of San Bernardino, part of what is known as the Inland Empire area of southern California, has experienced a foreclosure rate much higher than the national average.  Enter Mortgage Resolution Partners (“MRS”), a private investment firm based in San Francisco, which has been shopping around a solution for the housing crisis. Officials in San Bernardino, arguably facing one of the worst examples of the crisis, are now considering their offer.

Hoping to provide some relief for homeowners in a region that’s filled with abandoned and half-finished projects, San Bernardino local governments are exploring the option of allowing MRS to purchase mortgage loans on homes that are underwater.  The loans would then be restructured, with the goal of allowing the homeowners to keep their homes. In order to use eminent domain power to do this, the cities of Fontana and Ontario and the County of San Bernardino executed an agreement to create a Joint Powers Association. In California, the Joint Exercise of Powers Act, California Government Code § 6500, allows two or more public agencies to jointly exercise a common function.

The program is aimed at certain type of mortgages – those that have been securitized – this means that the loans were consolidated and sold off to multiple private investors. Because of this, these types of loans cannot be renegotiated because there are so many varied and unrelated parties that hold an interest in them.  According to news sources, there are about 150,000 homes in the County of San Bernardino with underwater mortgages, a fifth of which are securitized in this manner.

This unusual use of the power of eminent domain raises some important legal issues.  Article I, § 19, subdivision (a) of the California Constitution states that private property may be taken or damaged only for a "public use".   Subdivision (b) prohibits acquiring an owner occupied residence for the purpose of conveying it to a private person.  California Code of Civil Procedure § 1240.010, part of California's Eminent Domain Law, states that the "power of eminent domain may be exercised to acquire property only for a public use."  In addition, Code of Civil Procedure § 1240.030 sets forth the requirements for exercising the power of eminent domain: (a) the public interest and necessity require the project; (b) The project is planned or located in the manner that will be most compatible with the greatest public good and the least private injury; and (c) the property sought to be acquired is necessary for the project. 

When one thinks of the government acquiring property by way of eminent domain, one tends to think about a traditional public works project, such as a right of way for a bus line or light rail system, a highway widening, a school, police station, etc.  The proposal here is different.  MRP's proposal is to take a private person or entity's loan asset in an owner-occupied residence and sell it to another private investor entity.  One must apply the rules set forth above to see if that plan comports with California's Eminent Domain Law.  There are a number of issues, some of which may be:

      (1) Is MRP's plan a "public use"?  Well, it's not a traditional form of a public project, as listed above (not for a highway, school, etc.) However, the legislative comment to Code of Civil Procedure § 1240.030 states that the term "project" is intended "to apply to any type of public use regardless whether the use is active (requiring construction of an improvement) or passive (requiring appropriation of property in unimproved condition.)"  Whether the MRP plan is a public use will be a source of argument.  It seems to me though that the implication of the term "project" in the code section is for something requiring the physical use of the property, not a lien on the property. 
      (2) Is it permissible for a government entity to take away private property and give it to another private entity?  This will be another big source of argument. There is old case law in California which holds that the government does not have the power to take the property of one and give it to another.  For example, see Gillan v. Hutchinson (186) 16 Cal. 153, 156; Consolidated Channel Company v. The Central Pacific Railroad Company (1876) 51 Cal. 269, 272; Nickey v. Stearns Ranchos Company (1899) 126 Cal.150, 152-153; and Fall River Valley Irrigation District v. Mt. Shasta Power Corporation (1927) 202 Cal. 56, 67.
      (3) Since the loans in question relate to owner-occupied homes, is the proposal barred by subdivision (b) of Article I, § 19 of the California Constitution, which prohibits state and local governments from acquiring by eminent domain an owner-occupied residence for the purpose of conveying it to a private person? I suppose an argument can be made that since these loans relate to owner-occupied homes, the loans cannot be taken and given to another private entity, even though the private residences in question, under the proposal, are to remain with the same owner. (The whole goal of the program is to try to keep owners in their homes.)
      (4) Finally, plenty of arguments can be made about whether the MRP plan satisfies all 3 elements of Code of Civil Procedure section 1240.030, namely that the project is required by public interest and necessity, the project is planned in a manner most compatible with the greatest public good and least private injury, and that the property (i.e. the loans) is necessary for the project.  What do you think?