Eminent Domain and Fair Market Value in a Depressed Real Estate Market (2014)

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40 loss. They should not be left bankrupt and unable to purchase a comparable home. In addition, negotiated settlements considering the grantor’s negative equity situation were completed to reduce court and litigation costs in the number of condemnations going to court. The Idaho Transportation Department stated that it had voluntarily paid more on a case by case basis but that no policy had been established. The Wisconsin Department of Transportation advised that it had done so pursuant to the federal waiver program, discussed in Section X.B, for those property owners who qualify. X. TAKINGS OF MORTGAGED PROPERTY WITH NEGATIVE EQUITY A. Introduction In condemnation proceedings all tangible and intangible property interests must be satisfied, including the balance due under a mortgage secured by the property.460 Depending on how a state statute defines an owner a mortgagee may be considered to be an owner and have an interest in the collateral for purposes of eminent domain.461 If the statute requires encumbrances to be joined, the mortgagee is a necessary party. Statutory definitions of “land” and “real estate” often provide that these terms must include lands, tenements, hereditaments, and “all rights therein, equitable as well as legal.” Under such a definition, the word “owner” has been construed to include a mortgagee.462 If state law conveys a defeasible title to property subject to a mortgage, the holder of the mortgage has to collect directly from the condemnor.463 However, if state law requires a mortgagee to take possession of the property before the mortgagee receives title to the property, the mortgagee must collect from the owner or mortgagor rather than the condemnor.464 When mortgaged property is taken by eminent domain, the mortgagee’s rights against the land follow the award in equity, and he or she may, in suitable proceedings, have the mortgage debt satisfied out of that fund in advance of other creditors of the mortgagor or of an assignee of the award.465 Although the existence of a mortgage does not affect the valuation of a property, a mortgage occasionally is an indicator of a condemned 460 See 2 Nichols on Eminent Domain § 5.03[1]. 461 See id. § 5.03[6][c]. 462 Id. 463 See id. 464 See id. 465 See id. property’s value.466 When property is taken in its entirety and the condemnation award is for more than the amount due under the mortgage, a mortgagee is entitled to the full amount due under the mortgage.467 If the condemnation award is for less than the amount due under the mortgage, a mortgagee is entitled to the amount of the condemnation award less taxes.468 For partial takings of property subject to a mortgage there are two approaches. One is that if the mortgagee forecloses on the remainder of the property the mortgagee has a claim to the condemnation award up to the amount of the mortgagee’s deficiency judgment.469 The second approach is that a “mortgagee is entitled to as much of the compensation awarded as the amount due on the mortgage bears to the value of the entire mortgaged premises before the taking.”470 B. Calculation of Replacement Housing Payments and FHWA’s Waiver of 49 C.F.R. Section 24.401(b)(1) Under the URA,471 a homeowner who qualifies as a 180-day homeowner-occupant may receive a Replacement Housing Payment (RHP). Under Section 24.401(a), a displaced person is eligible for a RHP when the homeowner-occupant “[h]as actually owned and occupied” the dwelling from which he or she is being displaced “for not less than 180 days immediately prior to the initiation of negotiations” and the displacee “[p]urchases and occupies a decent, safe, and sanitary replacement dwelling within one year after the later” of two dates specified in 49 C.F.R. Section 24.401(a)(2) (that may be extended for a one year period for good cause).472 The purpose of the RHP 466 See id. § 12D.02[4] but see In re John Jay College of Criminal Justice of the City University of New York, 74 A.D.3d 460, 461 (2010) (holding that “[t]he amount of the mortgage loan, with interest at 18½%, did not nec- essarily reflect the value of the property” and therefore excluding the evidence of the loan). 467 See 4 Nichols on Eminent Domain § 12D.02[4]. 468 See id. 469 See id. § 5.03[6][c][i]. 470 See id. “[T]he mortgagee has a claim upon the award to the extent necessary to satisfy the entire amount of the mortgage.” Id. § 12D.02(4). 471 Uniform Relocation Assistance and Real Property Acquisition Policies for Federal and Federally Assisted Programs Act of 1970, 42 U.S.C. §§ 4601-4655 (2000). 472 The dates specified are the later of the date the displaced person receives final payment for the dis- placement dwelling or, in the case of condemnation, the date the full amount of the estimate of just compensa-

41 under the URA is to assist homeowner-occupants bridge the “gap between the just compensation they are constitutionally entitled to receive for the acquisition of their property and the additional costs they may incur to obtain a comparable replacement property.”473 The amount of the payment may not exceed $22,500 and is calculated as provided in Sections 24.401(b) and (c). With some adjustment for interest and other costs, Section 24.401(b)(1) provides that the payment is the sum of “[t]he amount by which the cost of a replacement dwelling exceeds the acquisition cost of the displacement dwelling, as determined in accordance with paragraph (c) of this section….” On November 10, 2010, FHWA issued a temporary waiver of Section 24.401(b)(1) and the “methodology for calculating [RHP] for displaced homeowner-occupants” that has been extended through December 31, 2014.474 The waiver was issued in response to state agencies being confronted with the “prospect of displacing homeowner-occupants who hold negative equity in what is commonly referred to as ‘upside-down’ mortgages….”475 FHWA’s memorandum regarding the waiver notes that an administrative settlement negotiated to acquire a property for a federally assisted project may eliminate a homeowner-occupant’s RHP benefit. As the Michigan Department of Transportation’s memorandum of 2009 notes, “an Administrative Settlement can be used to increase the acquisition amount to pay off the negative equity balance.”476 The FHWA waiver is intended to “ensure that homeowner-occupants receive the assistance needed to relocate to a comparable replacement dwelling.”477 Usually the RHP calculation is based on the amount finally determined and paid as just compensation for the property. Because of the waiver, however, the RHP calculation is based on tion is deposited in the court or the date the displacing Agency’s obligation under § 24.204 is met. 49 C.F.R. § 24.401(a)(2)(i) and (ii). 473 FHWA Memorandum, dated Sept. 25, 2012, Tem- porary Waiver of Methodology for Calculating Replace- ment Housing Payment for Negative Equity, at 1, here- inafter referred to as “FHWA Waiver Memorandum.” 474 Id. 475 Id. 476 Michigan DOT, Memorandum, dated June 30, 2009, Request for Approval of Policy Implementation. 477 FHWA Waiver Memorandum, supra note 473, at 1. the “appraisal-based just compensation in the amount in the original offer, even though the final just compensation amount may have been increased through an administrative settlement that takes into account the amount by which the mortgage/lien balance exceeds the fair market value of the property acquired.”478 The FHWA waiver only applies to those homeowner-occupants who have a negative equity position in the property taken. For a state to make use of the waiver a state DOT must make certain findings, one of which is “that the homeowner-occupants bought their homes during the times of rapidly increasing home values” and that while in a negative equity situation they are not in default of their payment-obligations under the mortgage. Furthermore, a state DOT must “[e]nsure that a homeowner-occupant with negative equity has not received and has not applied to receive mortgage debt relief or [a] mortgage reduction” so that the homeowner- occupant does not receive a “windfall.”479 A state DOT is not obligated to use the waiver.480 However, if a state DOT does voluntarily choose to use the waiver, its use is subject to approval by FHWA.481 “[The] FHWA does not give carte blanche authority to increase the Just Compensation offer because a mortgage is upside down. [The] local agency must document and justify the settlement.”482 If a state DOT chooses to implement the waiver it must “[e]nsure [that] use of the waiver will not reduce any assistance or protection to the homeowner;” “[m]ake a public interest finding that clearly demonstrates that the proposed process for use of the waiver is fair and equitable;” “[e]nsure [that] the State DOT’s procedures…justify administrative settlements and obtain adequate title, in accordance with its FHWA approved 478 Id. at 2. 479 Id. 480 Memorandum from Nelson Castellanos, Dir. of Real Estate Serv., to Division Administrators on the Temporary Waiver of Methodology for Calculating Re- placement Housing Payment for Negative Equity (Oct. 9, 2012), hereinafter referred to as “Castellanos Memo- randum,” available at http://www.fhwa.dot.gov/real_ estate/practitioners/uniform_act/relocation/tempwaiv 12.cfm). 481 Id. 482 Von Klug, The Downturn in the Real Estate Mar- ket: Positive and Negative Impacts (undated), at 9, here- inafter referred to as “Von Klug,” available at: http://www.irwa67.org/newsletter/pdfs/VonKlugPresent ation.pdf.

42 Right-of-Way Manual, will apply to the use of the waiver;” and “[e]nsure that a homeowner- occupant with negative equity has not received and has not applied to receive mortgage debt relief or mortgage reduction to ensure that a windfall is not realized as a result of a negative equity waiver negotiated settlement.”483 The waiver has positive and negative aspects. The positive aspects of the waiver are that the waiver provides a “clear direction on how to use administrative settlement and Last Resort Housing” and provides “clear authority to use Administrative Settlement and [Last Resort Housing] to solve upside down mortgages.”484 The negatives are that a “person [who] does not have negative equity but did lose equity” may not receive the same treatment or waiver benefits and after the real estate market returns to a normal one “[state] agencies must be able to get back to the old way of doing business.”485 Several states have implemented the waiver including California,486 Nevada,487 Ohio,488 Washington,489 and Wisconsin.490 Some state DOTs have provided training on how to 483 Castellanos Memorandum, supra note 480; see Letter from Daniel M. Mathis, Division Administrator, to Ms. Paula J. Hammond, Sec’y of Transp., Washing- ton State Dep’t of Transp. (Nov. 23, 2009), hereinafter referred to as “Mathis Letter,” available at: http://www.wsdot.wa.gov/NR/rdonlyres/31A37942-237F- 47CD-86AE-77CB1D522122/0/ProgWaiver.pdf) (discussing the implementation of the 2009 version of the Waiver before it was extended until Dec. 31, 2014). 484 Von Klug, supra note 482. 485 Id. at 17. 486 Memorandum from the California DOT, Div. of Right of Way & Land Surveys on Extension and Im- plementation of Temporary and Programmatic Waiver (Apr. 8, 2011), available at http://www.dot.ca.gov/hq/ row/rap/RARF2011-01.pdf). 487 Paul A. Saucedo, Chief Right of Way Agent, Ne- vada DOT, Negative Equity, Hardship Acquisitions & PISTOL, hereinafter referred to as “Saucedo,” available at http://rightoffway.transportation.org/Documents/ Session%2023%20-%20Saucedo%20AASHTO% 20Conference.pdf (last visited Nov. 18, 2013). 488 Letter from James J. Viau, Administrator on Negative Equity, Temporary Programmatic Waiver of Section 5501:2-5-04(A)(2(a) of the Ohio Administrative Code (July 30, 2009), available at http://www.dot.state. oh.us/Divisions/Engineering/RealEstate/Administrator %20Corner/07%2029%202009%20Relocation%20Consul tant%20Letter%20RE%20Negative%20Equity.pdf). 489 Mathis Letter, supra note 483. 490 Response of Wisconsin DOT. adequately implement or apply for the waiver.491 Michigan has initiated additional procedures because of Michigan law requiring that when an individual’s principal residence is acquired the amount of just compensation must be 125 percent of the property’s fair market value.492 Three transportation departments responding to the survey reported that they specifically had developed or revised eminent domain policies on the valuation of property because of the effect of the depressed real estate market.493 The states’ policies concern takings of residential property with negative equity. The California Department of Transportation reported that [o]n a case by basis, it was the policy of the Division of Right of Way to address the Negative Equity scenario for residential properties by compensating the land owner for the property’s Fair Market Value (FMV) and the difference between the FMV and the amount of the mortgage. This was not addressed on the valuation (appraisal) of the grantor’s property but on the final negotiated settlement of just compensation. In addition to the Relocation Assistance program the replacement Housing Valuation was calculated from the FMV and not the final negotiated settlement amount. As the Connecticut Department of Transpor- tation explained: In situations where homeowners have negative equity in the property being acquired, through no fault of their own, we have used our Administrative Settlement process as a means to address the gap between the appraised value and the debt owed. We have also applied the Federal Highway Administration’s Temporary Waiver of 49 C.F.R. 24.204(b)(1) to the calculation of replacement housing payments (RHP) for 180-day homeowner occupants in negative equity situations. The other departments responding to the survey stated that they had not developed new policies or revised existing policies because of the financial crisis affecting real property values.494 491 See, e.g., Saucedo, supra note 487. 492 Michigan DOT, Memorandum, dated June 30, 2009, Request for Approval of Policy Implementation. 493 Responses of California DOT, Connecticut DOT, and Wisconsin DOT. 494 Arizona DOT; Arkansas State Highway and Transportation Department (stating that “[n]o policies were developed; however, it was determined that no time adjustment would be made in the comparable sales approach appraisals during that period of time, as ap- plied to multiples sales”); Florida DOT; Idaho Transpor- tation Department; and Oregon DOT.

43 C. The Use of Eminent Domain to Take Underwater Mortgages 1. The Use of Eminent Domain to Acquire Underwater Mortgages at Fair Market Value In 2008 several law professors separately argued that the federal government should use its power to purchase underwater mortgages.495 Since 2008, two scholars have argued that state and municipal governments should use the power of eminent domain to acquire underwater mortgages, particularly those held either in bank portfolios or by securitization trusts.496 Robert Hockett notes that banks already have the power to curtail the principal balance of loans secured by mortgages but argues that state and municipalities should use their power of eminent domain to take underwater mortgages that are held in private label securitized (PLS) trusts.497 Hockett and John Vlahoplus state that [m]any of the pooling and servicing agreements (PSAs) pursuant to which most [PLS] loans are securitized prohibit or otherwise prevent the trustee or loan servicer from modifying or selling underwater loans in sufficient number. The same agreements typically require unanimity or supermajority voting among holders of mortgage-backed securities (MBSs) in order to change these rules, which in any event would be severely limited by income-tax-law limitations on trust activities.498 Hockett argues that the use of the power of eminent domain would avoid the burdensome contractual terms of the PLS trusts that prevent their modification.499 He argues that, using their traditional eminent domain powers, “states and/or their municipalities can purchase underwater mortgage loans from private label securitization trusts at fair value.”500 495 Hockett and Vlahoplus, supra note 164, at 266. 496 See id. See also Robert Hockett, It Takes a Village: Municipal Condemnation Proceeding and Pub- lic/Private Partnerships for Mortgage Loan Modifica- tion, Value Preservation, and Local Economic Recovery, 18 STAN. J. L. BUS & FIN. 121, 124-5 (Fall 2012); Robert Hockett, Paying Paul and Robbing No One: An Eminent Domain Solution for Underwater Mortgage Debt, CURRENT ISSUES IN ECONOMICS AND FINANCES, at 4 (June 19, 2013), hereinafter referred to as “Hockett, Paying Paul,” available at http://www.newyorkfed.org/ research/current_issues/ci19-5.pdf. 497 Hockett, Paying Paul, supra note 496, at 3, 4. 498 Hockett and Vlahoplus, supra note 164, at 260. 499 Hockett, Paying Paul, supra note 496, at 4. 500 Id. The writers note that “the power of eminent domain applies to all manner of intangible assets” including…mortgage loans and liens….”501 Some industry groups have threatened to take action against municipalities that use eminent domain to acquire underwater mortgages.502 The Securities Industry and Financial Markets Association (SIFMA) and eleven associations wrote to Congress to oppose any such eminent domain programs503 and to support proposed legislation entitled the Defending American Taxpayers from Abusive Government Takings Act of 2013 that would punish communities using eminent domain to acquire underwater mortgages.504 2. Federal Court Cases Against the City of Richmond, California On August 7, 2013, in Wells Fargo Bank, National Association v. City of Richmond, the plaintiffs Wells Fargo Bank and Deutsche Bank filed a complaint on behalf of their investors for declaratory and injunctive relief against the city of Richmond, California, and Mortgage Resolution Partners LLC (MRP).505 The plaintiffs claim that the city of Richmond and MRP have a plan to take mortgages through Richmond’s power of eminent domain, hereinafter referred to as the “Richmond Plan.” The plaintiffs allege that if the plan were allowed to go forward their investors would be 501 Hockett and Vlahoplus supra note 164, at 270 (cit- ing Louisville Joint Stock Land Bank v. Radford, 295 U.S. 555, 602 (1935) (“If the public interest re- quires…the taking of property of individual mortgagees in order to relieve the necessities of individual mortga- gors, resort must be had to proceedings by eminent do- main.”); W. Fertilizer & Cordage Co. v. City of Alliance, 504 N.W.2d 808, 816 (Neb. 1993) (holding that a mort- gagee’s lien on real estate is an interest that may be subjected to a taking for a public purpose and, therefore, may be the subject of an eminent-domain proceeding)). 502 Id. at 271–74. 503 SIFMA, SIFMA and Other Associations Submit Comments to Congress Opposing the Use of Eminent Domain to Acquire and Refinance Underwater Mort- gage Loans, July 22, 2013, available at http://www.sifma.org/issues/item.aspx?id=8589944483. 504 Id. 505 Complaint for Declaratory and Injunctive Relief at 1-9, Wells Fargo Bank, National Association v. City of Richmond, (N.D. Cal. 2013) (No. C 13-03663 CRB), hereinafter cited as the “Complaint,” available at: http://www.cand.uscourts.gov/pages/1020.

44 irreparably harmed financially; thus, they sought declaratory and injunctive relief. The plaintiffs’ complaint alleges that the Richmond Plan violates the United States and California Constitutions because the takings would not be for a public use, would violate the prohibition against extraterritorial seizures, and would not provide the plaintiffs with just compensation.506 It is alleged that the Richmond Plan has no public purpose, because it would seize property from private entities, the plaintiffs, and transfer it to MRP and its private investors, thereby conferring “private benefits on a select set of individuals.”507 The plaintiffs claim that the seizures of the mortgages would be extra- territorial, because the mortgages and the underlying notes are held in trusts outside the city of Richmond and because “the situs of a debt for eminent domain is deemed to be the location of the creditor.”508 The plaintiffs argue that the Richmond Plan would violate the Commerce Clause of the United States Constitution, because the plan would have the effect of regulating the national residential mortgage-backed securities market and cause substantial losses to trusts holding the loans around the nation.509 The plaintiffs contend that the city’s plan violates the Contracts Clause of the federal Constitution, because the program would nullify the trusts’ rights to obtain the payments they bargained for and the trusts would have to accept significantly lower payments instead. Finally, the plaintiffs also argue that the program violates the Equal Protection Clause of the United States and California Constitutions.510 The U.S. District Court for the Northern District of California dismissed the plaintiffs’ motion for a preliminary injunction in a relatively brief order, because the plaintiffs’ claims were not ripe in that they were based upon “future events that may never occur”511 and denied the plaintiffs’ request for leave to amend their complaint.512 506 Id. at 10-1. 507 Id. at 33, para 100. 508 Id. at 35, para 110. 509 Id. at 37, para 120, 121. 510 Id. at 42, para 143. 511 Wells Fargo Bank, National Association v. City of Richmond (N.D. Cal. 2013) (No. C 13-03663 CRB), Or- der Granting Defendants’ Motion to Dismiss and Deny- ing Plaintiffs’ Motion for a Preliminary Injunction, at 1, available at: http://www.cand.uscourts.gov/pages/1020. 512 Id. at 2, n.3. Nearly 2 months after the Wells Fargo case was dismissed, the U.S. District Court for the Northern District of California dismissed a similar case brought by the Bank of New York Mellon against the city of Richmond and MRP.513 Again, the court held that the plaintiffs’ case was not ripe, because it was based upon events that may not occur.514 In their complaint in Wells Fargo Bank, the plaintiffs refer to statements by the Federal Housing Finance Administration (FHFA) and the United States House of Representatives Financial Services Committee, both of which commented on the consequences of local governments using eminent domain to seize mortgages.515 FHFA expressed concern that the programs “could negatively affect the extension of credit to borrowers seeking to become homeowners and on investors that support the housing market,” as well as harm taxpayers.516 FHFA acts as a conservator of Fannie Mae and Freddie Mac and therefore must act to preserve and protect their assets and to minimize costs to taxpayers.517 If eminent domain programs were to be used nationwide, Fannie Mae and Freddie Mac allegedly could lose up to 30 percent “in their private-label residential mortgage-backed securities held in their portfolio” that would put tax revenues at risk.518 It is claimed that eminent domain programs such as the Richmond Plan would decrease homeowners’ ability to borrow in the future, because lenders may be wary that a loan contract would be broken by the government.519 If the Defending American Taxpayers from Abuses Government Takings Act were to be enacted it would prohibit Fannie Mae and Freddie Mac from purchasing mortgage loans in counties 513 Bank of N.Y. Mellon v. City of Richmond, 2013 U.S. Dist. LEXIS 159183 at *2-3 (N.D. Cal. Nov. 6, 2013). 514 Id. at *5. 515 Complaint, supra note 505, at 30. 516 Use of Eminent Domain to Restructure Perform- ing Loans, 77 Fed. Reg. 47652 (Aug. 9. 2012). 517 Id. 518 John Campbell, Release: Campbell Reintroduces Bill to Protect Taxpayers from Eminent Domain Schemes and Taxpayers from Abusive Government Tak- ing Act, available at http://www.campbell.house.gov/ press1/release-campbell-reintroduces-bill-to-protect- taxpayers-from-eminent-domain-schemesan-taxpayers- from-abusive-government-takings-act/. 519 Id.