Today I want to focus on whether the plan to seize underwater mortgages through eminent domain is legal. Getting into this topic, in my view the debate should not focus on whether this plan passes constitutional muster at the federal level.  I’ve seen much written on this subject, but I really think this is a red herring, and that the answer is pretty easy.   While others disagree, I believe the plan passes constitutional muster at the federal level.

The U.S. Supreme Court has issued a long line of cases that all make pretty clear that the government could constitutionally condemn underwater mortgages.  The now-infamous 2005 Kelo decision provides some good clues that this is the case.  But one can also look to even more direct precedent, such as the 1984 decision in Hawaii Housing Authority v. Midkiff.

In Midkiff, the Court approved of a plan even more extreme than this one.  It allowed the State of Hawaii to condemn properties for the purpose of selling them to individuals who owned homes on them.  There, the problem was that a few owners owned vast amounts of property, including many residential areas.  And unlike most parts of the country, when someone purchased a home in those areas, they did not acquire the land on which the home was built.  Instead, they acquired the home itself, along with a long-term lease of the land.

By approving Hawaii’s plan (in an 8-0 unanimous decision, no less), the Court affirmed the transfer of these property rights from one private owner to another, so long as there was some public purpose for the plan.  The Court explained this limitation:  “[O]ne person’s property may not be taken for the benefit of another private person without a justifying public purpose, even though compensation be paid.”

Here, there can be little doubt that the underwater-mortgage plan arises from a “justifying public purpose,” and I expect that it would pass constitutional muster.  Note again that not everyone agrees with this view.  One example is a July 2012 Special Alert authored by a group of attorneys at Dechert titled California County Considers Using Eminent Domain to Seize Underwater Mortgages.  They conclude that the plan fails because (1) it does not provide for just compensation, (2) it does not possess a sufficient public use, and (3) it may violate the Commerce Clause.

While I think these arguments (and others) will be made, ultimately I think agencies will survive right to take challenges as long as they work carefully to craft their public use findings, making clear the larger public goals being pursued by the plan.  On the other hand, if agencies get lazy with their findings, and if it appears that the main purpose of the condemnation is to benefit the property owner whose mortgage is being acquired, courts will likely conclude that the public use test has not been met.

(For anyone who really wants to puzzle over these federal constitutional issues, my colleague Ben Rubin pointed out to me that while Justice O’Connor wrote the majority opinion in the Midkiff case, she penned a strong dissent in Kelo.  Have fun reading those tea leaves.)

Assuming for a moment that I am right about the federal constitutional issue (i.e., that the plan, if properly implemented, does not violate the Constitution), this does not end the inquiry.  In fact, I think that the people who have framed the key legal issue as one of federal constitutional law have missed the mark.

Specifically, I think the far more interesting question is whether the plan complies with state law.  And this is no easy question given the nationwide eminent domain reform effort that followed the Kelo decision.

Since 2005, many states have passed laws designed to protect homeowners from eminent domain and, in particular, eminent domain that would involve the transfer of private property to another private owner (as opposed to a government owner).  Ironically, those very laws designed to help protect homeowners may now present legal obstacles to the underwater mortgage plan.

For example, in California voters approved Proposition 99 in 2008, and the Legislature passed a number of moderate reforms in 2006 and 2007.  It’s pretty clear that nobody was thinking about a plan to seize underwater mortgages when those new laws were adopted, but looking at them, they could raise concerns for proponents of the plan.

Indeed, the Dechert attorneys also conclude the plan violates California law, explaining that the proposed takings likely exceed the local agencies jurisdiction because the mortgages are “located” outside the territorial boundaries of the agencies, and because the proponents would be be able to make the requisite public use and necessity showing.

More fundamentally, condemnations that involve the transfer of property from one private owner to another typically involve findings of blight and proceed pursuant to powers granted to redevelopment agencies.  As we have been discussing all year, California’s redevelopment agencies have all been dissolved, making these types of condemnation actions impossible.  This could prove a significant hurdle to the underwater mortgage plan in California.

For anyone who wants to explore the California law on these issues a bit more closely, the 1982 California Supreme Court decision in City of Oakland v. Oakland Raiders provides a pretty detailed discussion of (1) condemning intangible rights, (2) condemning property and transferring it to a private party, and (3) the application of the territorial limitations of condemnation to intangible property, among other relevant topics.  There, the Raiders obtained a summary judgment ruling that the City of Oakland lacked the power to condemn the Raiders franchise, but the Supreme Court reversed, allowing the case to proceed on the merits of whether the City could establish a legitimate public use to support such a taking. 

Aside from California, other states have also passed reforms in the wake of Kelo, some more narrow, but some significantly more far-reaching than California’s.  These laws will likely become the focus of the legal battles over the underwater mortgage plan, not the federal constitutional questions that are currently getting far more publicity.

In sum, while I think the plan will survive scrutiny under the federal constitution, it may not fare so well under the various state laws, including California’s.

The next post will focus on whether the plan is likely to succeed if it proceeds, and what unintended consequences could result from the plan’s implementation.