Lawsuit Challenges Richmond, CA’s Plan to Use Eminent Domain to Condemn Mortgages

A group of bond investors has filed a lawsuit challenging the California City of Richmond’s plan to use eminent domain to condemn mortgages:

Bond investors including Pacific Investment Management Co. and BlackRock Inc. (BLK) are seeking a court order blocking Richmond, California, and Mortgage Resolution Partners LLC from seizing mortgages through eminent domain, saying the initiative would hurt savers and retirees.

The city’s plan is unconstitutional, according to a complaint filed today by mortgage-bond trustees in federal court in San Francisco. The trustees, Wells Fargo & Co. (WFC) and Deutsche Bank AG, were directed to take the action by investors in the debt that also include Jeffrey Gundlach’s DoubleLine Capital LP, said John Ertman, a partner at Ropes & Gray LLP….

The plan advanced last month with Richmond backing offers to buy 624 loans, making it the first city to push the idea so far forward. Those offers would need to be refused before the city could follow through with its mayor’s vow to invoke its potential powers to force sales of the mostly non-delinquent loans, so that homeowners could get their debt balances cut to less than the current values of their properties…

The plan is also discriminatory because it targets only certain loans, the trustees alleged. It violates California and U.S. constitutional protections against impairing private contracts and the taking of private property for public use without just compensation, according to the complaint.

I criticized the Richmond plan on policy grounds here. In a later post, I explained why the plan is likely unconstitutional because the compensation the city proposes to pay falls below the “fair market value” standard required by the Fifth Amendment’s Just Compensation Clause. The news report quoted above seems to say that this is one of the causes of action advanced by the bond investors in their lawsuit. However, I haven’t yet seen a copy of the complaint, so don’t yet know exactly what their claims are. If time permits, I will try to write a more detailed post once I get the complaint and have had a chance to study it.

UPDATE: I have now read the complaint. It does indeed raise the just compensation argument referred to above, along with several other claims. Because the city has not yet actually tried to condemn any of the mortgages in question, it’s possible that the lawsuit will be dismissed on procedural grounds, such as ripeness. But if the court reaches the merits, this claim has a good chance of prevailing. The complaint also argues that the takings are not for a “public use,” as required by the Fifth Amendment, because the official rationales of improving the local economy and helping distressed homeowners are mere “pretexts” for a scheme to use eminent domain to enrich private parties, especially Mortgage Resolution LLC, which is organizing private buyers for the mortgages threatened with condemnation. As I have suggested previously, I think the public use argument will be a tough sell under Kelo v. City of New London, which allows government to condemn property for almost any reason.

However, Kelo does still state that “pretextual” takings are unconstitutional. And post-Kelo jurisprudence on the meaning of pretext is deeply divided. At least five different interpretations of the concept have emerged in various state and federal courts. Thus, it is possible that the plaintiffs will win this claim, though I don’t consider it the most likely result. But they do have a much stronger argument on just compensation, where it is pretty clear that the City is planning to pay far less than the fair market value of the mortgages, as required by Supreme Court precedent.

As regular VC readers know, I believe Kelo was itself wrongly decided, and hope that the Supreme Court will eventually overrule it, especially in light of Justice John Paul Stevens’ admission that his majority opinion for the Court was partly based on a significant error in the interpretation of precedent. Unless and until that happens, however, lower courts will have to obey Kelo and continue to try to figure out what qualifies as a “pretextual” taking.

UPDATE: I have posted a copy of the complaint (which is unusually long and detailed) here. As is usually the case, the complaint has few citations to precedent and other types of legal arguments. These are generally saved for later briefing. Nonetheless, the complaint does give a very thorough listing of the many arguments the plaintiffs are making (not all of which have to do with the Takings Clauses of the state and federal constitutions).

UPDATE #2: A second, separate, complaint filed by Bank of NY Mellon, is available here.