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Being Creative with Condemnation

Several of the blogs we have posted have addressed different aspects of the law of condemnation (read here, here, and here).  This law addresses the power of eminent domain – the ability of the government to take private property.  Although the government has this right, it is qualified by, among other things, both the Oregon Constitution Article I, Section 18 and the U.S. Constitution’s Fifth Amendment, which provide that the government may exercise this right only upon paying “just compensation” for the property being taken.

Typically the traditional purpose of condemnation is to acquire property for public projects like roads and sewers.  However, it has also been used in a not so traditional way to acquire property that the condemning government may convey – i.e. “flip” – to private developers for purposes of redeveloping property.  Many of the urban renewal efforts have used the power of eminent domain to acquire “blighted” properties in order to include them in economic redevelopment projects.  This approach to economic development has been used for generations, but for many it was under the radar until it was addressed in the U.S. Supreme Court case of Kelo v. City of New London.  In Kelo, the facts aligned where the taking was of property owned by an elderly lady who had no interest in selling her property and wished to live out her days in her home.  However, the City of New London, Connecticut had a different plan for her property – it should be redeveloped along with other properties in order to boost the economic development of that area of the city.  Since the owner was unwilling to sell to the developer, the city would use its eminent domain powers to acquire her property and then convey it to the developer to be included in the larger redevelopment project.  Although this was nothing new, when the U.S. Supreme Court ruled the city was well within its authority to use its powers in this fashion there was public outrage across the country and many states passed legislation under public pressure that would not allow a government to use condemnation to acquire property that would then be conveyed to a private developer.  In Oregon the issue was placed on the ballot by an initiative which passed by a large margin, resulting in the ORS 35.015 prohibition that a public body may not use its power of eminent domain to acquire private property which it intends to convey to another private party.

CondemnationYou might think the backlash to Kelo would cause public agencies to be more discrete and conservative in utilizing condemnation for non-traditional purposes.  But that isn’t the case, at least in a couple of California jurisdictions, where they have considered using condemnation to acquire not real property itself, but interests in real property in the form of “underwater mortgages.”  This concept was apparently first floated in a Cornell Law School Legal Studies Research Paper authored by Professor Robert C. Hockett.  The idea of these “Mortgage Condemnations” is to condemn underwater mortgages secured by private deeds of trusts.  Only that interest in the property, i.e., the financial instrument, would be condemned, not the property itself.  The beneficiary of the deed of trust, generally a bank, would be paid less than the face value of the performing loan, reflecting the possibility that the property owner would eventually stop paying if the property value remains less than what is owed.  Once the deed of trust was acquired, the condemner would convey this interest in the property to a private entity that would offer the property owners an opportunity to refinance their mortgage for a lower principal amount and more favorable terms, increasing the chance they will stay in their home. 

This proposed approach may have a populist appeal in that it addresses the impact on homeowners of the declining value of residential property.  The concept is that, once the underwater mortgage was acquired, the owner’s loan could then be restructured in a way to allow the owner to stay in their home.  However, it is not necessarily entirely altruistic.  A primary advocate for mortgage condemnations is a private group of investors located in San Francisco, Mortgage Resolution Partners (MRP).  Purportedly MRP would provide to the condemning authority the funds necessary to acquire the underwater mortgage.  The acquired underwater mortgages would be transferred to MRP (or a similar private party), which would then renegotiate terms more favorable to the owner and manage the account.  As with any investor, it is assumed that MRP will get a return on its investment and efforts.

The use of condemnation to acquire underwater mortgages is fraught with issues, primarily the issue of whether it is constitutional.  To see the Points – Counterpoints view of this use of eminent domain, you can visit the web pages of Mortgage Resolution Partners (pro) and the Securities Industry and Financial Market Association (con).  There are also interesting issues concerning how the just compensation would be determined – i.e., what is the fair market value of an underwater mortgage?  However, the constitutional and other legal issues aside, at least in Oregon, given the ORS 35.015 prohibition on the use of eminent domain to acquire private property which is intended to be conveyed to another private party, it is unlikely this use of eminent domain is going to happen.

There is a certain irony that a populist response to the use of eminent domain in Kelo resulted in many cases of restrictions being legislatively imposed on condemnation, while a populist response to the housing crisis is the basis for likely the most “creative” expansion of the use of eminent domain authority since...well...since it was first used to acquire property to be turned over to private parties for redevelopment.

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We regularly update clients about changes in real estate law and on industry trends. This includes briefing clients on legislative proposals in the federal tax, housing and other legal areas affecting their businesses. Staying current enables you to anticipate and prevent legal problems as well as capitalize on new developments.
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