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Saturday, April 23, 2011

Seeking fairness for the loss of equity

The world of law often establishes guilt, settles disputes or establishes precedents by exploring and proving theories. There is a somewhat obscure and arcane branch of law called equity law. It takes place, when it happens at all, in special courts called chancery courts or in special sessions of the more normal civil courts. Only two states still have formal chancery courts – Mississippi and Delaware. The remainder of the states rolled their equity courts in the common law civil court after the Federal Rules of Civil Procedure were published in 1938. Chancery courts are sometimes appointed by the governor of the state.

The concept of equity that is separate from common law comes to us from our English heritage. In England people found reason to appeal directly to the King for redress of issues that were not dealt with fairly in the courts of common law. The King created Chanceries to hear the pleas of the people for fairness on matters that weren’t dealt with well under Common Law. The idea of appealing for “fairness” is core to the concept of equity in this branch of law.

According to The Free Dictionary by Farlex - In its broadest sense, equity is fairness. As a legal system, it is a body of law that addresses concerns that fall outside the jurisdiction of Common Law. Equity is also used to describe the money value of property in excess of claims, liens, or mortgages on the property.

There is also a concept under the broad heading of equity called waste. This concept is associated primarily with real estate equity in these courts.

Again as defined in The Free Dictionary:

Waste is an unreasonable or improper use of land by an individual in rightful possession of the land. A party with an interest in a parcel of land may file a civil action based on waste committed by an individual who also has an interest in the land. Such disputes may arise between life tenants and remainder persons and landlords and tenants.

The four common types of waste are voluntary, permissive, ameliorating, and equitable waste.

• Voluntary waste is the willful destruction or carrying away of something attached to the property.

• Permissive waste is an injury caused by an omission, rather than an affirmative act, on the part of the tenant.

• Ameliorating waste is an alteration in the physical characteristics of the premises by an unauthorized act of the tenant that increases the value of the property.

• Equitable waste is a harm to the reversionary interest in land that is inconsistent with fruitful use.

I read some about the background and theories that are involved in this peculiar branch of law after a potential client, who happens to be a lawyer, suggested that the concept of waste under the laws of equity might provide the legal umbrella under which successful class action lawsuits might be brought by homeowners who find themselves in positions of greatly reduced home equity due to no fault of their own.

Even though the concept of waste is usually applied towards an owner or a tenant, the theory here is that it can be extended to cover the mortgage holder who certainly is a person with “an interest in the property.” The line of reasoning in seeking redress would be based upon the premise (theory) that certain lenders willfully, knowingly and unfairly engaged in practices that caused a loss of equity for the owner.

There is already some evidence and a few admissions on the part of some lenders that they knowingly (and in some cases fraudulently) made risking loans and then packaged those risky loans together with pools of normal loans and sold the resulting investment instruments without proper disclosure of the risks to unsuspecting investors. When a high percentage of the bad loans went into default the pools themselves went bad and the whole house of cards that was based upon those investments came crashing down. The increased foreclosure rates caused by the bad loans had the effect of pulling down the value of those other homes in the pools, and the rest, as they say, is history – the housing crash and recession followed.

A few of the big lenders even created hedge instruments that allowed them to bet that the bonds for the mortgage-backed pools would fail. So, they made money selling the bonds based upon the pools of mortgage AND they made money by selling bonds (mainly to themselves and friends it would appear) that bet that those mortgage-backed bonds would fail due to high default rates.

Now, supposing that this behavior on the part of the lenders and the resulting loss of equity can be proven to the satisfaction of a chancery court judge (jury trials are not required in these courts, just a hearing in from of a judge or panel of judges) the directed redress from the court might well involve restoring the lost equity to the homeowners, which is usually how equity cases are settled.

Since it is literally impossible to restore the equity, even by court order; the next best solution might be for the court to direct that the lost equity be forgiven by the errant lenders involved and resets of loans to the current equity levels (which their actions caused to happen) should take place. While that is financially painful for the lenders involved, it does have a ring of fairness about it and it is what many experts have been saying needs to be done to get out from under the current cloud of negative equity. The banks aren’t about to do that on their own.

A solution based upon a court of equity decision wouldn’t necessarily apply to all mortgage loans everywhere. There were and are many lenders who did not engage in the practices that led to the crash of home equity. These might be smaller regional banks or credit unions which made mortgage loans and held on to them. They watched in horror, along with their mortgagees, as the home market tanked. They and their mortgagees probably have no chance for redress under actions that might be taken in the court of equity; however, these homeowners might join the class of actual customers of those lenders who caused the problem and claim that their actions tainted the entire mortgage pool and thus impacted their own equity. How that would be redressed is problematical.

So, what, you may ask, is the point of all of this? Well, the tobacco companies were able to thwart the legal efforts of many individuals and some early class action suits until lawyers finally found an argument (a theory) that they could apply across the class of smokers who became cancer victims even after the tobacco companies had plenty of evidence (and lots of juicy internal emails to boot) that their products were a cause of greatly increased risk of cancer for smokers. In other words they knowingly caused waste to the health of their customers. When enough States Attorneys General jumped on that bandwagon the big tobacco companies caved and they settled.

Perhaps the same cause-effect theories can be shown and proven for real estate under the concept of waste by the lenders causing the loss of equity of the homes of mortgage borrowers across America. It’s worth a shot by some good lawyers somewhere. Imagine the juicy emails that would come out of the disclosure process for that Chancery Court hearing.

To read more about this interesting, if somewhat obscure, branch of law just Google “waste and a legal term” and follow the links.

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