Columbia Law School Center for Climate Change Law: Court Refuses to Dismiss Lawsuit Concerning PACE Program in California

Columbia Law School Center for Climate Change Law


J. Cullen Howe   By J. Cullen Howe, Environmental Law Specialist, Arnold & Porter LLP

A federal court in California recently issued a decision, California ex rel. Harris v. Fed. Hous. Fin. Agency, 2011 U.S. Dist. LEXIS 96235 (N.D. Cal. Aug. 26, 2011), partially denying a motion to dismiss in a case concerning a Property Assessed Clean Energy (PACE) program in the state.  PACE programs allow property owners to obtain loans for energy efficiency retrofits.  More than 20 states and a handful of municipalities have enacted PACE programs in the last several years.

PACE programs reduce the up-front cost of making energy efficiency improvements by allowing owners to borrow the money at a low interest rate to make the necessary energy efficiency upgrades.  The property owners then repay their loans over 15-20 years via an annual assessment on their property tax bill. When the property owner borrows the money, a lien is placed on the property.  These bonds can be issued by municipal financing districts or finance companies.  A PACE lien runs with the land, meaning that if the loan is not fully paid off before the property is sold, the remaining payment obligation passes to the purchaser. PACE programs have been widely touted as an innovative way to improve energy efficiency in existing buildings because it means that property owners do not have to front the money to do so.  They have also proven very controversial.

A key component of a PACE lien is that, like other tax liens, it is senior to any mortgage on the property, meaning that it must be repaid first if the property goes into default.  In May 2010, Fannie Mae and Freddie Mac, apparently concerned about the ability of mortgage holders to pay off their existing loans, issued industry letters to mortgage lenders stating that these liens could not take priority over a mortgage financed by either entity.  In July 2010, the Director of the Federal Housing Finance Agency (FHFA) (the federal agency that regulates Fannie Mae and Freddie Mac) issued a statement, FHFA Statement on Certain Energy Retrofit Loan Programs, that PACE financing would increase homeowner debt burdens and "could create a greater potential for the loss of a home through a tax sale or foreclosure if the consumer cannot meet the extra debt burden."  The statement concluded that first liens created by PACE programs were different than routine tax assessments and posed significant risks to lenders, servicers, and mortgage securities holders.  The statement called for a pause in the programs so these concerns could be addressed and directed Fannie Mae and Freddie Mac to undertake "prudential actions," including reviewing their collateral policies to assure no adverse impact by PACE programs.  In August 2010, Fannie Mae and Freddie Mac, citing FHFA's July 2010 statement, announced to lenders that they would not purchase mortgages originated on or after July 6, 2010 which were secured by properties encumbered by a PACE lien.  The net result of these actions has been that virtually all PACE programs across the country have been put on hold or discontinued.

Following Fannie Mae's and Freddie Mac's refusal to purchase mortgages secured by PACE liens, several lawsuits were filed, including one filed by the State of California, several California counties and municipalities, and the Sierra Club challenging these agencies' actions.  In particular, the plaintiffs alleged that the defendants violated the Administrative Procedure Act (APA), the National Environmental Policy Act (NEPA), and various state laws.  One of the plaintiffs, Sonoma County, also moved for a preliminary injunction requiring FHFA to institute a notice and comment period concerning its July 2010 letter.  The defendants moved to dismiss on various grounds.

The court first addressed whether the plaintiffs had Article III standing.  The United States, although officially not a party to the lawsuit, raised this issue in its Statement of Interest, alleging that plaintiffs could not satisfy the causation requirement because Freddie Mac and Fannie Mae took the position that PACE debt obligations were incompatible with their uniform security instruments before FHFA issued its July 2010 statement, and because it was merely speculation that if FHFA changed its policy individuals would be able to obtain PACE mortgages.  The court disagreed, finding that FHFA had previously publicized its concerns in a June 2009 letter, leading to Fannie Mae and Freddie Mac's actions.  In addition, the court found that plaintiffs' alleged injuries were sufficiently connected to FHFA's actions.

The court next addressed whether three statutory provisions precluded judicial review of the agencies' actions.  The first section (12 U.S.C. § 4617(f)) authorizes appointment of the FHFA as conservator or receiver of a regulated entity under certain circumstances and limits judicial review of such actions.  The court found that FHFA was not acting as a conservator or receiver when it issued its July 2010 statement and held that FHFA's directions to Fannie Mae and Freddie Mac amounted to substantive rule-making that was distinct from its role as a conservator.  The second section (12 U.S.C. § 4623(d)) describes supervisory actions that FHFA may take concerning "significantly undercapitalized" regulated entities, and exempts these actions from judicial review.  The court found that FHFA did not impose such a designation on either Fannie Mae or Freddie Mac and thus the section did not apply.  The third section (12 U.S.C. § 4635(b)) bars judicial review of the issuance or enforcement of any notice or order issued by FHFA.  The court rejected this section as well, finding that the July 2010 statement did not amount to an order requiring the disposal or acquisition of any asset.

The court then turned to plaintiffs' first claim - that FHFA's policy statements regarding PACE obligations failed to comply with the notice and comment requirements of the APA and thus its actions were arbitrary and capricious.  The court, after first finding that all of the plaintiffs except the Sierra Club had standing under the statute, concluded that the July 2010 statement amounted to a final agency action and that, as such, it was subject to the APA's requirements for notice and comment.  The court also found that the agency's action was not subject to a discretionary act exemption from judicial review.  It thus declined to dismiss the APA claim, except with respect to the Sierra Club.

The court turned next to the second claim - that FHFA violated NEPA by failing to consider the environmental impact of its actions by preparing an environmental impact statement (EIS).  Defendants alleged that the July 2010 statement did not amount to a "major federal action significantly altering the quality of the human environment" such that the preparation of an EIS was required.  The court disagreed, finding that plaintiffs adequately alleged that FHFA's policy significantly impacted the environment by depriving California and its citizens of opportunities to improve water and energy conservation.  The court also rejected defendants' argument that it was statutorily precluded from altering its determinations based on environmental concerns, holding that these dual concerns were not mutually exclusive and there was no categorical bar to FHFA's authority to consider environmental impacts in this instance.

The court did grant defendants' motion with respect to alleged violations of the 10th Amendment by interfering with a county's taxation and spending powers, holding that Congress was well within its authority to do this where the enactment is a proper exercise of its constitutional authority.  The court also granted the motion with respect to alleged violations of the Constitution's Spending Clause for placing conditions on PACE programs without clear authorization from Congress to do so, holding that FHFA's statement did not impose any terms for states and counties to receive federal funds to support their PACE programs.  The court also dismissed the state law claims, holding that they were preempted by federal law.

Finally, the court granted the plaintiffs' request for a preliminary injunction requiring FHFA, without changing its current policy, to proceed with the notice and comment process concerning its policy on PACE-related debts.

This case marks the first time a lawsuit challenging FHFA's policy concerning PACE programs has not been dismissed at the outset.  While defendants are likely to appeal the decision, it could lead to an outpouring of comments on the value of PACE programs.  Even if FHFA reaches the same conclusion after the notice and comment period, this conclusion is subject to judicial review and would have to satisfy an arbitrary and capricious standard.

Energy Efficient Houses

Reprinted with permission from Green Building Law Update Service.

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J. Cullen Howe is an environmental law specialist at Arnold & Porter LLP. Much of Cullen's work focuses on climate change, where he attempts to educate lawyers and the public at large on the enormous cooperation necessary to adequately address this problem. In addition to his work on climate change, Cullen is the managing editor of Environmental Law in New York, edits the Environmental Law Practice Guide, Brownfields Law and Practice, the Environmental Impact Review in New York, and has drafted chapters in the Environmental Law Practice Guide on climate change and green building. Mr. Howe is a graduate of Vermont Law School, where he was the managing editor of the Vermont Law Review, and a graduate of DePauw University, where he was a member of Phi Beta Kappa.

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