Are Fannie Mae and Freddie Mac State Actors? State Action, Due Process, and Nonjudicial Foreclosure

• Publication year: 2015

Are Fannie Mae and Freddie Mac State Actors? State Action, Due Process, and Nonjudicial Foreclosure

William E. Eye

ARE FANNIE MAE AND FREDDIE MAC STATE ACTORS? STATE ACTION, DUE PROCESS, AND NONJUDICIAL FORECLOSURE^†

ABSTRACT

This Comment considers whether the federal conservatorship of Fannie Mae and Freddie Mac transformed these entities into state actors subject to constitutional constraints. In particular, it analyzes whether Fannie Mae and Freddie Mac must provide homeowners with due process—namely notice and an opportunity to be heard—when they initiate nonjudicial foreclosures.

This Comment surveys and applies five state action tests set forth by the Supreme Court to determine whether nonjudicial foreclosures initiated by Fannie Mae and Freddie Mac must satisfy due process requirements. Application of the state action tests from Lebron and Brentwood Academy most persuasively suggest that nonjudicial foreclosures initiated by Fannie Mae and Freddie Mac must satisfy due process requirements. Although a number of federal district courts and one circuit court of appeals hold that the test embodied by Lebron requires permanent government control to render the entity a state actor, this Comment argues that indefinite control—exhibited by the federal conservatorship—suffices. Alternatively, this Comment argues that pervasive federal entwinement with Fannie Mae and Freddie Mac renders their conduct state action under the test set forth in Brentwood Academy, notwithstanding satisfaction of the Lebron test.

To the author's knowledge, no case or academic work has explicitly applied the entwinement test to post-conservatorship Fannie Mae and Freddie Mac. This Comment concludes that Fannie Mae and Freddie Mac are state actors under the entwinement test. However, because courts are reluctant to find state action where the government regulates the secondary mortgage market, it remains unlikely that Fannie Mae and Freddie Mac will be required to provide notice and an opportunity to be heard to homeowners facing nonjudicial foreclosure.

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INTRODUCTION

In response to the mortgage crisis of 2008, Congress passed the Housing and Economic Recovery Act (HERA).¹ HERA created the Federal Housing Finance Agency (FHFA), an independent government agency tasked with the regulation of Fannie Mae and Freddie Mac.² HERA authorized the Director of the FHFA to appoint the FHFA as conservator of Fannie and Freddie³ and, on September 7, 2008, the Secretary of the U.S. Treasury announced that both Fannie and Freddie had been taken into federal conservatorship.⁴ As conservator, the FHFA "assumed the power of the board of directors and management of both corporations."⁵

The conservatorship of Fannie and Freddie marked a dramatic corporate restructuring that raises potentially great constitutional questions. One such question is whether the "deprivatization" of Fannie and Freddie transformed these entities into state actors, such that they are subject to constitutional constraints.⁶ This question is particularly relevant in the context of nonjudicial foreclosure because state actors, unlike private lenders, are required to afford due process to homeowners.⁷ Such nonjudicial foreclosure is the predominant method of foreclosure in a majority of states.⁸ Considering both that Fannie

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and Freddie own or guarantee over half the mortgages in the United States⁹ and that millions of homeowners have lost—and will continue to lose—their homes through foreclosure,¹⁰ answering this state action¹¹ question is more than mental gymnastics. The answer, in turn, will determine the due process rights of millions of homeowners.

Most scholars considering whether Fannie and Freddie are state actors have applied the test announced by the Supreme Court in Lebron v. National Railroad Passenger Corp.¹² to determine whether, post-conservatorship, Fannie and Freddie are "part of the government."¹³ Under the Lebron test, an entity is a state actor if two prongs are satisfied: government purpose and government control.¹⁴ Courts that have considered this issue in recent years have almost unanimously found that Fannie and Freddie do not satisfy the Lebron test.¹⁵ Although there is consensus that Fannie and Freddie satisfy the first prong of the Lebron test because they were created for the furtherance of government objectives,¹⁶ to date, courts have held that the entities fail the second, government-control prong because the FHFA conservatorship is not permanent.¹⁷

Alternatively, Professor Florence Roisman contends that the proper test is a bright-line rule: "[I]f 'a direct federal instrumentality' is the foreclosing

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mortgagee, then the requisite federal action exists, and a court will apply [F]ifth [A]mendment due process standards to test the constitutionality of the foreclosure."¹⁸ But courts are not likely to find Fannie and Freddie to be state actors by application of the bright-line rule either. Application of the bright-line rule¹⁹ to the FHFA presupposes that the FHFA is the foreclosing mortgagee when Fannie and Freddie foreclose on homes. Although the FHFA "conduct[s] all business of the regulated entit[ies],"²⁰ the FHFA does not directly foreclose upon mortgages. The relationship between the FHFA and the foreclosure action is more attenuated: the FHFA operates Fannie and Freddie under conservatorship; Fannie and Freddie initiate foreclosures; and servicers, who "usually are the originating lenders," effect foreclosures as agents of Fannie and Freddie.²¹ Because the FHFA is not the directly foreclosing entity, determining that the FHFA is a state actor would not necessarily render as state action the conduct of private servicers foreclosing on behalf of Fannie and Freddie. In other words, a court might consider the FHFA a state actor but not impute the actions of Fannie's and Freddie's agents to the FHFA. Without addressing whether action by Fannie and Freddie is action by the FHFA, this Comment argues that the entities themselves are state actors.

This Comment proposes a novel approach to determine whether Fannie and Freddie are state actors. It applies the entanglement state action exception²² to Fannie and Freddie, arguing that even if both are private entities, their operation under federal conservatorship constitutes sufficient government involvement to render Fannie's and Freddie's conduct "fairly attributable to the state."²³ This entanglement analysis eschews both the Lebron test and the bright-line rule because it does not consider whether the entities are "part of the government," but instead considers the extent of government involvement with Fannie's and Freddie's conduct.²⁴

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This Comment proceeds in four Parts. Part I discusses the nature of nonjudicial foreclosure and its due process implications. Part II provides background to the state action doctrine and surveys Lebron and the entanglement line of cases for tests to determine whether Fannie and Freddie are state actors. Part III discusses Fannie and Freddie before and after conservatorship and analyzes the nature and degree of governmental involvement under the FHFA conservatorship. Part IV applies the state action analyses to Fannie and Freddie and concludes that both entities are state actors under the Lebron and entanglement tests.

I. CONSTITUTIONAL IMPLICATIONS OF NONJUDICIAL FORECLOSURE

This Part describes foreclosure, the process by which a mortgagee initiates the sale of real property standing as security for an underlying debt.²⁵ Next, it contrasts the two most common types of foreclosure in the united states. Finally, it considers state action and the requirements of due process in the context of judicial and nonjudicial foreclosure.

A. Foreclosure Generally

A mortgage is the "transfer by a debtor-mortgagor to a creditor-mortgagee of a real estate interest, to be held as security for the performance of an obligation."²⁶ This obligation is typically the payment of a debt evinced by a promissory note.²⁷ In the event of default by the mortgagor, a mortgagee may protect its financial interest by electing to accelerate, declaring the whole amount of the mortgage debt due and payable.²⁸ When a mortgagor fails to tender payment to redeem the mortgage, a foreclosure sale ensues, and the proceeds of the sale are applied to the outstanding mortgage debt held by the mortgagee.²⁹

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B. Judicial and Nonjudicial Foreclosure

The two most common types of foreclosure in the United States are judicial and nonjudicial, or "power of sale," foreclosure.³⁰ Judicial foreclosure is available in every jurisdiction.³¹ As the name suggests, this mechanism requires a judge to enter an order authorizing the sale of the underlying security property. Compared to nonjudicial foreclosure, judicial foreclosure is complicated and time-consuming. It requires filing a foreclosure bill of complaint; service of process; a hearing; judgment; notice of sale to the mortgagor; sale and issuance of a certificate of sale; judicial determination of claimants' right to surplus; possible redemptions from foreclosure; and possible entry of a decree for a deficiency.³²

In contrast, nonjudicial foreclosure—permitted in approximately 60% of jurisdictions in the United States—does not typically involve judicial intervention.³³ After some degree of notice prescribed by state statute, property is sold at a public sale conducted by the mortgagee, a public official, or some other third party.³⁴ Because nonjudicial foreclosure is cheaper and faster than judicial foreclosure, it has become the predominant method of foreclosure in jurisdictions that permit it.³⁵ But increased expediency is not without cost: because nonjudicial foreclosure eschews the procedural requirements of judicial foreclosure, it raises federal constitutional due process concerns.³⁶

C. Due Process and Foreclosure

The Fifth and Fourteenth Amendments to the U.S. Constitution prohibit the deprivation of life, liberty, or...