Rulings Probably Won’t Affect PACE in Long Run

In a setback for efficiency advocates, the Eleventh Circuit has joined the Second Circuit in rebuffing challenges to a federal regulator’s decision not to allow lien-priming PACE financing on mortgaged residential property.

The decisions from the two circuit courts probably increase the likelihood that the Ninth Circuit will hear and reach a similar conclusion in an appeal from a California district court decision that, at this point, is the only one of several pro-PACE lawsuits to have succeeded.

PACE and the FHFA

PACE is a financing mechanism that has attracted considerable attention in the last few years.  In a nutshell, it provides upfront funding for efficiency upgrades on real property.  The obligation is repaid through a tax assessment.

In 2010, the Federal Housing Financing Agency (FHA) instructed the government-sponsored entities that it regulates – and that effectively control the secondary market for residential mortgages – not to purchase mortgages encumbered with first-priority PACE liens.  PACE liens that leapfrogged mortgage liens in seniority exposed mortgage holders to too much risk, according to the FHFA.

Until that point, PACE had built considerable momentum, with a majority of states passing enabling legislation and increasing numbers of cities developing and launching PACE programs.

The FHFA killed much of this momentum, at least in the residential sector.  PACE has continued to gain traction in the commercial sector.  San   Francisco, for instance, just closed the first deal under its PACE program, a $1.6 retrofit on the offices of real estate giant ProLogis.

Following the FHFA instruction, with residential PACE on the ropes, environmental groups and jurisdictions with PACE programs filed lawsuits against the FHFA, accusing it of issuing a directive that should have complied with the Administrative Procedure Act and NEPA but did not.

California Decision

The Northern District of California preliminary enjoined the FHFA from proceeding without following APA rulemaking procedures and, over the summer, ruled against the agency.  The FHFA dutifully complied, issuing advanced notice of proposed rulemaking and receiving comments that generally broke down along expected lines.

Environmental groups, local governments and the green industry argued that the FHFA had overstated the risk exposure of PACE properties and that property underwriting standards could make that risk tolerable.  The residential real estate industry – including home builders, title insurers and real estate agents – warned that PACE financing would cause property owners to be more indebted and could reduce the marketability and sales prices of PACE properties.

After considering these comments, the FHFA issued a proposed rule that established the same policy as its original directive and started its NEPA process.

Second and Eleventh Circuits

While the FHFA was acting on the Californiadecision, all the pro-PACE lawsuits that plaintiffs had filed in other jurisdictions fell flat.  In October month, in a tandem opinion, the Second Circuit upheld separate decisions from the Southern and Eastern districts of New York that found the FHFA had acted properly.

The latest entry into PACE case law is the Eleventh Circuit opinion, which upholds a decision from the Northern District of Florida that rejected a challenge to the FHFA directive brought byLeonCounty.

Like the other PACE cases, the Eleventh Circuit opinion turns on whether the FHFA was acting as a regulator (which would require APA compliance) or a conservator (which would not) when it issued its instruction.  The Eleventh and Second circuits both found the FHFA had acted as conservator.

Future of PACE

The circuit court decisions do not absolve the FHFA of the obligations the California court imposed.  But all that the California decision requires is for FHFA to comply with APA and NEPA – a procedural headache for the agency, to be sure, but not an obligation to reach a different outcome.  The decision does not require the agency to permit any type of financing, PACE or otherwise.

At most, the California decision will engender more public process and litigation without changing agency policy.  If the Ninth Circuit upholds the district decision, the agency will grind through its procedural requirements and probably issue a final rule that resembles its proposed rule and its initial directive.

If the Ninth Circuit follows the lead of the Eleventh and Second circuits and overturns the Northern District decision, it will cut short the administrative process now underway and put residential PACE in much the same position it was in before the start of the PACE litigation.

At that point, the key difference will be context.  PACE is gaining ground in the commercial sector.  That precedent, along with increasingly compelling data about the cost savings enjoyed by properties that are energy and water efficient, will normalize PACE and make it more attractive to a residential industry that is still sorting through the trauma of the late-aughts housing collapse.

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