Appeals court rejects public nuisance suit over foreclosures

CLEVELAND (Legal Newsline) - The U.S. Court of Appeals for the Sixth Circuit has rejected the city of Cleveland's attempt to use a public nuisance doctrine to pin liability on major investment banks for the foreclosure crisis in the city.

Institutions that financed subprime home mortgages may not be held liable under Ohio law for the crisis, the appeals court ruled late last month.

Judge Richard F. Suhrheinrich said the securitization activities of the defendants -- including Citigroup Global Markets Inc., Goldman Sachs & Co., and other major investment banks -- were not the proximate cause of the city's troubles.

Even viewing the allegations in the light most favorable to the city, "the connection between the alleged harm and the alleged misconduct is too indirect to warrant recovery," he said.

The suit is one of several filed in recent years against lenders and investment firms by municipalities facing housing problems and plunging tax revenues.

And those suits aren't expected to dry up any time soon, a report by U.S. Law Week says.

The National League of Cities, the U.S. Conference of Mayors and the National Association of Counties has predicted more cuts in services, saying job losses and dysfunctional housing markets are key factors.

Cleveland's suit, though one of several brought by local governments against financial companies as of late, is different because it features a common law tort claim, Law Week says.

The lawsuit, originally filed in 2008, said the financing and securitization of subprime loans amounted to a public nuisance -- blaming banks, mortgage companies, securities firms and others for a foreclosure crisis that wiped out neighborhoods, leaving eyesores, fires, drug deals, looting and other problems in the city.

The city argued Wall Street first made cash available to subprime lenders, which used the funds to make subprime loans to consumers, then sold the related mortgages back to the same cadre of Wall Street, which packaged them and sold the income they generated to investors in the form of mortgage-backed securities, and used the proceeds to repeat the process.

The district court dismissed the suit on various grounds, including state law preemption, "the economic loss rule," unreasonable interference with a public right, and proximate cause.

The appeals court affirmed, resting solely on proximate cause.

Allowing suits in the absence of a direct link, the court said, between the alleged injury and the challenged conduct makes it difficult to determine which of the plaintiff's damages are attributable to the defendant's misconduct; complicates the apportionment of damages among plaintiffs to avoid multiple recoveries; and supplants suits by directly injured parties who can remedy the harm without those problems.

The court cited the interpretation of Holmes in Cincinnati v. Beretta U.S.A. Corp., 768 N.E.2 1136 (Ohio 2002).

"Homeowners, whether the initial buyers or mortgagees that later took possession of a home, were responsible for maintaining their properties," the appeals court said. "Fires were likely started by negligent or malicious individuals or occurred because a home was poorly built. Drug dealers and looters made independent decisions to engage in that criminal conduct. Additionally, other companies not listed in the complaint financed subprime loans and properties not subject to a subprime loan nevertheless entered into foreclosure."

The court found that the city's alleged injuries "could have been caused many other factors" with no connection to the defendants' conduct.

The alleged damages, the court continued, also were not directly caused by the defendants, but by intervening acts of third parties.

Cleveland attorney Joshua R. Cohen, of Cohen Rosenthal & Kramer LLP, who argued for the city, has said his client intends to ask the court to review the decision.

From Legal Newsline: Reach Jessica Karmasek by e-mail at jessica@legalnewsline.com.