There are many different types of regulatory takings, each with their own unique rules and body of Supreme Court jurisprudence. Although the Supreme Court has articulated different inquiries based on the type of taking, each of the tests “aims to identify regulatory actions that are functionally equivalent to the classic taking in which government directly appropriates private property or ousts the owner from his domain. Accordingly, each of these tests focuses directly upon the severity of the burden that government imposes upon private property rights.”1
In Penn Cent. Transp. Co. v. City of New York, the Court acknowledged it had been “unable to develop any ‘set formula’ for determining when ‘justice and fairness’ require” compensation for a taking and instead created a flexible standard of review.2 The Penn Central test is an ad hoc determination based upon all facts and circumstances but with particular attention paid to a set of three factors: (i) “economic impact of the regulation on the claimant”; (ii) the extent to which the regulation interferes with “distinct investment-backed expectations”; and (iii) the character of the government action.3 Since then, the Court has provided little guidance on the application of these factors.
Economic impact Economic impact is a factual determination that is relatively simple to measure: an expert appraiser determines the fair market value of the property at its highest and best use before the regulation was enacted, as compared to the fair market value at its highest and best use after the regulation was enacted.
There is, however, an argument to be made that the extent of the economic impact should not be as important. Property rights are defined by state law, not the economic value attached to them. And although property rights do not magically vest at certain price points or certain percentage losses, courts require a significant diminution in value to constitute a taking. For example, in New York, 82 percent is enough of a loss to constitute a taking,4 but 64 percent is not enough.5 How does constitutionality turn on 18 percentage points of value? The answer is that it doesn’t. The difference between those two cases was whether the owner could still use the property for economic benefit.
The reality is that constitutional regulations can sometimes cause large degrees of economic suffering and unconstitutional regulations can sometimes cause very little. The Constitution is about rights; economics are about damages. And thus, what a market buyer will pay for a property that is restricted by a regulation reflects the extent of the regulation (i.e., damages), not whether there was a vesting of a property right.
Reasonable investment-backed expectations
Reasonable investment-backed expectations are an objective determination, not a subjective one. It is not about the impact to a specific person, disconnected from market realities. Rather, it is about the regulation’s impact upon the property, regardless of individual preferences, and grounded in what a reasonable market participant would have expected.6
The determination of reasonable investment-backed expectations is also a before-and-after comparison. The court evaluates the investment-backed expectations of market participants before the regulation was enacted as compared to those same expectations after the regulation was enacted. Thus, reasonable market participants have investment-backed expectations of utilizing a property to its maximum economic potential at its maximum permitted use. Any use other than that is not objectively reasonable. For example, if a regulation precluded all development on a valuable piece of land, the fact that the owner only intended to use it to tend sheep and grow grass does not make that regulation constitutional.
Prior to Palazzolo v. Rhode Island, owners that took title after a regulation was passed often had difficulty in claiming that the regulation was a taking since they had notice of the limitation before the purchase. Courts often found that they had notice of the regulation at the time of purchase.7 However, Palazzolo held that the potential regulatory takings claim runs with the land and is transferable from owner to owner:
Were we to accept the State’s rule, the post enactment transfer of title would absolve the State of its obligation to defend any action restricting land use, no matter how extreme or unreasonable. A State would be allowed, in effect, to put an expiration date on the Takings Clause. This ought not to be the rule. Future generations, too, have a right to challenge unreasonable limitations on the use and value of land.
Nor does the justification of notice take into account the effect on owners at the time of enactment, who are prejudiced as well. Should an owner attempt to challenge a new regulation, but not survive the process of ripening his or her claim (which, as this case demonstrates, will often take years), under the proposed rule the right to compensation may not be asserted by an heir or successor, and so may not be asserted at all. The State’s rule would work a critical alteration to the nature of property, as the newly regulated landowner is stripped of the ability to transfer the interest which was possessed prior to the regulation.8
However, Justice O’Connor’s concurrence differentiated between the right to bring a regulatory takings claim and the ability to win that claim. In accord with the majority opinion, she confirmed that a post-enactment purchaser can bring a takings claim,9 but suggested that with notice of the regulation, a claimant’s reasonable investment-backed expectations may not have been negatively impacted.
Today’s holding does not mean that the timing of the regulation’s enactment relative to the acquisition of title is immaterial to the Penn Central analysis. Indeed, it would be just as much error to expungåe this consideration from the takings inquiry as it would be to accord it exclusive significance. If existing regulations do nothing to inform the analysis, then some property owners may reap windfalls and an important indicium of fairness is lost.10
While Justice O’Conner also stated that investment backed expectations are “not talismanic,”11 and are not to be given exclusive significance,12 the damage was done.
Justice O’Connor’s interpretation is both contrary to the majority opinion in Palazzolo and unworkable in practice. If someone buys property with notice of a pre-existing unconstitutional regulation, either the owner can bring a claim, or he can’t. Notice cannot be both a non-factor and a penalizing factor at the same time. Yet, that would seem to be the end result of Justice O’Connor’s concurrence.
CLICK HERE to read the full article, which was originally published in ALI CLE’s The Practical Real Estate Lawyer.
With $1.2 trillion of federal funds approved under the Infrastructure Investment and Jobs Act to rebuild America’s infrastructure, states will soon be flooded with monies aimed at addressing a slew of road, highway, bridge, railway and dam projects. Electrical and utility projects are also part of the plan, not to mention the $65 billion set aside to upgrade broadband in many of our rural communities.
But whether the work will involve repairing existing structures or building new ones, one thing seems certain: a significant amount of private property and right of way will be needed in order to accomplish the extensive list of projects that are currently being considered. This means that many of the property owners who are currently celebrating the infusion of fresh funds into our crumbling infrastructure, may also find themselves the source of supply for the vast amounts of property rights needed to get the job done.
Click here to continue reading this post by Owners’ Counsel of America.
Prepare for a potential eminent domain taking
Join us for our upcoming program, Eminent Domain and Land Valuation Litigation 2022 either in-person or via live webcast from January 27-29! Explore a full range of cutting-edge issues and hear from experts in the field. Learn more about this upcoming program here.
Of the many things that landlords and tenants are thinking about when entering into a new lease, the possibility that the property might be subjected to eminent domain proceedings is usually very low on the list. But condemnation cases do happen, and it is important for both the landlord and tenant to consider that possibility.
Understanding what rights a tenant has under common law principles, how and when those rights are valued, and how they can be modified by the terms of a condemnation clause in the lease is critical to addressing these things. It is challenging enough to face a taking by a governmental entity and the prospect of litigation that this entails. It is even more challenging to face a second set of litigation problems when the landlord and the tenant cannot agree about how their rights will be affected or who will be compensated. Having a clear and well-understood road map of what will happen if the government comes knocking on the door
is the best way to avoid these problems.
This is the second in a three-part series addressing some of the common questions we hear in our eminent domain practice at Faegre Baker Daniels from our landlord and tenant clients about these issues.
The first article addressed how a tenant’s rights are usually treated under common law condemnation principles. This second article will address how the parties to a lease may modify these common law principles by adding a “condemnation clause” to their agreement. The third article will provide a checklist of considerations when negotiating such a condemnation clause.
Lease provisions can, and often do, change the common law rules about what will happen in an eminent domain case.
Most leases between sophisticated parties, promissory notes with banks, and even some easement documents provide for these issues by adding a “condemnation clause” addressing how their respective interests will be handled in the event of a taking. Sometimes they even include provisions that allocate a portion of the award to a third party, such as a bank.
Unfortunately, most condemnation clauses are given little attention at the time the overall contracts are being drafted and are sometimes plugged in or “cut and pasted” from other documents by real estate or corporate professionals with a limited understanding of the eminent domain process and how it may vary from jurisdiction to jurisdiction. When that happens, such clauses often create more litigation issues than they resolve.
Nonetheless, courts do recognize that parties may contractually determine how condemnation funds are to be distributed, including the waiver of rights to compensation they would otherwise be entitled to under constitutional or common law principles. To waive rights to an award, the language must be clear and unequivocal. This is because the law does not favor clauses forfeiting rights, and courts will construe such provisions to not have that effect whenever they can.
Are there things to look out for in condemnation clauses?
Yes. Sometimes condemnation clauses are drafted in a way that creates traps for the unwary or uninitiated.
Where a lease indicates that it will automatically terminate upon the condemnation of the property and is otherwise silent about allocation of the award, in some states a lessee may be deemed to have waived all rights to compensation. But an automatic termination clause is different than a clause giving the tenant the option to terminate. Such an option doesn’t by itself waive the right to condemnation proceeds, particularly if the option is not exercised. In addition, even in the face of true automatic termination clauses, a tenant may retain rights to share in the condemnation proceeds if additional provisions specifically allow the tenant to do so.
Clauses waiving a right to share in the condemnation proceeds but allowing lessees to pursue separate claims against the condemnor may be interpreted as precluding any right to compensation. This is because, as discussed in our first article, in many jurisdictions there is no right for a tenant to directly pursue separate claims. Thus, some courts will construe such language as a legal impossibility and hold that the tenant has no right to any portion of the award. Others may determine that the language evidences an intent to compensate the tenant, even if poorly drafted, and will allow it to share in the award.
Accordingly, a tenant should not be lulled into believing they have preserved their rights to compensation if the lease provides only for separate awards.
Condemnation clauses addressing how an award is to be apportioned may control the distribution between the parties regardless of how the compensation was determined at a valuation trial or in a settlement with the condemnor. For example, a condemnation clause providing that the tenant will be compensated for the value of its improvements may entitle it to receive those funds in an apportionment hearing even where the condemnation award was based upon the theory that the property would be redeveloped for a more valuable use requiring the demolition of the improvements. Thus, it is important for both the landlord and tenant to recognize that what the condemnation clause provides for may be different than how the value of the property as a whole is maximized, and to plan accordingly for both phases of the case.
Many leases fail to address the rights of other interested parties and how they will interact with any apportionment agreed to between the landlord and tenant. This can lead to all sorts to troubles. For example, most lenders have provisions in their loan documents giving them the first right to any condemnation proceeds. If the landlord has already agreed that the tenant will be entitled to certain compensation, it is possible that the entire award will go to the lender and the landlord will then need to satisfy the tenant’s claims on its own. Or, if there are multiple tenants in a shopping center, it is possible that the overall award will be insufficient to compensate for multiple below market rates, or there may be uncertainty about which tenant is entitled to compensation for damages to common areas that all of them have the right to use.
When there are not enough funds to satisfy all contractual rights to a portion of the award, some jurisdictions have held that each claimant is entitled only to his or her equitable share of condemnation award; not the actual value of the interest when considered alone. In other words, each claimant is entitled to a proportionate share of the award based upon the relative value of its interest in the property, regardless of whether the whole condemnation award is greater than or less than the total of all such claims.
But what if some parties have contracted with respect to apportionment and some have not? Does the fact that a tenant has a contractual right to receive the value of its improvements from the award even if no compensation was paid for them mean that another tenant on the same property is left without any compensation because there is nothing left for the bonus value of his lease? Or should the landlord receive even less money because both tenants’ contractual and common law claims are honored first? And what if a contract provides for the payment of non-compensable items to one tenant — who suffers the shortfall that inevitably must follow because the overall condemnation award does not include money for that non-compensable harm?
These questions demonstrate the difficulties sometimes presented by the undivided basis rule, particularly when multiple respondents are involved and there is not a comprehensive and cohesive set of condemnation clauses addressing these kinds of circumstances.
Consideration of these and other issues when drafting a condemnation clause will be the subject of our final article.
This is the second in a three-part series addressing some of the common questions we hear in our eminent domain practice at Faegre Baker Daniels from our landlord and tenant clients about these issues. You may read the first article by clicking here.
About the Author
Jack Sperber has been representing private owners and condemning entities in eminent domain proceedings for 25 years. He does this work around the country, and has been involved in more than 30 trials, numerous evidentiary hearings, and more than 20 appellate arguments.
Mr Sperber is a planning co-chair for ALI CLE’s Eminent Domain and Land Valuation Litigation 2019 conference.
Of the many things that landlords and tenants are thinking about when entering into a new lease, the possibility that the property might be subjected to eminent domain proceedings is usually very low on the list. But condemnation cases do happen, and it is important for both the landlord and tenant to consider that possibility (and have an understanding of property rights in eminent domain litigation).
Understanding what rights a tenant has under common law principles, how and when those rights are valued, and how they can be modified by the terms of a condemnation clause in the lease is critical to addressing these things. It is challenging enough to face a taking by a governmental entity and the prospect of litigation that this entails. It is even more challenging to face a second set of litigation problems when the landlord and the tenant cannot agree about how their rights will be affected or who will be compensated. Having a clear and well-understood road map of what will happen if the government comes knocking on the door is the best way to avoid these problems.
This is the first in a three-part series addressing some of the common questions we hear in our eminent domain practice at Faegre Baker Daniels from our landlord and tenant clients about these issues.
How are a tenant’s rights treated in condemnation?
A tenant’s leasehold interest is a property right entitled to compensation if taken or damaged in a condemnation action. Unless a condemnation clause in the lease changes things, a tenant is usually entitled to compensation for the value of its leasehold estate and, in partial takings cases, damages to the portions of it not taken.
How are a tenant’s rights valued?
A tenant’s interest in the lease itself is typically measured by the difference between market rental rates and the contract rate provided for in the lease. To the extent the contract rate is below market, the lessee has a “bonus value” in the property that can be calculated over the life of the lease and discounted back to present value.
A tenant is also typically entitled to the value of any buildings or site improvements it has constructed on the property. This is generally true even when the lease requires the tenant to remove the improvements at the time the lease is terminated. The improvements are often valued based upon their contributory value to the overall property, as measured by comparable sales of similar improved properties or the income generated by such properties, and then backing out the underlying land value. They are sometimes also valued under a “cost approach,” where an appraiser determines how much it would cost to construct a
similar building today and then reduces its value for “depreciation” to account for its age and condition.
Finally, if only part of the property is taken, a tenant is typically entitled to any reduction in the value of its remaining leasehold interest caused by taking part of the property and the impacts of the project upon the remainder. These impacts are often referred to as “damages to the remainder,” “severance damages,” or simply “damages.” Different states have different rules
about how damages are measured and for what types of damages a landlord or tenant should receive compensation. If a damage causing a reduction in the property’s value can be fixed (such as by replacing a sign or fence that has been removed by the government’s project, reconstructing a drive aisle, or re-striping a parking lot), this lesser “cost to cure” expense is typically awarded instead. Whether the landlord or tenant is entitled to such damages may depend upon a number of issues, including the length of the lease and the type of damages incurred.
When and how do compensation decisions get made?
How a tenant can present claims for compensation depends upon the state that you are in.
A few states allow a tenant to present direct claims for compensation at a valuation trial, and the jury or fact finder can then award separate values to the tenant, the landlord and other interested parties.
But most states don’t allow for this. They instead follow the “undivided fee” or “unit” rule, whereby a condemnation award is initially made on a lump sum basis, as if only one person owned the whole property. After that award is returned, the condemnor deposits the money and takes the property. Then anyone who has an interest in the property makes a claim for
their portion of the award. In these jurisdictions, most settlements are made on a global basis, and neither the landlord nor the tenant can bind the other to an agreement with the condemnor without their consent.
If the parties cannot reach an agreement about how to divvy up the award, these issues are then litigated in a subsequent proceeding. This process is typically called the apportionment phase of the case, and the hearing, not surprisingly, is called an apportionment hearing.
Can the lease change these rules?
Lease provisions can, and often do, change these common law rules and procedures by adding a “condemnation clause” indicating what will happen if an eminent domain case is threatened. That will be the subject of our next article.
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About the Author
Jack Sperber has been representing private owners and condemning entities in eminent domain proceedings for 25 years. He does this work around the country, and has been involved in more than 30 trials, numerous evidentiary hearings, and more than 20 appellate arguments.
Mr Sperber is a planning co-chair for ALI CLE’s Eminent Domain and Land Valuation Litigation 2019 conference. To learn more about this upcoming conference in Palm Springs, CA, click here: www.ali-cle.org/CA007
ALI CLE is pleased to announce the addition of keynote speaker and President Emeritus of The College of William & Mary, W. Taylor Reveley, III, to the agenda of Eminent Domain and Land Valuation Litigation. President Reveley’s talk on “Property Rights: Foundation for a Free Society” will kick off this nationally acclaimed conference on January 24-26, 2019, in Palm Springs, California.
Law professors, government officials, members of the judiciary, and private practitioners make up Eminent Domain and Land Valuation Litigation’s respected faculty. This conference offers dual tracks, as well as more introductory-level presentations, so that attendees can create customizable experiences through the unique curriculum.
“Not only does this conference bring together the national experts on the cutting edge of eminent domain and related topics under one roof,” said planning co-chair, Robert H. Thomas, “we pride ourselves on our welcoming environment, with multiple networking opportunities for you to get to know your colleagues one-on-one.”
The program is designed to provide attendees with the opportunity to explore a full-range of cutting-edge issues while networking with faculty and colleagues from across the country. Just some of this year’s topics include:
Flood, wildfire, and other inverse cases
Pipelines, challenging the take, and compensation pitfalls
Eminent domain and takings misinformation in the media and social platforms
Fence and wall condemnations
The impact and valuation of power lines in partial takings
To learn more about this program and to register for the in-person course or webcast, click here.
