12 th Annual Texas Eminent Domain SuperConference

1. 12th Annual Texas Eminent Domain SuperConference • Denominator Problems with • Penn Central (1978) and Mayhew (1998) • William W. Wade, Ph. D. • Energy and Water Economics • 931-490-0060 • wade@energyandwatereconomics.com • February 11, 2013

2. Presentation Outline • 1 Day Decision, Groundwater and Regulatory Takings • 2 Pennsylvania Coal v. Mahon (1922): Too Far Back and Still Too Cryptic • 3 Penn Central v. New York City (1978): Next Takings Case – 56 years later • 4 Subsequent Interpretations Derailed Penn Central’s Economic Factors • 4.1 Kaiser Aetna v. United States, 444 U.S. 164 (1979) • 4.2Keystone Bituminous Coal Assn. v. Debenedictis, 480 U.S. 470 (1987). • 4.3 “The Denominator Problem” vitiated Penn Central’s “Reasonable Returns” • 5 Hope for “The Denominator Problem” in Federal Courts: Florida Rock & Cienega Gardens VIII • Pop Quiz: Is this Evidence to Support a Takings Decision for Plaintiff?

3. 1. Day Decision, Groundwater and Regulatory Takings The Texas Supreme Court in February 2012 reversed a hundred years of water law, changing groundwater ownership rights from a “rule of capture” to ownership of “groundwater in place.” (Edwards Aquifer Authority v. Day, 274 SW.3d 742, (Tex. Feb. 23, 2012, “Day”)) The decision equated groundwater ownership to oil and gas and concluded that differentiating “between groundwater and oil and gas in their importance to modern life would be difficult.” Ownership of the surface provides ownership of the water regardless of capture. Day sets-up a conflict between value of the owner’s groundwater in place and management of the larger aquifer for public benefit. Land owners may assert regulatory takings claims against governmental entities in response to regulation that limits or prohibits access to groundwater. The Day decision invoked SCOTUS legal theories that might govern compensation--Loretto, Lucas and Penn Central--and remanded Day “to the district court for further proceedings” to sort them out.  Water is scarce in Texas. Drought is expected to become increasingly recurrent. Groundwater Conservation Districts (GCDs) regulate usage of groundwater within most Texas counties. With title to the water in place residing with the landowner, GCD management of the aquifer for the public good runs the risk of a takings claim seeking compensation. If Penn Central were the governing legal theory, a number of empirical hurdles must be surmounted to establish severity of economic impact and frustration of distinct investment backed expectations. In short, “further proceedings” for the Penn Central test invokes myriad challenges well beyond multiplying some water price times a quantity to claim damages!

4. 2. Pennsylvania Coal v. Mahon (1922) Too Far Back and Still Too Cryptic

5. You would think that some clarity would have been infused into takings jurisprudence in the last 90 years! • Justice Holmes’ well-known, but still undefined, 1922 formulation, • “while property may be regulated to a certain extent, if a regulation goes too far it will be recognized as a taking.” (Pennsylvania Coal Co. v. Mahon, 260 U.S. 393, 415 (1922).) • How far is “too far” has haunted takings Jurisprudence since Pennsylvania Coal. • How far is “too far” is a fact and empirical economic question. • Actually, too far is no mystery to economists – today.

6. 3. Penn Central v. New York City Next Takings Case – 56 years later 35 years ago

7. You would hope that Penn Central test would have cleared things up. • Penn Central decision set three “particularly significant factors” as an empirical balancing test: • Economic effect of the regulation on the claimant; • Interference with distinct investment-backed expectations (DIBE); • Character of government action. (Penn Central Transportation Co. v. New York City, 438 U. S. 104, 124 (1978).) • Two of Penn Central’sprongs hinge on economic theory. • Economic impacts are measurable with standard methods. • Interference with DIBE is defined by economic theory & measurable with standard financial methods. • Set “parcel as a whole” to evaluate economic impacts.

8. Required Economic Analysis – Not Ad Hoc. • Develop financial evidence to evaluate claim for damages; • Determine economic effects of regulatory change on parcel as a whole; • Show that the economic facts evaluated under the Penn Central testimpose severe economic losses. • 3. Determine whether investment-backed expectations for investment in the property are frustrated. • Standard financial methods and benchmarks exist to reveal this outcome.

9. Before anyone actually applied the Penn Central test, two years later Court created another test. • AginsIIin 1980 ignored the Penn Central 3-prong test to require compensation, • if the regulation fails to substantially advance a legitimate state interest • OR • if the regulation denies the owner “economically viable use” of the property. • (Agins v. Tiburon, 447 U.S. 255, 260 (1980).) • The remaining prong would seem to bolster the Penn Central frustration of DIBE.

10. Texas Supreme Court articulates different criteria to evaluate a compensable regulatory taking. (Mayhew 1998) • The regulatory action does not substantially advance the government’s legitimate interests; or • The regulatory action deprives the property owner of all economically viable use of his property; or • The regulatory action unreasonably interferes with the owner’s use of the property as measured by: • the severity of the economic impact on the property owner and • the extent to which it interferes with investment backed expectations.

11. 4. Interpretations Derailed Penn Central’s Economic Factors

12. What happened to confound the Penn Central test? Rehnquist. • Justice Rehnquist replaced “reasonable” as the touchstone of IBE for “distinct” the year following Penn Central for no discernible legal or linguistic purpose. • (Kaiser Aetna v. United States, 444 U.S. 164, 175 (1979). ) • This confounded courts’ views of necessary returns to justify investment • with • reasonable expectations about plaintiffs’ notice of regulatory prohibitions.

13. What happened to confound the Penn Central test? Keystone Bituminous. • Keystone Bituminous confirmed Penn Central’s parcel as a whole but added an important nuance to the language: the transformation of the parcel as a whole to a search for a denominator: • “Because our test for regulatory taking requires us to compare the value that has been taken from the property with the value that remains in the property, one of the critical questions is determining how to define the unit of property whose value is to furnish the denominator of the fraction.” (Keystone Bituminous Coal Assn. v. Debenedictis, 480 U.S. 470, 497 (1987).)

14. Math Lesson for English Majors Fraction = Numerator Denominator

15. What happened to confound the Penn Central test? Takings Fraction. • Keystone created a Takings Fraction that compared value of the real property AFTER to value BEFORE. • Led to hundreds of decisions arguing about how much diminution is “too much” and requires “just compensation.” • Comparing two values produces a percent diminution that reveals only that one number is smaller. So what? • Takings cases have applied subjective qualitative judgments, mostly unique to each case - • To decide whether the smaller number is diminished sufficiently to justify compensation.

16. Keystone Takings Fraction Keystone Takings Fraction = After Value Before Value Compares two numerator concepts. No Economic Decision Benchmark.

17. What happened to confound the Penn Central test? The Denominator Problem. • What’s wrong with Keystone’s Takings Fraction? • It compares two numerator values! • Thousands of words in briefs, decisions and journal articles debating “how much is enough” should be sufficient proof that comparing two numerator values provides poor empirical takings guidance for jurists. • Comparison providesno theoretical guidance that would be required by Federal Evidence Rule 702.

18. 5. Hope for the Denominator Problem in Federal Courts Florida Rock & Cienega Gardens VIII

19. Interaction between Federal Courts Recognized the Correct Denominator. • Florida Rock V Opinion clarified when a partial reduction in value (“partial taking”) would justify payment of damages—and corrected the denominator problem. • (Florida Rock Industries v. U. S. 45 Fed. Cl. 21, 23-24 (1999) -- “Rock V”) • The comparison of Keystone’s before and after values is not a sufficient economic decision benchmark – • “not dispositiveof severity of economic impact.” • Decision corrected denominator value to be the owner’s equityor investment in the property – • Consistent with economic theory and practice.

20. Florida Rock VCorrected The Denominator Problem. • Florida Rock V applied the Penn Central test toprovide quantitative answers to two questions related to the change in regulations that prevented mining on the property. • Has the value of the property been significantly diminished? [73% - but, not dispositive!] • Do revenues after regulatory change recoup investment in the property? [No.] • Economic viability has to be measured with reference to returns and investments – • To perform standard financial performance evaluations.

21. Investment is the Correct Denominator Florida Rock V Takings Fraction = Before Value = $10,500>1 Investment $ 6,000 After Value = $2,822<1 Investment $6,000 A fraction <1 is evidence of frustration of DIBE.

22. Cienega Gardens VIII (2003) Applied Rock V’s Denominator to Temporary Takings. • Cienega VIIIin the Federal Circuit extended Rock V. • Diminution in value of the property is not dispositive of the magnitude of the economic impact. • Diminution alone is not sufficient to reveal that economic viability has been destroyed. (Cienega Gardens v. United States, 331 F.3d 1319, (Fed. Cir. 2003.)) • Economic viability is measured with reference to returns and investmentsin order to evaluate a standard financial performance measure – return on equity. • Cienega IX (2005) & CCA Associates (2007) followed Fed.Cir. precedent in CFC.

23. Four Problems with Government Argument The property value as numerator is aimed at the wrong stick in the bundle –– not the cash flow from property use. Appraisal of real property is not an accurate tool to measure the change in net income caused by the taking. Analytic tools to evaluate taking of income are readily available to determine when “too far” crosses a threshold The property value as denominator includes debt, typically 75% of the property value, and precludes evaluation of return on equity.

24. 6 Pop Quiz Is This Evidence to Support a Taking Decision for Plaintiff?

25. Two Income Streams: Evidence of a Taking?

26. Is the % Diminution Evidence of a Taking?

27. Decision Criteria Results as Evidence of a Taking: Taking Fraction. Takings Fraction = PV(Net Revenues/Investment) Discounted with appropriate opportunity cost of money.

28. Decision Criteria Results as Evidence of a Taking: Net Present Value. NPV = PV(Net Revenues) – Investment Discounted with appropriate opportunity cost of money

29. Decision Criteria Results as Evidence of a Taking: IRR IRR must exceed owner’s opportunity cost of money, assumed to be 10% here.