Inverse Condemnation and Related Government Liability

1. Inverse Condemnation and Related Government Liability • Penn Central’s Economic Failings • Confounded Takings Jurisprudence • William W. Wade, Ph. D. • Senior Vice President • ALI - ABA Conference • September 30, 1999 • Boston Mass. • 810 Walker Street • Columbia TN 38401 • ph. 931-490-0060 • www.foster-tn.com

2. Overview of Presentation • 1.Economic Failings of Penn Central • Penn Central’s Economic Problems - Off on the Wrong Foot. • Brennan v. Rehnquist. • Value Remaining and the Takings Fraction. • 2. Economic Methods and Thresholds • Where are we? • What criteria to establish compensable taking? • Decision rules. • Where should we be?

3. PennCentral’s Economic Failings & Takings • 1.Economic Failings of Penn Central

4. Penn Central’s Economic Problems - Off on the Wrong Foot • Takings guidance originates with Penn Central (1978). • Three “particularly significant” factors govern payment: • Economic impact on the claimant; • Interference with distinct investment-backed expectations; • Character of government regulation. • Two hinge on economic theory, not legal doctrine! • Economic impacts - measurable. • Interference - defined by theory & accepted practice. • Decision at odds with economic theory and practice.

5. Penn Central - Brennan v. Rehnquist • Bottom Line Economic Conflict: • Award compensation because Landmark Law precluded earning future returns on new permitted investment? OR - • Deny compensation because existing terminal business earning a reasonable return on past investments? • Decision: Parcel-as-a-whole ruling eliminated incremental importance of future lease income. • “Bundle,” not “Sticks.” • No precedent for this cavalier ruling.

6. Penn Central - Brennan v. Rehnquist (2) • Economic Value = Tangible Asset Value + Intangible Asset Value • Tangible Assets are real property - Balance Sheet Items. • Intangible Assets result from economic uses of property. • Penn Central City Tax Block - Tangible Asset • Air Rights - Tangible Asset • Revenues from the air space - Intangible Asset

7. Penn Central - Brennan v. Rehnquist (3) • Brennan looked backward and saw terminal earning a “reasonable return.” • No evidence submitted by claimants to the contrary. • Unrebutted assumption by Brennan. • Terminal value remaining matters. • Rehnquist looked forward and saw foreclosed lease income important to Penn Central finances. • Recognized that majority had no notion of reasonable returns or not. (FN 13) • Defined loss consistent with economic doctrine. • Argued value taken matters.

8. Brennan, Michelman & Breitel (1) • Where did parcel-as-a-whole come from? • The takings fraction dispute was born of two errors. • 1. Double Misread of Michelman’s 1967 HLR article! • Misapplied “Speculator Exception.” • Misconstrued “fraction of value destroyed” test: • “Once having found the denominator, [the ‘thing’ affected by the imposition], the test ask[s] what [fraction has been destroyed.]” • Test should not ask “how much value has been destroyed, but whether . . . the [regulation] can . . . be seen to have [reduced] some sharply crystallized, investment-backed expectation.” • Michelman created the language found in Penn Central and applied it to the discrete twigs of the bundle. • Brennan misused the words.

9. “. . . focus on the the particular thing [injured]” (p. 1192) “’fraction of value destroyed’ test . . . [proceeds] by first . . . [isolating ] some ‘thing’ owned . . . .” (p. 1232) “. . . Land speculator . . . unable to show . . . any specific plans . . . still has a package of possibilities, . . . though lessened. . . .” (p.1234) “parcel as a whole.” “parcel as a whole.” Penn Central building development was planned and had no other possibilities. Brennan, Michelman & Breitel (2)

10. Brennan, Michelman & Breitel (3) • 2. NY Chief Judge Breitel’s economic lunacy in the underlying decision confused the Brennan majority. • Breitel’s agglomerated income from the vicinity of Grand Central to Penn Central’s owners, failing to recognize that prior investments laid claim to these revenues. • Breitel doctrine of legal-economic gobbelty-gook: • “[P]roperty may be capable of producing a resonable return . . . even if it can never operate at a profit.” • “City Tax Block” in Penn Central delimited “vicinity,” but still makes no commonsense as denominator. • Sunk costs are sunk!

11. Takings Fraction • A permit denial that reduces property value begs the measurement and calculation of the percentage of value lost in comparison to the relevant property. • Justice Stevens articulated the Court’s confusion and imprinted the Keystone Comparison error: • “[O]ur test . . .requires us to compare the value that has been taken from the property with the value that remains[;] one of the critical questions is . . . to define the unit of property ‘whose value is to furnish the denominator of the fraction.’” (Keystone, 480 U.S. at 497.) • Value remaining should not be an issue!

12. Takings Fraction (2) • Evaluation of economic viability begins with tabulating numerator items and denominator items. • Numerator before and after permit denial houses before and after revenues from services provided by the relevant parcel. • Denominator before and after houses investments in the relevant parcel. • So, revenues go to numerator; investments go to denominator. • Value taken matters. How much are revenues reduced?

13. Takings Fraction (3) • The “takings fraction” is the ratio of the values to the investments in the single parcel or aggregated parcels. • Stand alone parcel compares revenues before and after denial to investment. • Parcel as a whole compares revenues from whole parcel to investment in whole parcel. • Calculation of takings fraction per se reveals little about the change in economic viability associated with permit denial. • Further financial calculations are required.

14. Takings Fraction (4) • Economic viability is measured by the return on investment before and after permit denial. • Economic viability is tautologically equivalent to a competitive, risk adjusted rate of return. • If before permit denial the owner’s project made good economic sense, and after permit denial, earnings are too low to attract and reward capital, economic viability has been extinguished. • Literally, present value (Net Operating Revenues - Investments) > 0 is the test.

15. Takings Fraction (5) • Parcel as a whole analysis reveals whether the foreclosed project is essential to the economic viability of the entire property. • This is the same as asking whether the owner can “do without” the incremental income and still earn sufficient income to justify the entire investment. • While economists can calculate the result, the question is inconsistent with economics and common sense. • Moreover, the takings question hinges on the balance of the two economic tests with the “character of government regulation.”

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22. Penn Central - Claimant’s Failings (1) • Loss of intangible asset values not well presented by claimants and not recognized by the majority. • No evidence of health of rails business. • Importance of lease income v. rails income to IRR not reported. • No evidence of investment expectations w/ & w/o building. • Effect on shareholders/owners not reported. • NPV of cash flows w/ & w/o building not reported.

23. Penn Central - Claimant’s Failings (2) • Accounting testimony looked backward. • Couldn’t afford cost of upkeep on the building. • Claimed operating loss. • Didn’t emphasize lost income. • Court disregarded testimony. • “Failed to impute rental values . . . .” • “Improperly attributed . . . operating expenses and taxes . . . .” • Court ruled terminal earned a “reasonable return.” • Brennan’s economic failings began with submitted evidence -- accounting data, without financial analysis.

24. Rehnquist’s Grasp of Economics • Duquesne Light (1989) shows grasp of physical assets not as balance sheet items, but as “assets . . . to be valued . . . [as] devoted to the . . . enterprise.” • Loss is return on assets, not cost of assets. • Parallel argument made in Penn Central dissent: • “Just compensation . . . requires ‘a full and perfect equivalent for the property taken.’” • Property taken is foregone building opportunity in the air space. • Rehnquist invoked Brandeis in Missouri Southern Bell (1923) • “Capital so invested . . .[entitled] to earn a fair return.”

25. Value Remaining or Value Taken? • Penn Central “Remaining Value” economic (non)theory confounded takings law. • Regulation a taking only if owner denied “economically viable use” of the “whole” property. • Mis-focus on value remaining rather than size of loss confounded evaluation of economic efficiency. • Efficiency governs too little/too much regulation. • Investors not compensated for change in firm value. • Value taken - essential economic element to balance with public gain to achieve efficiency.

26. PennCentral’s Economic Failings & Takings • 2. Economic Methods and Thresholds

27. Regulatory Takings - Where Are We? • 1. Lucas Standard - Categorical Taking if all economic value taken. (Lucas, 1992) • 2. Less-than-Categorical Taking • Where regulation impairs, but does not eliminate all economic value, decision depends on the balance of public interest versus the severity of private deprivation. • Federal Law - Agins Test (1980) • Taking if regulation: • Does not advance legitimate state interests, OR • Denies the owner “economically viable” use. • Introduced explicit balancing test.

28. Necessary and Sufficient Conditions • Economic Impact is necessary, but not sufficient basis, to prevail in a takings claim - • unless the loss is 100 percent (Lucas categorical). • "mere diminution in the value of property, however serious, is insufficient to demonstrate a taking." • Concrete Pipe and Products, 1993 • “threshold requirement. . . serious financial loss . . . .” • Loveladies Harbor, 1994. • Interference with reasonable investment-backed profit expectations sufficient for favorable takings decision • if loss undermines economic viability of entire property.

29. Florida Rock IV - Losses Matter • Loss need not be 100 percent to justify compensation. • "Nothing in the language of the Fifth Amendment compels a court to find a taking only when the Government divests the total ownership of the property: • Fifth Amendment prohibits the uncompensated taking of private property without reference to the owner's remaining property interests." • Florida Rock IV conformed the law to economic practice: • Dropped Penn Central's value remaining (non)theory of economics.

30. Criteria to Measure Economic Impacts • Appropriate measure of loss: • The opportunity foreclosed by unforeseen regulation that prohibits the planned economic use of the assets. • 1. Establish timing and amounts of invested capital, and property interests to demonstrate legitimate, reasonable investment-backed expectation. • 2. Document planned activities proscribed by regulation. • Show ability of the property and business to supply activities/uses intended; • Show market conditions that create foreclosed opportunity.

31. Criteria to Measure Economic Impacts • 3. Establish time period of loss: a specific temporary period or in perpetuity. • 4. Estimate reduced profits caused by regulation. • 5. Estimate tangible asset values reduced by the regulatory constraint: • Determine portion of property retaining any economic use, if any.

32. Criteria to Measure Economic Impacts • 6. Estimate intangible asset values, including business goodwill, reduced by regulatory constraint: • How severe is economic loss as measured by change in net present value of ongoing and foreclosed enterprise? • Does economic viability of entire enterprise remain, although at a lower level?

33. Takings Economic Decision Rules • Economic value for asset in use = net present value (NPV) of project cash flows. • Diminution in NPV is proper measure of loss. • If regulation reduces the NPV, but it remains positive, this is an "economic impact." • When NPV swings from positive to negative, investment expectations frustrated. • Difference between the calculated NPV before/after regulatory prohibition measures loss/damages. • NPV of project matters, not remaining value of firm.

34. A View of Takings Balance Had Michelman been understood • Foreclosed project, not the firm, is the denominator, the measure of shareholder expectations. • “Sticks,” not “bundles!” • Incremental economic loss, not value remaining! • Remaining value of firm has no bearing on economic impact of proscribed incremental project. • The value remaining should be a moot point. • Keystone Comparison test is meaningless. • Loss per se measured and compared with Benefits from regulation to achieve economic efficiency.