“Sophistical and Abstruse Formulas” Made Simple, or:
Advances in Measurement of Penn Central’s Economic Prongs
and Estimation of Economic Damages
in Federal Claims and Circuit Courts
ALI-ABA Conference
Inverse Condemnation and Related Government Liability
Boston October 1, 2005
William W. Wade, Ph. D.
Draft September 12, 2005
E&WE
1
Presentation Outline
1
Clear Benchmarks to Recognize a Regulatory Taking Vex Supremes –
and Everybody Else.
2
Fed. Cl. and Cir. Courts Advanced Penn Central test for Partial &
Temporary Taking and conformed damages to good economics.
•
•
•
•
Florida Rock V 1999
Cienega Gardens VIII 2003
Independence Park Apartments 2004
Cienega Gardens & Chancellor Manor 2005
3
Effect of Tulare Lake Basin on Payment of Damages
4
Conclusions: Economic Implications of Decisions
STOP
5
Vicissitudes of Measurement of Damages: from Kimball Laundry to
Independence Park Apartments
E&WE
2
Abstract: Federal Cl. & Cir. Courts have
advanced judicial understanding of the
economic underpinnings of Penn Central test
The U.S. Supreme Court reaffirmed the Penn Central test as the polestar to guide
resolution of regulatory takings claims several times in recent years: Palazzolo
(2001), Tahoe-Sierra (2002), Lingle (2005). At the same time, at least two Justices,
O’Connor and Stevens, have bemoaned the lack of clear mile markers to reach that
polestar.
Regulatory takings litigators and educators on both sides of the issue have criticized the
Courts “vague ad hocery” in approaching the “famously muddy language of the
Penn Central decision.” (Berger 2003 & Echeverria 2002; Kanner 2004 & 1998)
Hubbard et al 2003 wonder about fairness of a test with “no substantive standard.”
My own writings have objected to the failure of numerous courts to understand the
empirical analysis invoked in an ad hoc fashion in Penn Central.
While Supreme Court justices have beleaguered the language of the law but failed to
clarify issues of use and value, Federal Claims and Federal Circuit Courts have
conformed the analysis of the Penn Central test to standard financial and economic
practice. Decisions in 2003, 2004 and forthcoming 2005 have relied upon, and
quoted extensively from, expert testimony. To a significant degree, numerical analysis
adopted within the decisions has been the compass guiding case decisions.
This presentation will elucidate the economic failings of a host of temporary takings cases
beginning with the 1943 Kimball Laundry District Court decision and contrast those
with the good economics found in recent Fed. Cir. & Cl. Ct. decisions: Cienega
Gardens 2003; Independence Park 2004; Tulare Lake Basin 2004; & Chancellor
Manor v. U.S. 2005.
E&WE
3
Fed. Cl. and Cir. Court Decisions
Advancing Economic Methods
Date
Case
Legal Decision
Economic Implication
1999
Florida Rock V
Denominator = inflation
adjusted Investment basis in
the property and not before
value.
Established Recoupment of
investment as the benchmark for
the taking; denominator.
2003
Cienega VIII
Serious economic loss =
return lower than external
opportunity benchmark return.
Added reasonable return on
investment to recoupment;
reasonable expectations imply
return of investment and
reasonable profit.
2004
Independence
Park
Damages = lost profits and not
fair rental value;
damages measured at end
date of temporary taking.
Set net present value of lost
profits as value of lost use.
End point benchmark reduces
chance of bias against plaintiff.
2004
Tulare Lake
Interest on damages = prudent
investor’s foregone
opportunity.
Eliminates faulty legal theory
that low risk interest rates apply
to damages. Interest on
damages due at owner’s lost
alternative.
E&WE
4
1 Clear Benchmarks to Recognize
A Regulatory Taking Vex
Supreme Justices –
And Most Everybody Else.
E&WE
5
Frequently Repeated but Difficult to
Apply Language
How far is “too far” has haunted Takings Jurisprudence since
Pennsylvania Coal v. Mahon (1922).
“Too far” is a fact and analytic intensive question with widely
accepted methods to use and benchmarks to evaluate.
•
•
Ad hoc legal decisions have little to do with empirical economics.
Economic and financial tools reveal frustration of DIBE.
Supreme Court does not deal with quantitative
measurement.
•
E&WE
Perhaps, Justices Stevens and O’Connor are vexed in their search for
clear predicates to measure and evaluate Penn Central from fear of
“Sophistical and Abstruse Formulas.” (338 U.S. 1, 20, 1949).
6
Clear Benchmarks Needed to Help
Justice Stevens Evaluate a Regulatory Taking
When the government condemns or physically
appropriates property, the fact of a taking is obvious
and undisputed.
When, however, a regulation imposes [severe] . . .
restrictions . . . the predicate of a taking is not selfevident, and the analysis is more complex.
(Tahoe-Sierra Preservation Council, Inc., et al. v. Tahoe Regional Planning Agency, et al.,
535 U. S. 302, FN17, (2002.))
E&WE
7
Justice O’Connor Emphasized Complex Factual
Assessments under Penn Central -- 2001
Palazzolo v. Rhode Island, 533 US 606, 631- 636 passim (2001), Justice O’Connor,
concurring.
Concepts of ‘fairness and justice’ that underlie the Takings Clause are . . .
less than fully determinate. . . .
•
•
Eschewed any ‘set formula.’ . . . Regulatory takings cases
necessarily entail complex factual assessments of the purposes
and economic effects of government actions.
Pole-star remains . . . Penn Central.
Courts must consider the relevant factors under Penn
Central.
•
Two Penn Central economic factors are being measured and
evaluated in Federal Claims Court.
• Yes, Virginia, experts are using formulas!
E&WE
8
Justice O’Connor Again Emphasizes
Penn Central test (Lingle 2005)
Lingle v. Chevron USA, 544 U. S. __ (2005)
“The Penn Central factors -- though each has given rise to
vexing subsidiary questions -- have served as the
principal guidelines for resolving regulatory takings claims
. . . .”
“Penn Central inquiry turns in large part, albeit not
exclusively, upon the magnitude of a regulation’s
economic impact and the degree to which it interferes
with legitimate property interests.” [emphasis added.]
• What does property interest mean?
• How do you measure it vis a vis denominator?
• Why introduce new language? What became of DIBE?
E&WE
9
Litigators and Educators bemoan Shortcomings
of Missing Clarity of Penn Central test
Gideon Kanner. “Landmark Justice” or “Economic Lunacy”? A Quarter Century Retrospective on
Penn Central.” Draft presentation, ALI-ABA, 2004.
Gideon Kanner. “Hunting the Snark, Not the Quark: Has the U.S. Supreme Court Been
Competent in Its Effort to Formulate Coherent Regulatory Takings Law?” 30 Urb. Law. 307
(1998).
F. Patrick Hubbard, et al. “Do Owners Have a Fair Chance of Prevailing under the Ad Hoc
Regulatory Takings Test of Penn Central? 14 Duke Environmental Law and Policy 121,
2003.
Michael M. Berger. “Tahoe Sierra: Much Ado About What.” 25 Hawaii Law Review 295. Summer
2003.
John D. Echeverria. “A Turning of the Tide: The Tahoe-Sierra Regulatory Takings Decision.” 32
ELR 11235. October 2002.
John D. Echeverria. “Is the Penn Central Three-Factor Test Ready for History’s Dustbin?” 52
Land Use L. & Zoning Dig. 3. (2000).
Steven J. Eagle. http://mason.gmu.edu/~seagle/pubs/publist.htm. (Too many to choose one.)
William W. Wade. Penn Central’s Economic Failings Confounded Taking Jurisprudence. 31 Urb.
Law. 277, 282, 307 (Aug. 1999)
E&WE
10
2 Fed Cl. and Cir. Courts
Advanced Penn Central test
For Partial & Temporary Takings &
Conformed Damages to Good
Economics
E&WE
11
Cases Conforming Law to
Good Economic Practice
Florida Rock Industries, Inc. v. U. S., 45 Fed. Cl. 21
(1999)(“Rock V”).
Cienega Gardens v. U. S., 331 F.3d 1319, 1337 (Fed. Cir. 2003)
(“Cienega VIII”)
Independence Park Apartments v. U. S., Court of Federal
Claims, No. 94-1A-C, (August 27, 2004.)
Tulare Lake Basin v. U.S., Court of Federal Claims, No. 98101L, (August 11, 2004).
Chancellor Manor v. U.S and Cienega Gardens v. U.S., U.S.
Court of Federal Claims, No. 94-1C & 98-39C, (August 29,
2005.)
E&WE
12
U.S. Supreme Court Penn Central test
Penn Central decision set three “particularly
significant factors” as a balancing test:
•
•
•
Economic effect of the regulation;
Interference with distinct investment-backed expectations;
Character of government action.
(Penn Central Transportation Co. v. New York City, 438 U. S. 104, 124 (1978).)
Two of Penn Central’s “particularly significant
factors” hinge on economic theory.
•
•
E&WE
Economic impacts are measurable with standard methods.
Interference with IBE is defined by economic theory & measurable
by standard financial practice.
13
Required Economic Analysis for a
Regulatory Taking
1. Develop empirical evidence to evaluate claim:
• Analyze economic effects of regulation in terms of % of lost value;
• Measure and evaluate interference with distinct investmentbacked expectations.
2. Distinguish remaining “economically viable use” from “any
remaining use” with financial benchmarks.
3. Determine whether economic facts deny the plaintiff substantial
“economic use” of his property.
4. Determine whether investment-backed numerical expectations
for the investment are reasonable and frustrated.
E&WE
14
Florida Rock V Decision Clarified and
Analyzed Partial Taking
The Florida Rock V Opinion, August 31, 1999, clarified
conditions when a partial reduction in value would justify
payment of damages. (Florida Rock Industries v. U. S. 45 Fed. Cl. 21, (1999) -“Rock V”)
“[A] partial regulatory taking may be found where a regulation
results in a deprivation of ‘a substantial part but not
essentially all of the economic use or value of the
property.’” (Rock V @ 31 citing Florida Rock IV, 18 F.3d 1560,1568, 1994)
Established “a logical framework . . . a stable framework,” to
undertake the balancing called for in the Penn Central
three factor balancing test. (Rock V @ 23.)
E&WE
15
Florida Rock V Set Framework
to Evaluate Economic Effects
Framework requires quantitative answers to two
economic questions:
1.
Has the value of the property been significantly diminished?
2.
Can investment be recouped at its inflation-adjusted basis
benchmarked to date of taking?
•
•
•
Established investment basis as the denominator of takings fraction.
Compared returns before and after the change in regulation to the
investment basis.
Do returns at least recover investment in the property as a whole?
Key:
Corrected denominator of Takings Fraction from
“Before” value to Investment basis in the property as
a whole.
E&WE
16
Cienega Gardens VIII Clarified Penn Central
Measurement for Temporary Takings
Cienega Gardens 2003 conformed measurement
approaches closely to economic doctrine.
Treated the “diminution in value” prong of the Penn Central
test as a threshold requirement akin to Rock V .
Evaluated "serious financial loss“ by return on investment
to decide if plaintiff’s loss of return sufficient to frustrate
DIBE.
E&WE
17
Cienega VIII Applied Standard Financial
Techniques to Penn Central Test
Cienega VIII measured economic viability with reference to returns
and investments.
Economic viability measured with reference to both:
•
•
recoupment of investment
plus a reasonable return on investment.
Return on investment after regulatory change was compared to the
rate of return on Fannie Mae bonds as a conservative benchmark.
Key:
Evaluated a standard financial performance measure and
compared it to a benchmark measure of opportunity cost
of owner’s capital.
E&WE
18
Independence Park 2004 Abandoned
Fair Rental Value
Independence Park Apartments 2004 set damages as the present value of
lost profits at the valuation date.
• What was lost was the time value of the rental income.
Decision established the valuation date for a temporary taking as the “end
of the temporary takings period, not the beginning or some intermediate
date.” (Independence Park Apartments v. U. S., discussion @ 20 - 23.)
KEY:
This approach measures accurately the value of the lost use of the
property during the temporary taking as lost profits.
Corrects a whole line of cases that mistakenly calculate in many ways a
notion of Fair Rental Value, which arose in the 1943 Nebraska District
court that led up to Kimball Laundry Co. v. U. S., (338 U.S. 1, 3 (1949).
E&WE
19
Cienega/Chancellor 2005 Decision:
Three Ways to Address Economics Impacts
Keystone Bituminous - “comparison of value taken from the
property with value remaining.” (480 U. S. 470, 497(1987))
Florida Rock - “Owner’s opportunity to recoup its investment or
better.” Rock V at 32 citing to Florida Rock IV, 18 F.3d, 1560 1567 (Fed. Cir. 1994.)
Cienega VIII - “return on equity approach”: “the court compared the
annual return on the owners’ real equity in their properties to a
conservative market return on Fannie Mae bonds.” (331F.3d at
1342-1343.)
“Measuring an owner’s return on equity better demonstrates the
economic impact on the owner of the temporary takings of
income generating property than . . . the change of fair market
value.” (Cienega/Chancellor 2005 @ 52.)
E&WE
20
Remedial Note on Valuation of
Temporary Loss of Use Values
Total Economic Value =
Tangible Asset Values + Intangible Asset Values
Tangible Assets = Real Property.
Valued typically by real estate appraisal methods.
Intangible Assets = Ongoing profits from the
use of the Property;
Business operations.
Value is Present Value of Net Cash Flows.
E&WE
21
Real Estate Appraisals Not Relevant to
Economic changes due to Temporary Takings
Before and After real property values have no relevance to a
temporary loss of income due to loss of use of the property.
• Appraisal values at the second point in time will reflect
exogenous market forces unrelated to temporary use losses.
•
Real property values could go up. Measured by appraisal comps,
the lost earning would be confounded.
Appraisal methods employ the wrong tool -- Comps.
The right tool is a financial analysis of lost cash flows during
the period of the taking.
E&WE
22
Lost Use Value = Amount and Time
Temporary Taking Lost Use Value
$1,200,000
$1,000,000
Start
End
$800,000
End
Damages
$600,000
$400,000
Valuation
Date
$200,000
$0
2006
2005
2004
2003
2002
2001
2000
E&WE
1999
1998
1997
1996
1995
Market Conversion
Restricted Rents
23
Cienega VIII Penn Central Test
Market Rents
IRR
PV Oct 1997
13.6%
$2,236,404
Restricted Rents
IRR
PV Oct 1997
5.0%
($503,686)
Taking Ratio
Market Rents
PV Returns Oct 1997
PV Equity Oct 1997
Taking Ratio
Benchmark Return:
14%
E&WE
Restricted Rents
$6,394,544
($4,158,140)
$3,654,454
($4,158,140)
1.54
0.88
Taking? Yes
Damages:
$2,740,090 @ 1997
24
3 Effect of Tulare Lake Basin Decision on
Payment of Damages
E&WE
25
Effect of Tulare Lake Basin –
“Prudent Investor Rule”
Courts tend to set interest rates on awarded damages
based on a risk free rate of return.
As a matter of economics, just compensation should keep plaintiff
whole.
Seaboard made it a matter of law in 1923 : Damages must restore the
“full and perfect equivalent in money of the property taken.”
(Seaboard Air Line Railway v. United States, 261 U.S. 299, 304 (1923).)
Economic standard is not and never has been that risk free interest
rates apply because government payment is virtually assured.
Tulare Lake Basin decision makes clear that the interest rate should
be based on what a reasonably prudent plaintiff would have done
with the cash flows had they not been disrupted by the temporary
taking.
(Tulare Lake Basin v. U.S., Court of Federal Claims, No. 98-101L, (August
11, 2004)
E&WE
26
Effect of Tulare Lake Basin On Payment
of Damages – w/Interest
Damages 1997
Damages 2005 @ 14%
Damages 2005 @ 5%
E&WE
$2,740,090
$7,816,344
$4,048,361
27
4 Conclusions: Economic Implications of
Fed. Cl. & Cir. Court Decisions
E&WE
28
Fed. Cl. and Cir. Court Decisions
Advancing Economic Support
Date
Case
Legal Decision
Economic Implication
1999
Florida Rock V
Denominator = inflation
adjusted Investment basis in
the property and not before
value.
Established Recoupment of
investment as the benchmark for
the taking; denominator.
2003
Cienega VIII
Serious economic loss =
return lower than external
opportunity benchmark return.
Added reasonable return on
investment to recoupment;
reasonable expectations imply
return of investment and
reasonable profit.
2004
Independence
Park
Damages = lost profits and not
fair rental value;
damages measured at end
date of temporary taking.
Set net present value of lost
profits as value of lost use.
End point benchmark reduces
chance of bias against plaintiff.
2004
Tulare Lake
Interest on damages = prudent
investor’s foregone
opportunity.
Eliminates faulty legal theory
that low risk interest rates apply
to damages. Interest on
damages due at owner’s lost
alternative.
29
E&WE
Recent Economic Changes in
Fed. Cl. and Cir. Courts
Three poor economic applications are sidelined by
recent decisions.
1. Value of lost profits replaced Fair Rental Value to
measure damages from lost use;
2. Percent diminution in value is replaced as Penn
Central guiding prong by economic returns
benchmarked to owner’s investment basis and his
opportunity cost of capital;
3. Court-sanctioned interest rates are replaced by
owner’s demonstrably prudent lost opportunity value
of invested capital.
E&WE
30
5 Vicissitudes of Measurement of
Damages:
Temporary Takings from Kimball
Laundry to Independence Park
E&WE
31
Kimball Laundry Established
Fair Rental Value in Lower Courts
1. Fair Rental Value
FMV of Taken Property
Assumed Rental Rate
Annual Rental Value
$1,000,000
10%
$100,000
Period of Temporary Take
3
Just Compensation
$300,000
Kimball Laundry , 8 Cir., 166 F.2d 856,
E&WE
Fair Rental Value went down the wrong path. District
Court 1943 awarded FMV only. 8th Circuit Affirmed.
Rental value understates loss; covers value of use of plant
& equipment, only.
Excluded business losses both during take and thereafter.
Returns to management skills and ongoing business lost.
Supreme Court remanded to District Court to discover lost
value of trade routes -- lost value of the business.
32
Fair Rental Value Applied only to Delayed
Use Right
2. Fair Rental Value of Development
FMV w/o Restriction
$1,000,000
FMV w/ Restriction
$200,000
Value of Lost Use Right
$800,000
Assumed Rental Rate
Annual Rental Value
10%
$80,000
Period of Temporary Take
3
Just Compensation
$240,000
Assumes FMV of Lost Opportunity
Rental rate concept remains lower than
lost profits of delayed project.
E&WE
33
Wheeler Applied Market Rate of Return
Only to Owner’s Equity
4. Equity Interest Return
Value of Developed Project
$1,000,000
Value of Land
$100,000
* % of Owner's Equity
25%
Value of the Lost Use Right
$900,000
Lost Equity Value of the Right
$225,000
Assumed Market Return
Period of Temporary Take
Just Compensation
Wheeler, 833 F.2d 267 (1987)
10%
3
$67,500
Wheeler Error: Plaintiff's Deprived Leverage
Assumed Market Return
10%
Assumed Debt Cost
3%
Just Compensation
$189,000
E&WE
34
FRV based on Owner’s Cost of Capital
5. Miller Brothers Fair Rental Value
Pre-Taking Fair Market Value
$1,000,000
Market Rate = WACC
10%
Period of Temporary Take
3
Just Compensation
$300,000
Miller Brothers v. MI DNR, 4 Mich. Cl. Ct., 1995.
WACC only provides a floor value of loss and does not measure
the actual lost value of the use of the property.
Resultant Values do not meet Seaboard standard.
E&WE
35
Most Egregious: SDDS and Bass IV
6. SDDS Fair Rental Value
NPV Cash Flows w/o Delay
$1,000,000
NPV Cash Flows w/ 36 Month Delay
$700,000
Owner's Property Loss due to delay
$300,000
"Appropriate interest rate"
10%
Period of Temporary Take
3
Just Compensation
$90,000
plus mandatory interest from end of period
SDDS Inc. v. State, SD 90, 2002, FN 15
Bass IV, Fed. Cl. Ct. No. 95-52 L, Feb., 2001
Awarded difference in interest on cash flows.
Damages award is the interest on the diminution of cash flows.
Excludes compensation for the loss itself.
While patently specious, government offered this concept in ongoing
HUD cases: Independence Park, Cienega Gardens & Chancellor Manor.
E&WE
36
Independence Park Apartments Finally
Got it Right!
7. Independence Park Apartments
NPV Cash Flows w/o Delay
NPV Cash Flows w/ Delay
PV Lost Rental Income @ Start of Take
Assume Risk-Weighted Discount Rate
PV Lost Rental Income @ End of Take
@ 3-yr compound factor (1.1)^3
Just Compensation @ End of Take Period
Effect of Tulare Lake on Payment of Damages
Assumed years from end of Take to Payment
Typical Court-Mandated 52-week Treasury bill
Owners' Demonstrated "prudend investment" opportunity
Damages at 52-week T Bill
Damages at opportunity cost of capital
$1,000,000
$700,000
$300,000
10%
1.331
$399,300
5
4%
10%
$485,809.50
$643,076.64
Independence Park v. U.S, Fed. Cl. Ct., No. 94-1A-C, August, 2004
Tulare Lake v. U.S., Fed. Cl. Ct., No. 98-101L, August 20004.
E&WE
37