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
E&WE
1
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)
4.2 Keystone 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
6
Pop Quiz: Is this Evidence to Support a Takings Decision for Plaintiff?
E&WE
2
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!
3
E&WE
2. Pennsylvania Coal v. Mahon
(1922)
Too Far Back and Still
Too Cryptic
E&WE
4
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.
E&WE
5
3.
Penn Central v. New York City
Next Takings Case – 56 years later
35 years ago
E&WE
6
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’s prongs 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.
E&WE
7
Required Economic Analysis –
Not Ad Hoc.
1. Develop financial evidence to evaluate claim for damages;
• Determine economic effects of regulatory change on parcel as
a whole;
2. Show that the economic facts evaluated under the Penn
Central test impose severe economic losses.
3. Determine whether investment-backed expectations for
investment in the property are frustrated.
•
E&WE
Standard financial methods and benchmarks exist to reveal
this outcome.
8
Before anyone actually applied the Penn Central test,
two years later Court created another test.
Agins II in 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.
E&WE
9
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
•
E&WE
and
the extent to which it interferes with investment backed
expectations.
10
4. Interpretations Derailed
Penn Central’s
Economic Factors
E&WE
11
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.
E&WE
12
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).)
E&WE
13
Math Lesson for English Majors
Fraction
E&WE
=
Numerator
Denominator
14
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.
E&WE
15
Keystone Takings Fraction
Keystone
Takings Fraction = After Value
Before Value
Compares two numerator concepts. No
Economic Decision Benchmark.
E&WE
16
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 provides no theoretical guidance that would be
required by Federal Evidence Rule 702.
E&WE
17
5.
Hope for the Denominator Problem
in Federal Courts
Florida Rock &
Cienega Gardens VIII
E&WE
18
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 dispositive of severity of economic impact.”
Decision corrected denominator value to be the owner’s
equity or investment in the property –
• Consistent with economic theory and practice.
E&WE
19
Florida Rock V
Corrected The Denominator Problem.
Florida Rock V applied the Penn Central test to provide
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.
E&WE
20
Investment is the Correct Denominator
Florida Rock V
Takings Fraction =
Before Value
Investment
=
$10,500
$ 6,000
>1
After Value
Investment
=
$2,822
$6,000
<1
A fraction <1 is evidence of frustration of DIBE.
E&WE
21
Cienega Gardens VIII (2003) Applied Rock
V’s Denominator to Temporary Takings.
Cienega VIII in 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
investments in order to evaluate a standard financial
performance measure – return on equity.
Cienega IX (2005) & CCA Associates (2007) followed Fed.Cir.
precedent in CFC.
E&WE
22
Four Problems with Government Argument
1
The property value as numerator is aimed at the wrong
stick in the bundle –– not the cash flow from property use.
2
Appraisal of real property is not an accurate tool to
measure the change in net income caused by the taking.
3
Analytic tools to evaluate taking of income are readily
available to determine when “too far” crosses a threshold
4
The property value as denominator includes debt,
typically 75% of the property value, and precludes
evaluation of return on equity.
E&WE
23
6 Pop Quiz
Is This Evidence to Support a
Taking Decision for Plaintiff?
E&WE
24
Two Income Streams:
Evidence of a Taking?
Net Revenue Forecast Example
$1,400,000
$1,200,000
$1,000,000
$800,000
$600,000
$400,000
Unregulated Revenues
E&WE
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
$200,000
Regulated Revenues
25
Is the % Diminution Evidence of a Taking?
$8,000,000
PV Net Revenues
PV Expected Net Revenues
$7,000,000
$6,000,000
% Diminution
65%
$5,000,000
$4,000,000
$3,000,000
PV Regulated Revenues
$2,000,000
$1,000,000
$0
E&WE
26
Decision Criteria Results as Evidence of
a Taking: Taking Fraction.
Takings Economic Prongs Decision Criteria
Benchmarks
Forecast
Expected
Decision Criteria
Actual Regulated
Investment
$4,000,000
$4,000,000
Value
$7,379,967
$2,577,587
Taking
Fraction
1.84
0.64
>1
Takings Fraction = PV(Net Revenues/Investment)
Discounted with appropriate opportunity cost of money.
E&WE
27
Decision Criteria Results as Evidence of a
Taking: Net Present Value.
Takings Economic Prongs Decision Criteria
Benchmarks
Forecast
Expected
Decision Criteria
Actual Regulated
Investment
$4,000,000
$4,000,000
Value
$7,379,967
$2,577,587
Taking Fraction
NPV
1.84
0.64
$3,379,967 ($1,422,413)
>1
>0
NPV = PV(Net Revenues) – Investment
Discounted with appropriate opportunity cost of money
E&WE
28
Decision Criteria Results as Evidence of a
Taking: IRR
Takings Economic Prongs Decision Criteria
Benchmarks
Forecast
Expected
Decision Criteria
Actual Regulated
Investment
$4,000,000
$4,000,000
Value
$7,379,967
$2,577,587
Taking Fraction
1.84
0.64
NPV
$3,379,967
($1,422,413)
IRR
16%
4.4%
>1
>0
>10%
IRR must exceed owner’s opportunity cost of
money, assumed to be 10% here.
E&WE
29