Drafting Condemnation Clauses for Leases in Colorado-issues and Strategies

JurisdictionColorado,United States
CitationVol. 43 No. 1 Pg. 57
Pages57
Publication year2014
43 Colo.Law. 57
Drafting Condemnation Clauses for Leases in Colorado-Issues and Strategies
Vol. 43, No. 1 [Page 57]
The Colorado Lawyer
January, 2014

ARTICLES REAL ESTATE LAW

By Michael R. McCormick.

Real Estate Law articles are sponsored by the CBA Real Estate Law Section.

Coordinating Editor

Joseph E. Lubinski, Denver, of Ballard Spahr LLP(303) 299-7359, lubinskij@ballardspahr.com

About the Author

Michael R. McCormick is a Senior Associate at Montgomery Little & Soran, PC, where he represents landowners in eminent domain proceedings against governmental entities such as CDOT and RTD/FasTracks—(303) 779-2721, mmccormick@montgomerylittle.com.

Most leases in Colorado include a condemnation clause that addresses what happens if the leased property is condemned by a public entity using eminent domain. This article discusses drafting lease condemnation clauses in Colorado.

Colorado courts recognize that landlords and tenants claiming an interest in a condemnation award may contractually determine how these funds are to be distributed.[1] Most leases between sophisticated parties include a condemnation clause addressing how their respective interests will be handled in the event of a taking by a governmental entity. Unfortunately, most condemnation clauses are given little attention at the time the leases are being drafted and often are created by lawyers with little understanding of the eminent domain process and how it may vary from jurisdiction to jurisdiction.

This article provides an overview of the eminent domain process in Colorado and identifies issues and strategies applicable to drafting condemnation clauses.[2] Although no condemnation clause can prevent all litigation, a well-crafted condemnation clause can help avoid many disputes. This article is a basic discussion concerning common issues. Practitioners are advised to consult more in-depth treatises[3] dealing with specific circumstances that may be applicable to their situation.

Overview of Condemnation Proceedings

Generally, a condemnation[4] proceeding has three phases. These are: immediate possession, valuation, and apportionment.[5]

Immediate Possession

In the immediate possession phase, the condemnor asks the court to provide possession of the property to construct the project in return for depositing a sufficient sum in the court's registry to pay just compensation when ascertained.[6] The landlord and tenant(s) are permitted to withdraw three-fourths of the amount of the condemnor's appraisal from the court registry (or more if the condemnor consents), but only if they can agree among themselves on how to distribute the withdrawal.[7]

Valuation

In the valuation phase, a commission or jury determines the amount of just compensation to be paid by the condemning authority in return for its obtaining title to the property.[8] Instead of making individual awards to each interest holder in the property, the commission or jury determines the amount of just compensation on an "undivided basis." This means that the value of the entire property as a whole is determined as if owned by a single entity.[9]

Nonetheless, Colorado law differs from pure "undivided fee" jurisdictions because encumbrances that positively or negatively affect the overall value also must be considered.[10] For example, if a tenant is paying rent that is above the market rate, evidence of that rental is admissible during the valuation phase to determine the overall value of the property.[11]

Apportionment

Following the overall value determination, the condemnor deposits the award, takes ownership of the property interest acquired, and moves on with its project. The parties with an interest in the property, however, have another issue to resolve or litigate: how the award will be apportioned—that is, distributed— among them. This subsequent process is called the apportionment phase of the case.[12]

A leasehold tenancy is a property right entitled to compensation if taken or damaged as a result of a condemnation action.[13] An apportionment proceeding provides a tenant the only basis under Colorado law to establish the separate value of its leasehold interests and rights. This is because a tenant cannot present separate evidence regarding the value of its leasehold interests at the valuation proceeding or pursue such claims in a separate action.[14] For this reason, settlements between landowners and condemnors cannot preclude the rights of tenants to otherwise obtain their rightful share of the settlement amount.[15] However, a condemnation clause may impact or determine this issue.

Apportionment via Agreement

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. In the 1990 Colorado Supreme Court decision Total v. Farrar, the landlord owned several leasehold properties as part of the same "larger parcel, " one of which was leased by a gas station.[16] The landlord settled the case with the condemnor based on a highest and best use of the entire larger parcel—that is, a parcel including all of its tenants' properties—as commercial redevelopment, which would require demolishing the gas station tenant's property.[17] Because the gas station's improvements contributed nothing to that highest and best use, the landlord argued that the gas station tenant should get nothing in the apportionment phase.[18]

The Colorado Supreme Court disagreed and determined that the parties had contractually agreed in the lease that the contributory value of the improvements was to be determined based exclusively on its relationship to the individual leased premises rather than the entire larger parcel owned by the landlord and, under that scenario, the improvements did have value for which the gas station tenant could recover.[19] Thus, it is important for both the landlord and tenant to recognize that the condemnation clause can provide for a different method of apportionment than what might be implied by the valuation phase or a settlement between the landlord and the condemnor.

It is common for landowners to agree to sell their property to the condemning authority after receiving a notice of intent to acquire the property without the public entity actually filing a condemnation proceeding. Although the terms "condemnation" and "award" are used in this article, the condemnation clause should state that its terms also apply to apportionment of sales proceeds resulting from sales made to a condemnor under threat of, or in lieu of, condemnation.[20]

Bargaining Power

Before considering specific strategies and issues, knowing the landlord's and tenant's bargaining power is important at the outset when drafting or negotiating a condemnation clause. If the tenant is leasing a small 2, 000-square-foot space in a commercial building owned by the landlord, the tenant probably will not have much bargaining power. On the other hand, if the tenant is leasing a large and vacant parcel of land (ground lease) for the tenant to construct a building on, the tenant will have significant bargaining power. Knowing the client's bargaining power will help the practitioner decide how hard to push during negotiations.

Common Traps to Avoid

Condemnation clauses can—and often do—change common law rules, often with the tenant waiving some or all of its constitutional rights to compensation. However, as noted in Nichols on Eminent Domain, the law does not look with favor on clauses causing forfeiture of the tenant's interest due to condemnation.[21] A lease provision will be construed not to have that effect if its language and the circumstances possibly permit.[22] Notwithstanding this rule, landlords commonly request that the tenant explicitly waive any and all compensation related to a condemnation proceeding and permit the award to be recovered solely by the landlord. Unfortunately, many tenants sign these waivers without reading them, and greatly regret that they did so later. Such a waiver can lead to catastrophic consequences for the tenant.

Further, Colorado law creates several traps for the unwary regarding condemnation clauses. A tenant is generally entitled to compensation for the condemnation of the tenant's unexpired leasehold interest.[23] However, the tenant may forego its right to compensation, and permit the landlord to receive all the condemnation proceeds, where the lease agreement contains a legally adequate automatic termination clause.[24] Where a lease indicates that it will automatically terminate on the condemnation of the property and is otherwise silent about allocation of the award, a tenant may be deemed to have waived all rights to compensation.[25] Many tenants agree to these automatic termination clauses without realizing they may be waiving their rights to any compensation.

In contrast, an automatic termination clause is different from a clause giving the tenant the option to terminate. Such an option may not by itself waive the right to condemnation proceeds, particularly if the option is not exercised.[26]

In addition, even in the face of true automatic termination clauses, tenants may retain rights to share in the condemnation proceeds if additional provisions allow the tenant to do so.[27] In contrast, clauses waiving a right to share in the condemnation proceeds but allowing tenants to pursue separate claims against the condemnor may be interpreted as precluding any right to compensation. This is because, as discussed above, there is generally no right under Colorado law for a tenant to directly pursue separate claims.[28]

The condemning authority must give notice to anyone having an interest of record in the property involved.[29] If the lease is not recorded, the condemning authority is not required to provide notice to...

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