VALUATION BLUNDERS IN THE LAW OF EMINENT DOMAIN.

• Author: Epstein, Richard A.

INTRODUCTION

Virtually all legal disputes can be divided into two separate phases. The first deals with entitlements, and the second with remedies. The distinction helps sort out the conceptual and practical difficulties in takings cases. Entitlement questions are in most instances capable of being answered with some degree of clarity, because they involve typically only the identification of property taken and justifications for the taking. But remedial questions, in the eminent domain context as elsewhere, do not lend themselves to that kind of precision for there is always a real valuation question of whether the compensation supplied is in fact just. On liability, the inquiry is disjunctive: the answer is either yes or no. On remedies, the inquiry lies on a spectrum: once the taking is found, the set of possibilities for compensation (like the level of damages in contracts or tort cases) takes the form of a smooth, monotonic, and continuous function. The more that is taken, the greater the compensation owed. These functions should be well behaved, without kinks or gaps.

Subject to that key constraint, the selection of the proper single point on that continuum can be troublesome. These difficulties are unavoidable no matter how perfect and impartial the decisionmaker. All valuation issues depend on some distribution of possible future values of the asset taken or destroyed that may, or may not, exhibit some kind of normal distribution. In market exchanges, public bodies do not have to resolve these difficult matters of valuation because they need only observe the price (typically in money) that the parties set for a particular asset.

Any appeal to market prices conceals a lurking uncertainty in valuation that looms larger when voluntary transactions are not available to set pricing benchmarks. If each asset had the same unique value for all people, why engage in routine voluntary exchanges? The accurate way therefore to understand market transactions at a distinct price is that they only provide the illusion of a unique, agreed upon valuation. Some of these concealed issues relate to differences in value in use, as opposed to exchange: all other things being equal, tangible assets, like homes or businesses, will be sold if the buyer intends to make more intensive use of the asset than the seller. But in addition, every voluntary exchange of some real asset shifts the uncertainty about future and contingent asset values from the seller to the buyer. That risk transfer takes place in naked form in any contract of insurance, but it is also embedded in transfers of tangible assets that have (unlike insurance contracts) value in use as well as in exchange.

There is, of course, no reason whatsoever to set aside or even question any contract that moves any asset from one party to others, except on those grounds like duress, concealment, and maybe mistake. But there are of course many situations in which asset valuation takes place in the absence of the unique (or near unique) prices in competitive markets, such as during the dissolution of a marriage or a business partnership. Public valuations under the tort system are also necessary to determine compensation when property or human life is either taken or impaired, even (in the form of "clean-up" damages) where injunctions or specific performance are available for either the breach of contract or the commission of a tort. But by definition, no form of equitable relief is available in ordinary eminent domain cases where the government may force the exchange for just compensation in any transaction that meets today's capacious standard for public use. (1) The key term, "just compensation," is left undefined in the Constitution, but the necessity for its use is clear. (2) To say, as did John Locke, that the government should never take property without the consent of its owner, invites holdout problems of enormous potential that could easily make it impossible to assemble land for a railroad, highway, or even a public office building. (3)

Yet the alternative, which is to allow the taking without compensation so long as the new use is for the public benefit, will lead to excessive levels of condemnation because a dominant political faction can easily find, or manufacture, public reasons to claim that the property taken is worth more in public than in private hands. Accordingly, the just compensation measure imposes a pricing constraint on the government to increase the odds that the property taken will be indeed worth more in public hands than it is in private ones. Hence, functionally just compensation should be at a level that deters these unwise transactions while allowing socially beneficial transactions to go forward.

But how is that just level of compensation determined? Here the link between private and public law arises because fair market value of property sets the appropriate standard. There are several difficulties in the implementation of this standard. First, most property that is taken through condemnation is not for sale, because the property has greater value in the hands of its current owner than anyone else. To rely on the fair market value for a property that is not for sale necessarily eliminates the owner's surplus derived from his subjective enjoyment of the property. The resulting undercompensation thus leads to a distorted choice between public and private uses. Awarding compensation for subjective value, however, presents distinct valuation problems of its own. Hence, the gap between use and exchange value creates a constant crimp on any valuation system. The second glitch in valuation arises from an emphasis on the value of the "property... taken." (4) Although that formulation looks expansive, it is not. If literally followed, it removes compensation for incidental or consequential damages from government takings, including, for example, site-specific goodwill, (5) and litigation and appraisal fees, which now have become "legislative grace," not constitutional obligation. (6) To ignore these elements of consequential damages is to guarantee that the property owner will be left worse off after the taking than if it never took place at all.

This Essay does address these defects, which, though serious, are not fatal to the mission of the Takings Clause. Even these artificially low compensation levels, when coupled with the considerable expenses to the government to take property, often accomplish a key benefit of the Takings Clause that is never observed in litigation: that benefit is measured in the transactions that are blocked, not executed.

Yet even if we put all these difficulties aside, the valuation of real estate cases is fraught with gratuitous complexities that arise even after courts settle on the right abstract standard for just compensation, namely, that "'just compensation' means the full monetary equivalent of the property taken. The owner is to be put in the same position monetarily as he would have occupied if his property had not been taken," (7) such that he receives "the full and perfect equivalent in money of the property taken." (8) That standard asks courts to determine what counts as the fair market (or exchange) value of the property by looking to "[a]ll facts which would influence a person of ordinary prudence, desiring to purchase the property," such that "any evidence is admissible which might reasonably influence a willing seller and a willing buyer," (9) including, of course, expert evidence from parties with knowledge of the relevant market. (10) In Olson v. United States, (11) Justice Butler wrote:

The sum required to be paid the owner does not depend upon the uses to which he has devoted his land but is to be arrived at upon just consideration of all the uses for which it is suitable. The highest and most profitable use for which the property is adaptable and needed or likely to be needed in the reasonably near future is to be considered, not necessarily as the measure of value, but to the full extent that the prospect of demand for such use affects the market value while the property is privately held. (12) In addition, courts commonly caution that "[a]lthough mere speculative uses of the property should not be entertained by the factfinder, evidence of a potential use should not be excluded merely because it depends upon the existence of extrinsic conditions." (13)

These principles are well established, even if difficult to apply. In the context of the usual takings case, the inquiry is necessarily hypothetical precisely because of the absence of a willing private buyer for the condemned property. There are a number of standard techniques to fill that market gap, including using the discounted cashflow of future use, which seeks (at least for business assets) to determine the expected net profits for each particular period, say a year, and then apply some correct discount rate (usually around two percent after inflation) to determine asset value. Replacement cost (less depreciation) is a common alternative. Both formulas necessarily pose difficult estimation questions, which can raise honest differences of opinion.

In dealing with the valuation problem, I will bracket these estimation issues in order to look to different and disturbing types of difficulties in the valuation enterprise. The law of eminent domain starts with the implicit assumption that the government is in general a good actor whose motives and laudable and whose behavior does not need excessive judicial oversight. Hence the general norm of judicial deference often applies to valuation decisions. In the cases that I shall review, as well as others, a general pattern emerges, whereby all doubtful valuation questions that arise dealing with key problems are at best obliquely touched by the standard valuation formulas. The problems that I shall talk about here involve three major issues. The first of these addresses the many...