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Business Valuation

June 10, 2003

Business valuation increasingly impacts eminent domain law. The condemned business-owners recognize that they must convince courts that governmental taking of a business causes loss of not only tangible property but also of the intangible aspects of business, including going-concern value and goodwill. The values of the real property and the business that the property houses are inextricably intertwined.  Often, however, compensation is "just" only if the business owner receives the value of the business separate and apart from that of the real property. Some states judicially or legislatively recognize business loss as an element of just compensation, but recovery for business loss remains the exception to the rule. 

Note: Eminent domain and inverse condemnation are distinct concepts, but the same business loss considerations apply in both contexts.  Eminent domain is the legal proceeding by which the governmental authority condemns property, while inverse condemnation is the process by which the property owner recovers just compensation when the condemning authority has not instituted condemnation proceedings. "[Eminent domain] and inverse condemnation are merely different forms of the same limitation of governmental power.  Principals applicable to eminent domain proceedings apply  . . . to suits in inverse condemnation."  Kong v. City of Hawaiian Gardens, 2002 WL 1303390, n.10 (Cal. App. 2 Dist. June 13, 2002).  "Eminent domain" in this presentation encompasses both concepts.

A. Original Framework Of "Property" And "Taking"
Virtually no courts recognized the loss of intangible property as compensable for much of United States legal history.  Some exceptions existed, such as a New York court's early recognition that diverting water from land constituted a taking entitling the property owner to just compensation.  Gardner v. Trustees of Newburgh (N.Y. Ch. 1816).  But the vast majority of courts held to a narrow, purely physical definition of "property."   Courts required physical removal for a "taking" -- physical invasion and appropriation of land for public use.  "Just compensation" consisted of the value of the taken property to the government, not to the owner stripped of its property.  Banner Milling Co. v. State, 240 N.Y. 533, 148 N.E. 668, cert. denied, 269 U.S. 582 (1925).  See generally Lynda J. Oswald, Goodwill and Going-Concern Value:  Emerging Factors in the Just Compensation Equation, 32 B.C.L.R. 283 (1991).

The early definition of "property" as purely physical made sense.  The government wanted the land itself, to build roads and the like.  The land was the most valuable property aspect to the owner as well, particularly in the agrarian parts of the county.   As our economy transformed to corporate and industrial, courts were forced to recognize that the value of a particular property was not necessarily limited to its physical features.   Beginning in the 1940s, the Supreme Court recognized that for the property owner to be compensated "justly," compensation sometimes must include loss of property other than land, including such things as aerial easements and trade secrets.  Ruckelshaus v. Monsanto Co., 467 U.S. 986, 1003-04 (1984); United States v. Causby, 328 U.S. 256, 266-68 (1946).

B. Trend Toward Allowing Business Loss Compensation
1. Kimball Laundry Co. v. United States, 338 U.S. 1 (1949) is perhaps the launching point of the law regarding business loss recovery in eminent domain.  The facts were as follows:  The government temporarily occupied and operated the Kimball Laundry plant to serve the members of the Army.  The market value of the property dropped considerably during the time period in which the government used Kimball's property.  The district court awarded recovery for the physical takings related to equipment, machinery, and the like.  But it wholly denied recovery for the diminution in value of the business caused by the loss of trade routes (customer list and customers' loyal patronage). 

The Supreme Court held that the intangible property of a business owner, in and of itself, does not preclude compensation for its loss -- when a business is temporarily condemned.  The government had in effect pre-empted, or temporarily used, the trade routes during the occupancy period.  Therefore, the Court reasoned, the government had to compensate Kimball for the going-concern value of the lost business, particularly because of the monopolistic nature of public utilities.

As for the actual value of the going-concern of a business taken for public use, the Court reasoned that the lower court should have should considered any evidence likely to convince a potential purchaser of the going-concern value, including records of past earnings, growth expenditures, and gross income.   Further, going-concern value may exist even in a business losing money.  Therefore, the value of a business depends in part on the goodwill and earning power that the owner generated over the years.  For example, a prospective purchaser might decide the value of a business by looking at its total income and not just the owner's investment and physical property.  

The Court recognized that compensating the property owner for the loss of "going-concern value" would require defining the elements of that value:

The market value of land as a business site tends to be as high as the reasonably probable earnings of a business there situated would justify, and the value of a specially adapted plant and machinery exceeds its value as scrap only on the assumption that it is income-producing. And income, in the case of a service industry, presupposes patronage. Since petitioner has been fully compensated for the value of its physical property, any separate value that its trade routes may have must therefore result from the contribution to the earning capacity of the business of greater skill in management and more effective solicitation of patronage than are commonly given to such a combination of land, plant, and equipment. The product of such contributions is an intangible which may be compendiously designated as 'going-concern value,' but this is a portmanteau phrase that needs unpacking.

Kimball Laundry, 338 U.S. 1 at 12-13.  

2. A Trend, Not The General Rule

The law increasingly recognizes business loss as part of just compensation, but courts generally remain reluctant to compensate property owners for business loss that cannot be quantified precisely.  The most common lines of reasoning courts articulate for denying business loss recovery are these:

  • Business loss is too speculative to calculate to an acceptable degree of certainty.  See, e.g., Dahl-Smyth, Inc. v. City Of Walla Walla, 38 P.3d 366 (Wash. App. Jan. 15, 2002).
  • The United States Constitution does not grant compensation for the taking of personal or intangible property.  See, e.g., Heir v. Delaware River Port Authority, 2002 WL 1796580 (D.N.J. Aug. 6, 2002); San Mateo County Transit District v. Flat Rate Rent-A-Car, 2002 WL 856846 (Cal. App. 1 Dist. 2002).
  • The condemning authority has not taken the business from the owner; it has taken only the real property.  Boynton v. State, 215 N.Y.S.2d 953 (N.Y.Ct.Cl. 1961).

C. Market Value

Courts overwhelmingly employ the fair market value standard to determine just compensation for property.  The Supreme Court has defined "market value" as the price property would command in the open market, assuming a willing seller and willing purchaser.  Olson v. United States, 292 U.S. 246, 275 (1934). The Court, however, expressly has recognized that market value may not be the best measure of value in some cases. Id.  See generally Michael Debow, Unjust Compensation:  The Continuing Need For Reform, 46 S.C.L.R. 579 (1995).

The most common valuation methods for determining market value are the following:

1. Comparable sales or market data.

 This method relies on sales and prices of comparable properties and is considered the most reliable approach for determining fair market value of unimproved real property. See generally James D. Masterman, Eminent Domain And Land Value Litigation, SG059 ALI-ABA 377 (2002) and cases cited therein.

2. Income capitalization.

The income method looks at the amount of income the property recently has generated and presently generates, projects future income, and discounts income to present value.  This approach is popular in relation to the fair market value of apartment buildings, office buildings, shopping centers, and the like.  Id.  See also State ex. Re. Filler v. Miller, 812 P.2d 620 (Az. 1991).

3.  Replacement Cost Less Depreciation.

The "cost" method looks at what it would cost at present to construct a comparable structure, plus tangible assets and minus accrued depreciation.   It is thus based on market comparisons – this approach compares the market price for a parcel of land with other similar parcels and accounts for the improved, unimproved, or in-need-of-repair state of the parcels.    See Masterman, Eminent Domain And Land Value Litigation SG059 ALI-ABA 377 (2002) and cases cited therein.

D. Measuring Business Loss

Market value often is inadequate to compensate the business owner for the actual amount of loss it suffers upon the taking of a business that it has built and which has thrived.  Loss of a business means loss of intangibles - including profits, relocation costs, and two intangibles at the heart of just compensation for business loss:  goodwill and going-concern value.

The key to recovering business loss in an eminent domain proceeding is to offer evidence that enables the judge to, in effect, "calculate" the value of the business. Courts tend to admit a wide array of evidence to prove business value.  "In making admissibility determinations in eminent domain proceedings . . . as a general rule, a bias towards inclusion rather than exclusion is the fairer practice."  United States v. 320.0 Acres of Land, 605 F.2d 762 (5th Cir. 1979) citing U.S.C.A. Const. Amend. 5.  See generally Leslie A. Fields, Valuation And Appraisal Techniques For Limited Market And Special Use Properties, SG059 ALI-ABA 75 (2002).

1. Profits and Relocation Costs.

The majority view is that lost profits and relocation costs and losses are not recoverable in eminent domain.  Courts generally deny recovery for lost profits both when the business remains at its location but suffers profit loss during a temporary taking, and when the business loses profits due to forced relocation.  See, e.g., United States v. Petty Motor Co., 327 U.S. 372, rehearing denied, 327 U.S. 818 (1946); State v. Allen, 870 S.W.2d 1 (1994); Kings Mountain v. Cline, 198 S.E.2d 64 (1973).  Likewise, only some jurisdictions allow compensation for relocation costs when the taken business successfully can relocate in only one area or a limited number of areas.  Compare O'Donnell v. State, 370 A.2d 233 (1977) (business owner bears cost of relocating in interest of public); with City of Shreveport v. Standard Printing Co., 427 So.2d 1304 (1983).

2. Goodwill and Going-Concern Value.

Proving the value of goodwill and going concern is the valuation expert's biggest challenge.  These two intangibles are distinct conceptually, but courts often consider them as two parts of one aspect of business loss.  See Oswald, Goodwill and Going-Concern Value, 32 B.C.L.Rev. 283, 289-90 (1991). 

  • Goodwill is "the tendency for customers to return to the same location or business because of its name or other attributes, regardless of its location," and the "value which inheres in the fixed and favorable consideration of customers, arising from an established and well-known and well-connected business."  Los Angeles Gas & Electric Corporation v. Railroad Commission, 289 U.S. 287, 313 (1933) (citations omitted); Benjamin Cardozo, Marriage of Brown (NY 1926). Calculating goodwill involves (1) capitalizing excess earnings, assuming that past performance is a predictor of the future; or (2) calculating the difference between sales price and tangible asset value.
  • Going-concern value is the advantage in "acquiring an operating business" instead of starting a new business.  Avoiding start-up costs and assuming in-place operating and marketing procedures contribute to going-concern value.  An established business generally has a higher rate of return than a comparable new business because of going-concern value.  Los Angeles Gas & Electric, 289 U.S. at 313; City of Omaha v. Omaha Water Co., 218 U.S. 180 (1910); Gray Line Bus v. Greater Bridgeport Transit Dist., 449 A.2d 1036 (1982) (citations omitted); Comment, Depreciability Of Going Concern Value, 122 U. PA. L. REV. 484 (1973).

3. Medical Practices, Hotels, Limited Market Businesses.

Business valuation for these entities requires particularly keen attention to the variable weight of the multiple components of real property, personal tangible property, profit, relocation, goodwill, and going-concern value.  For good discussion of the valuation of these businesses, see Thomas E. Kabat, Hotel Valuation And Considerations In Eminent Domain, SG059 ALI-ABA 245 (2002); Valuation And Appraisal Techniques For Limited Market And Special Use Properties, SG059 ALI-ABA 75 (2002). 

E. Judicial And Statutory Recognition of Business Loss

Courts and legislatures in several states within the past decade or so have narrowed application of the business losses rule.  (Louisiana did so by constitutional amendment.)

1. State Statutes.

A business owner may recover goodwill by proving (1) the taking of property or injury to the remainder caused the business loss, (2) neither relocation nor other reasonable steps will prevent the loss, (3) no other statutory or other form of recovery will include compensation for the loss.  West's Ann. Cal. C.C.P. § 1263.510.

"Where less than the entire property is sought to be appropriated," "an established business of more than 4 years' standing before January 1, 2005," or "an established business of more than 5 years' standing on or after January 1, 2005" may recover for business loss.   Florida Stat. §  73.071.

Public service companies must compensate owners for damage to business as a separate element of value.   29 V.S.A. § 792, 30 V.S.A. § 112

Any time the power of eminent domain is exercised pursuant to this act, the property owner shall be compensated for all damages associated with the taking of the land including costs of moving a dwelling or equipment or any loss of present or future business or other associated damages personal to property owners.
OK. St. T. 27, § 7.1

The expert witness may address the capitalized value of the reasonable net rental income attributable to the condemned property.  Ala. Code 1975, § 18-1A-196(4).

A business owner may recover for loss of goodwill by proving the same elements that the California statute demands.
W.S.1977 § 1-26-713.

2. Judicial Reform.

Georgia courts allow recovery for business loss when the condemned proves that the condemned property has a "unique or peculiar relationship to the condemnee and his business."   Metropolitan Atlanta Rapid Transit Authority v. Ply-Marts, 241 S.E.2d 599, 601 (Ga. App. 1978).

The property owner must be in as good a position post taking as it was pre taking.  Michigan allows recovery of goodwill and going-concern value, however, only when the business is taken for use as a going concern.  See City of Detroit v. Michael's Prescriptions, 373 N.W.2d 219, 220-21 (1985) (citations omitted); In re Edward J. Jeffries Homes Housing Project, 11 N.W.2d 272, 276 (1943) (citations omitted).   See generally Oswald, Goodwill and Going-Concern Value, 32 B.C.L.Rev. at 342-44.

Minnesota courts hold to the general rule denying recovery of going-concern value in condemnation but recognize the need to make exceptions and allow recovery of intangible damages.  See Oswald, Goodwill and Going-Concern Value, 32 B.C.L.Rev. at 338-39 and cases cited therein.

Case law in Wisconsin is inconsistent as to whether the business owner may recover for incidental losses.  In Luber v. Milwaukee County, 177 N.W.2d 380 (1970), the Wisconsin Supreme Court held that rental income is a property interest for which an owner must receive compensation.  Recent decisions, however, are in sharp contrast.  For example, in Rademann v. Wisconsin Department Of Transportation, 642 N.W.2d 600 (Wis. Ct. App.), review denied, 648 N.W.2d 476 (2002), the court held that (1) evidence of net income is speculative and therefore ordinarily inadmissible to establish property values in condemnation cases involving commercial enterprises, and (2) expert valuation testimony as to income is inadmissible because the trier of fact cannot be expected to ascertain how much income can be attributed to the owner's management versus consumer goodwill.

 F. Recent Case Law

The following recent case law fairly represents the differing treatment of business valuation as an element of just compensation among the courts of various states.

1. Dahl-Smyth v. City Of Walla Walla, 38 P.3d 366 (Wash. App. 2002).  The Court of Appeals held that the condemned (a franchisee) could not recover for loss in value of the franchise that occurred when the country stripped it of the right to serve some of its customers.  The franchisee operated a waste-collection business for nearly 40 years and held the exclusive right to provide waste collection in the county.  The county government reconfigured county lines via annexation, which caused the franchisee to lose customers.  State statute required the county to compensate the franchisee for the customer loss that the annexation caused.  Nonetheless, the court held that the franchise certificate was not a property right. 

2. City of Englewood v. Denver Waste Transfer, 2002 WL 287629 (Colo. App. Feb. 28, 2002).  Residual value land method accurately calculated value of land that the condemned was planning to develop as a waste transfer station.  The valuation accounted for business profits, but did so as a factor in calculating the amount a willing buyer would pay for the land. 

3. Waghray v. City Of Westlake, 2002 WL 509557 (Ohio App. 8 Dist. April 4, 2002).  The condemned could not recover lost profits when its business was forced to relocate to a less desirable location due to a public street improvement. 

4. San Mateo County Transit District, 2002 WL 856846 (Cal. App. 1 Dist. May 6, 2002).  Car-rental company could not recover for loss of goodwill because it held no lease, and hence no property interest on which to base loss of goodwill.  The car rental company leased the condemned property, but its long-term lease expired before the condemnation and it had since leased on a month-to-month basis.   

5. Housing and Redevelopment Authority of St. Paul v. Lambrecht, 645 N.W.2d 157 (Minn. App. 2002).  The fact that the condemned's lease would terminate upon condemnation did not negate its claim for going-concern value of its business.  The fact that the condemned could have relocated the business did not mean that its present (condemned) location was not an element of its going-concern value. 

6. Heir v. Delaware River Port Authority, 218 F. Supp.2d 627 (D.N.J. 2002).  Contrary to the above, in New Jersey the federal court held that franchisees did not to have a compensable interest for the loss of their franchise, where the agreement provided that it would termination upon condemnation, where there was no other legitimate expectation the franchise would continue, and where only the real property was taken as opposed to the business as a going concern.

7. City of Virginia Beach v. Oakes, 263 Va. 510 (2002).  The Virginia Supreme Court held that a landowner could not recover lost profits on the basis of a proposed office building, where the evidence was too speculative that an office building would have been built on the property.

8.  State of Washington v. Hokenson, 2002 Wash. App. LEXIS 2436 (Oct. 7 2002).  The Washington Court of Appeals recognized that "temporary loss of use of property, including loss of income," may be compensable as consequential damages in a condemnation of a portion of property.

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