Aug. 3, 2009 – A lease’s value to the lessor or lessee is not factored into the amount of compensation awarded in condemnation of real property, the Wisconsin Supreme Court held on July 17 in Post 2874 VFW v. Milw. Redev. Authority, 2009 WI 84.

Thus, if the underlying property is worth nothing, the leaseholder receives no compensation for the confiscated leasehold interest under the state constitution’s takings clause. A tenant must sue the landlord to redeem whatever value exists separately in the lease, if the lease contract allows for such an action, the court majority explained.

But dissenting justices declared “unprecedented” and “disturbing” the court’s holding that “no compensation” can be considered “just compensation” for the taking of valuable property.

A condemned hotel

The Veterans of Foreign Wars gave its ownership of land at 2601 W. Wisconsin Ave. in Milwaukee to a developer in exchange for a lease of offices in the building the developer constructed at that site. The VFW received favorable terms under the 99-year lease, including the rent of $1 a year. In the decades that followed, different owners acquired the property, but each honored the lease.

When the condition of the building and the surrounding neighborhood deteriorated, the Redevelopment Authority for the City of Milwaukee (RACM) condemned the property. As compensation, RACM offered $440,000 to the VFW and the building’s owner. The VFW appealed the adequacy of the award to the Condemnation Commission, which valued the property at $425,000 according to the unit rule.

Under the “unit rule,” condemned real property is valued as if it were held as an undivided interest, rather than assigning a value to each owner’s partial interest. The amount of an award is then divided among the multiple owners.

Appealing the Condemnation Commission’s decision to the circuit court, the VFW filed a pretrial motion to prevent further application of the unit rule. The circuit court denied the VFW motion.

The jury heard the VFW and RACM appraisers testify that the cost of demolishing the building outweighed any value derived from the vacant land. The RACM appraiser also said the costs of renovating the building exceeded its potential benefits, although the VFW appraiser disagreed. Asked to consider just the value of the entire property, the jury determined its fair market value to be $0.

Before the court of appeals, the VFW argued that the terms of the lease were so favorable, that it had value independent of the underlying property. The court of appeals agreed that application of the unit rule in these circumstances deprived the VFW of just compensation in violation of Article I, Section 13, of the Wisconsin Constitution.

“Just compensation” can be zero

In a majority opinion authored by Chief Justice Shirley Abrahamson, the supreme court concluded that no compensation can be just compensation for a leasehold interest in a property without value.

The justices acknowledged that “just compensation” is determined as much by “equitable principles of fairness” as “technical concepts of property law.” But in a matter that defies easy formulation, the unit rule is a “carefully guarded rule and only in rare and exceptional situations are departures permitted,” the court explained.

Although the unit rule left the VFW with no compensation, the court said this case does not qualify as an “exceptional situation.” The court said the VFW’s loss did not result from application of the unit rule. Rather, the loss is a contract matter between VFW and the building owners who are free to allocate risks such as this among themselves.

Compensate for the land, not the contracts

“[C]ontracts between the owners of different interests in the land should not be permitted to result in a total sum which is in excess of the whole value of the undivided fee,” the court said, quoting Green Bay Broadcasting Co. v. Redevelopment Authority of Green Bay, 116 Wis. 2d 1 (1983).

The court reasoned that the constitution only obligates the public to give full value of the property it takes, but not “to pay excess value attributable to contracts between the owners of different interests in the property.” Moreover, the court pointed out, eminent domain terminates leases so the condemnor is only purchasing the entire fee simple estate.

A “fairness doctrine,” advanced by the court of appeals, imposes a cost greater than the property’s fair market value to compensate the lessee. “The result of the fairness award doctrine is that the condemnor becomes a guarantor of a private lease in low-to-no-value leased property,” the court said. “Such a bailout by the condemnor is not authorized by statute and is not required by the state constitution.”

Likewise, the court said Walgreen Co. v. City of Madison, 2008 WI 80, concluded that a business arrangement extraneous to the lease, but built into a rental agreement, reflects a business-contractual arrangement, not real property value. “The VFW’s sweetheart sale-and-leaseback business arrangement reflects a business-contractual arrangement, and according to Walgreen, should not be considered in determining the fair market value of the fee simple estate,” the court wrote.

In a concurring opinion, Justice Annette Kingsland Ziegler – joined by Justice Michael Gableman – expressed regret that precedent dictated this result. “While my heart may want to rule in favor of the VFW, that would require me to circumvent the unit rule, which our precedent requires that we apply to this case,” Kingsland Ziegler wrote. “To invent an exception here would swallow, and thus abandon, the rule.”

A ‘grossly unjust result’

In dissent, Justice David Prosser – joined by Justices N. Patrick Crooks and Patience Roggensack – wrote that the circumstances presented “cry out for an exception to the ‘unit rule’ because of the grossly unjust result that it visits upon the leaseholder.”

“Zero compensation is not ‘just’ to the leaseholder in this case,” Prosser wrote. “It takes the position that ‘compensation may be just although it does not provide full indemnification to a condemnee’ to its extreme, as though it were some inexorable rule that Stepford judges are powerless to resist regardless of the circumstances.”

Prosser noted that the unit rule was set aside in Luber v. Milwaukee County, 47 Wis. 2d 271 (1970). The Luber court expanded the condemnation award to include the rental income the condemnee stood to lose. “Luber is the flip side of this case, because here, the ‘rent’ was prepaid when the VFW conveyed its entire property to the developer for its leasehold interest,” Prosser wrote.

But the majority rejected the comparison, commenting that decision did not mention the unit rule.

Prosser argued that the City of Milwaukee’s failure to grant occupancy permits so that the building owners could put the property to productive use recalled the inverse condemnation found in Maxey v. Redev. Auth. of Racine, 94 Wis. 2d 375 (1980). The Maxey court sought “to avoid a narrow interpretation of condemnation damages under the unit rule because it recognized damages that were incurred before the formal taking,” Prosser wrote.

Similarly, the VFW had argued that the RACM intentionally refrained from enforcing building codes, permitting the hotel building to deteriorate so that it could acquire the property at a reduced cost.

The court majority faulted the VFW and Prosser for making assertions not established by the record. Further, the court said that the VFW's allegations were inconsistent with the fact that RACM “initially paid a substantial sum in compensation for the taking of a property that was, according to the jury’s verdict, worthless.”

Prosser and the majority also argued over the meaning of Redevelopment Authority of Green Bay v. Bee Frank, Inc. 120 Wis. 2d 402 (1984). Prosser asserted that the Bee Frank court did not actually apply the unit rule in a dispute over the valuation of immovable fixtures, despite its “rhetoric” to the contrary. But the majority said, “The Bee Frank case held that the unit rule is not applicable ‘in determining entitlement to litigation expenses’ … and did not address the manner of determining just compensation under the constitution.”

  ‘What the owner has lost’

In determining a condemnation award, Justice Oliver Wendell Holmes stated in Boston Chamber of Commerce v City of Boston, 217 U.S. 189 (1910) that “the question is, What has the owner lost? not, What has the taker gained?”

The court majority reviewed the facts of Boston in which the property owners sought to be compensated according to the value of the undivided interest in the land that was taken. But Holmes, writing for the U.S. Supreme Court, held that the property owners were only entitled to recover a lesser amount for the actual loss incurred by the condemnation of property encumbered with several easements.

In Brown v. Legal Foundation of Washington, 538 U.S. 216 (2003), this Supreme Court cited Holmes’ principle when it upheld a program that collected interest on lawyers’ trust accounts to fund charitable and educational activities, the Wisconsin justices observed.

  “Only [clients’] funds that could not generate interest for the client were to be placed in trust accounts yielding interest for the use of the Legal Foundation,” the Wisconsin justices recounted.

“The Court concluded that although the condemnor gained a lot of money from the plan of ‘condemning’ the clients’ interest, the clients lost nothing from the taking of interest,” the Wisconsin justices observed. “The Court examined what the clients [the owners] lost, not what the condemnor gained, and concluded that ‘just compensation for a net loss of zero is zero.’”

If Holmes’ words are taken out of context, the Wisconsin justices said, “it could be interpreted as meaning that the condemnor must indemnify condemnees for all losses resulting from the condemnation, although doing so may mean paying more than the fair market value of the property that is taken,”

But the Wisconsin justices said the principle of indemnity does not go that far. “Thus, for example, the United States Supreme Court has held that the condemnor generally may provide just compensation by paying the fair market value of condemned property, even though the market-value standard clearly leaves owners undercompensated to the extent that property is uniquely suited to their needs,” the Wisconsin court wrote.