July 26, 2007

Is condemnation in your business plan?

  • Proper planning can minimize condemnation impacts.
    Schwabe, Williamson & Wyatt

    Real-world business plans rarely address remote contingencies. The lions within immediate view leave little time for business owners to dream up less likely challenges.

    A dozen years ago, few Seattle business owners would have given a moment’s thought to planning against the prospect of a condemnation. However, in the wake of a series of robust public projects including Safeco Field, the Seattle Monorail, Sound Transit’s Central Link and University Link, and the Brightwater Treatment Plant, planning for the possible condemnation of business property is a prudent strategy.

    Washington law grants government entities of all kinds — including the state, cities, counties, public ports and special-purpose entities such as Sound Transit — the right to take private property for public purposes. This is called the right of eminent domain, or condemnation. And as long as there is some possibility the plans for a project might make an acquisition necessary — even if only for the interim construction period — the entity can take property rather than lease it, then later resell it.

    A case in point is Sound Transit’s massive taking along Broadway in the Capitol Hill neighborhood for the purpose of construction staging. This will result in a large assemblage that will surely be resold for a nifty profit once construction is complete.

    Upon determining that the government intends to and can lawfully take property, an owner’s legal rights are restricted to receiving “just compensation” for the taking, which is defined as the fair value of the real property taken plus damages to any remaining property. The condemning agency will make an appraisal-backed offer for the property, which will likely be highly conservative. One needn’t look further than the resale data from the Monorail properties to see how government-appraised values compare to real market values. Absent a negotiated agreement, a condemnation lawsuit provides the final mechanism to determine the value, usually by a jury.

    Most important, the recovery is limited to the value of the real property itself, plus relocation costs in some instances. This means business losses are generally not compensable, even if they are a direct result of the taking. However, there are some steps that can be taken in advance to maximize the chances of a favorable outcome in negotiations or at trial. These should be made a part of your business plan.

    It is critically important to review the key environmental planning documents of public projects being considered in the vicinity of your business location. The draft environmental impact statement will usually list all potentially affected properties months, and even years, before the agency actually notifies owners of its intent to condemn.

    Here are some other steps business owners should take:

    Read all leases

    If you have tenants or are a tenant yourself, review lease(s) for any provisions governing condemnation. The lease may or may not allow for termination, and may address whether the just compensation award is to be shared between the owner and tenant. If leases are about to expire in the face of a potential condemnation, savvy owners will focus on this critical area.

    Steve Dearborn is the CEO of Miller Paint Co., a Northwest institution since 1890. When he became aware of the Seattle Monorail Project’s plans for a potential route that would bridge over Miller Paint’s Ballard location, he took action.

    “I conducted a review of the lease of a small tenant on the property, made sure we were protected, and notified the local manager not to renew the lease without close attention to the condemnation clause,” Dearborn said. “I wanted to make sure that Miller Paint would be in control of the negotiations with the Monorail people.”

    Maximize relocation benefits

    State law generally requires the condemning authority to pay allowances for any moving and related expenses and it is often possible to qualify for relocation assistance. Under the relevant statute, benefits are only payable if the owner or tenant is “displaced.” Therefore, to protect rights to relocation benefits, an owner or tenant should not move out until given written direction from the government.

    Also, relocation benefits are generally not taxable. If a business is faced with a significant relocation benefit, sophisticated tax planning will be in order. In some circumstances, it may be best for a closely held corporation to take as much money as possible in the form of a relocation benefit, even if it reduces the amount of the actual condemnation award.

    Condemnation is an unsought “liquidity event” and business owners need to adjust promptly. Eddie Lee and Michelle Lin, second-generation co-owners of Ajax Parking near Sea-Tac Airport, faced this cold reality when they became aware that Sound Transit would condemn their five-acre park-and-fly lot.

    “We quickly became educated on the special condemnation rules we needed to comply with to preserve an opportunity for a tax-free exchange. We also took a hard look at planning to diversify our business interests,” Lee said.

    Property tax assessments

    If your business may be facing a future condemnation, you should not challenge a tax assessment of your property. Such a challenge could be used against you as an admission of lower value in the government’s condemnation action.

    Check your insurance

    Review the property values declared on your insurance policies to make sure no one you are responsible for has declared values on structures or fixtures that are too low. Otherwise, the government may try to use this low declaration of value as an admission.

    Review the legal title

    In Washington state, “severance damages” are available when the government takes a portion of a single parcel of land or one or more multiple parcels that were used as a unit. Severance damages are meant to compensate the owner for the devaluation of the remaining land. A severance payout is only available, however, if the property taken and the property that remains have the same owner. Therefore, if an owner has several parcels that are either contiguous or used as a unit, the owner should review the status of legal title for each parcel with his or her tax advisor and strongly consider making them all the same.

    Assess other interests

    Make sure you identify all the holders of partial interests in the property, including easement owners, tax liens, mineral rights, mortgagees and lessees. All of these will be affected to one extent or another by the condemnation and there may be some opportunity for adjustment of these various interests prior to the start of condemnation.

    Act early

    This is perhaps the most important step an owner or tenant faced with a condemnation can take. Denial in the face of a potential threat can provide short-term comfort, but it is not a business strategy. The early collection of information about a potential threat of condemnation, as well as early consultation with your business planning team and supporting professionals, can pay dividends in the long run by protecting your right to just compensation and relocation benefits. You can hope you will never need this contingent protection, but you will sleep better knowing that it is in place.

    Dennis Dunphy is a shareholder in the Seattle law office of Schwabe, Williamson & Wyatt, focusing his practice in condemnation law and real estate development risk management.

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