Eminent Domain Report

When entering into a lease agreement, parties rarely contemplate that the property may be subject to a future eminent domain proceeding.  As a result, many times the condemnation provision in the lease is given little thought.  But when a condemnation action does arise, that provision becomes critically important for purposes of determining how the eminent domain award is to be allocated among the property owner and business owner, and any ambiguities are likely to lead to a dispute as to apportionment of the award.  A recent California Court of Appeal decision, Thee Aguila v. Century Law Group (July 2, 2019 - B289452), highlights what can go wrong and serves as an important lesson on how to avoid such disputes.

Background

In Thee Aguila v. Century Law Group, the Los Angeles Unified School District (LAUSD) condemned a commercial property for a new school site.  The eminent domain action named both the property owner and the business, El Parral Restaurant.  The matter was eventually resolved, and the trial court entered a judgment awarding (i) $6.2 million to the property owner for its interest in the property, and (ii) $6.1 million to the business for its interest in the property, including "any claims for leasehold value, goodwill, fixtures and equipment, relocation benefits, litigation expenses, interest and costs . . . ."

After the entry of judgment, the property owner filed a complaint against the business.  The owner claimed that the business had agreed in its lease that any award received as a result of condemnation was to be assigned to the owner, and therefore the $6.1 million award to the business actually belonged to the owner.   Specifically, the parties' lease provided that if the property was taken by eminent domain:

All awards for the taking of any part of the Premises or any payment made under the threat of the exercise of the power of eminent domain shall be the property of the Landlord, whether made as compensation for the diminution of the value of the leasehold or for the taking of the fee or as severance damages; provided, however, that Tenant shall be entitled to any award for loss or damage to Tenant's trade fixtures and removable personal property.

The trial court concluded that the lease's condemnation clause did not give the owner an interest in the business or entitlement to monies awarded to the business in the eminent domain judgment.  The trial court also concluded that the eminent domain judgment collaterally estopped the owner from any of its various claims to the money awarded to the business in the eminent domain judgment.  The property owner appealed.

Court of Appeal Decision

On appeal, the Court held that the property owner was not entitled to compensation for the business' goodwill.  While parties are free to contract between themselves to allocate eminent domain awards, the lease provision here did not specifically allocate the goodwill of the business to the owner.  While the lease language stated that "any payment" made under eminent domain belonged to the landlord, it went on to state that this applied regardless of whether the compensation was for "diminution of the value of the leasehold or for taking of the fee or as severance damages . . . ."   In other words, the assignment to the landlord was for all real estate claims, which are separate and apart from the lessee's goodwill as an owner of a business.  The Court explained that goodwill exists separate and apart from the parties' interests in the property taken, and the owner's attempt to broadly interpret the lease's condemnation provision was inappropriate.  The goodwill award continued to belong to the business.

The Court further explained that the property owner was precluded from bringing such a separate lawsuit against the tenant with respect to the allocation of the eminent domain proceeds.  If the owner sought to claim the funds awarded to the business, the appropriate time to do so was in the eminent domain action -- not after in a separate action.   Pursuant to Code of Civil Procedure section 1260.220, where there are divided interests in property acquired by eminent domain:

the value of each interest and the injury, if any, to the remainder of such interest shall be separately assessed and compensation awarded therefor. . . .   The plaintiff may require that the amount of compensation be first determined as between plaintiff and all defendants claiming an interest in the property. Thereafter, in the same proceeding, the trier of fact shall determine the respective rights of the defendants in and to the amount of compensation awarded and shall apportion the award accordingly.

Therefore, the owner's only opportunity to contest the apportionment of the award was in the actual eminent domain action.

Conclusion

The case serves as an important reminder for property owners and businesses to carefully draft and review the condemnation provision in their lease agreements.  While a condemnation action is never anticipated at the time the lease is entered into and will rarely occur, when it does happen, the parties need to be prepared and have a good understanding of who is entitled to what.  The allocation of the eminent domain award may have huge consequences, particularly if the property involves a long-term lease, there are substantial improvements made to the site, or there is a wide discrepancy in market and contract rent.

The case also highlights the importance of resolving any apportionment disputes within the actual eminent domain action -- not later in a separate action.  For all parties -- including public agencies -- if there is a dispute regarding allocation of the proceeds, the best approach is to obtain a determination as to the overall award, and then allow the defendants to sort out apportionment.