Eminent Domain Report

When a business is taken as a result of a public improvement, the business is entitled to seek compensation for, among other things, loss of business goodwill. Typically, this loss is calculated by measuring the business’ before-condition value and comparing to its after-condition value.  This traditional methodology was the cornerstone for business goodwill appraisers to determine just compensation.  Yet late last year, the California Court of Appeal issued a ruling in People ex rel. Dep't of Transp. v. Presidio Performing Arts Found. (2016) 5 Cal. App.5th 190 which may have changed the law in eminent domain actions by arguably all but eliminating the need to quantify pre-taking -- or before condition -- goodwill value.

Background

The Presidio Performing Arts Foundation (the Foundation), a non-profit founded in 1998, is an acclaimed non-profit dance theatre serving the San Francisco Bay Area youth. In 2009, the California Department of Transportation (Caltrans) undertook a highway project which impacted the building from which the Foundation operated.  The Foundation was displaced from its location and relocated to another facility.  The relocation site resulted in increased rent as well as a less functional space, and the Foundation made a claim for loss of business goodwill.

In January of 2015, the court held a bench trial to determine whether the Foundation could establish entitlement to goodwill. The Foundation’s expert identified indicators concerning the Foundation’s location, its reputation, its workers and its quality, and concluded there was the presence of goodwill at the Foundation before the impact of the project. The Foundation’s expert then opined that these indicators had changed along with the Foundation’s revenues.  Using the discounted cash flow methodology, he determined the Foundation’s before condition cash flow to be approximately negative $14,000 and the after condition cash flow to be approximately negative $77,000.  He attributed the $63,000 shortfall to loss of goodwill.  Capitalizing the lost cash flow, the Foundation’s expert concluded that the Foundation had lost $781,000 in goodwill and opined that the Foundation must have had at least that much in goodwill before the taking.  In other words, the Foundation’s expert did not value the Foundation’s entire business in the before condition, subtract the value of tangible assets, and determine whether there was in fact goodwill remaining, before concluding to whether there was a loss in the after condition.

Caltrans sought to exclude the business appraiser’s testimony since the appraiser did not establish the business had goodwill in the first place. The trial court agreed with Caltrans and concluded that although the taking may have caused the Foundation to suffer a loss due to change in location, reputation, etc., the Foundation had failed to meet its burden under Code of Civil Procedure §1263.510(a)(1) because it failed to prove the quantitative … loss of goodwill.  The trial court relied on City of San Diego v. Sobke (1998) 65 Cal.App.4th 379 (Sobke) indicating that a business must have quantifiable goodwill in the before condition, before the loss of such goodwill can be calculated – a principal which was also affirmed in People ex rel. Dep't of Transp. v. Dry Canyon Enters., LLC, 211 Cal.App.4th 486, 149 Cal.Rptr.3d 601 (Cal. App., 2012).

Court of Appeal Decision

The Court of Appeal disagreed. The Court began its analysis by looking at the definition of goodwill under the statute.  Subdivision (b) of 1263.510 states: [w]ithin the meaning of this article, ‘goodwill’ consists of the benefits that accrue to a business as a result of its location, reputation for dependability, skill or quality, and any other circumstances resulting in probable retention of old or acquisition of new patronage.

Unlike the progeny of cases that have preceded Presidio and have looked for a quantitative before condition goodwill value, the Appellate Court was interested in whether the Foundation offered sufficient evidence of the factors listed in the statutory definition of goodwill, i.e. benefits that accrue…as a result of its location, reputation…., to establish the existence of goodwill.  The Foundation, through witnesses and its expert had produced evidence that it had a favorable location and a great reputation prior to its relocation.  Moreover, since the Foundation had also shown evidence that it had experienced a reduction in patronage and that there were disadvantages to its new location, the Court drew the reasonable inference that the Foundation had goodwill prior to being displaced and of course suffered some loss of the benefits when it relocated.  In other words, the Foundation had goodwill based on the qualities set forth in the statute – and that was sufficient.

The Court reasoned that for purposes of the threshold determination of entitlement to compensation, a party must establish that the taking caused some amount of loss of goodwill due to the taking, but need not quantify the loss in a specified manner. In contrast to Sobke, the court in Presidio concludes:

…we are not convinced ... that the only way to quantify lost goodwill is by establishing pre-taking goodwill value and subtracting post-taking goodwill value. Nowhere in the statutory language is there a precondition that this [goodwill] compensation is available only to a business that, before the taking, had a total business value in excess of its tangible assets, or profits in excess of a fair rate of return on its total assets.

Conclusion

So is Presidio the demise of the before-condition valuation on the threshold issue of entitlement to goodwill, or is it limited to its facts?  Would the Court have decided this case differently if the business wasn’t a non-profit?  The Court does go out of its way to distinguish Presidio from Sobke and Dry Canyon; nevertheless, the decision is likely to have broad implications on future goodwill claims and certainly leaves room for arguments by business owners and agencies alike.