By Paul Kiernan

Law360 (April 22, 2020, 7:48 PM EDT )

Paul Kiernan

It's remarkable when you stop to think about all the things the American public has agreed to do because a governor or other official issues an order to do so.

During the coronavirus crisis, mayors and governors have ordered businesses closed, blocked access to public property, told people they can't visit relatives in assisted living facilities, even forbidden people from holding parties in their backyards if there are more than 10 guests. The government has pressed hotels and other property owners about using properties to house health care workers.

Of course, everyone might agree that such actions are good, important and should be followed, but what is the legal underpinning for the exercise of such power, and where does such power stop? More pointedly, what can a property owner do when the government shows up at the door with a "request" that the owner surrender the property in service of the public good?

The answer to that question involves analyzing whether the government's action is a compensable taking, and viewing compensation and valuation through the right lens.

Comparing Eminent Domain and Police Power

Individual use of property is always hemmed in by legal restrictions. The government can prevent you from building something that does not comply with zoning requirements and it can stop you from operating a lead smelter in your basement.

Such restrictions usually do not rise to the level of a taking that requires compensation to be paid to the property owner under the Fifth Amendment to the U.S. Constitution (or parallel state laws or constitutional requirements) because the property owner still retains the right to use property in a productive way.

Moreover, the government has not displaced the property owner's ownership or appropriated the property for a public purpose. The exercise of the government's police power to regulate the use of property is not usually compensable.

Eminent domain is an inherent power of the state and federal governments. It generally allows the government to take private property without the owner's consent when the property is to be put to public use, with the government obligated to compensate the owner.

Normally, the exercise of the power of eminent domain, or condemnation, follows a well-established pattern: The government secures funding to acquire real property to build a highway or bridge or for another public use; it approaches the owner to negotiate a purchase price; it files a formal court action to confirm the acquisition at the negotiated price or to determine the compensation due to the owner (usually fair market value); and title is formally transferred through the eminent domain filing.

But the line between eminent domain and the exercise of police power starts to blur in connection with pandemic orders. Whereas eminent domain involves the taking of property for public use, the police power involves regulating the use of property to prevent harm to the public interest.

Is an order to limit the number of customers allowed in the liquor store a taking of the liquor store to advance public health values, or is it a regulation through the exercise of police power? What about the impact on a shopping center of a stay-at-home order directed to residents of the state?

Thus, the first important analytical step for a property owner is to determine whether the government action can properly be characterized as a taking of property as opposed to a regulation of the property's use. Business and property owners who are affected by government orders need to understand on which side of the line they stand, because impacts caused by the exercise of police power are usually not compensable, while the exercise of eminent domain power is compensable.

Take an example using poultry, which is subject to epizootics (epidemics among animals). During the avian flu, certain counties in Pennsylvania were put under a quarantine which prohibited, among other things, shipping day-old chicks outside the quarantine zone.

In a resulting case, the plaintiffs owned a farm within the quarantine zone. They offered evidence that 95% of their business came from shipping chicks around the country, they had already purchased their breeding stock before the quarantine was imposed and the quarantine months coincided with their traditionally busiest season.

The court held that there was no taking under the law and that the plaintiffs were not entitled to any compensation. The government had acted within the proper scope of the police power in imposing the quarantine, had not entered onto the plaintiffs' property, had not destroyed any animals, and had not singled out the plaintiffs for unique treatment — all of which meant that the plaintiffs' property had not been taken.[1]

By contrast, when there was an outbreak of Newcastle disease among chickens in California in 2002, the government imposed a quarantine on certain counties and proceeded to depopulate flocks that had been infected or suspected of such infection, including the plaintiffs' unique breeders. The government argued that no taking had occurred because the government was acting pursuant to its police powers to protect public safety and therefore did not owe compensation.

But the court held that the owner should be allowed to present testimony at trial that its flock was not infected, that that the U.S. Department of Agriculture had made errors in identifying what chickens needed to be destroyed to stop the spread of the disease and that the owner had not received adequate compensation in the payment received from the USDA. If the owner's flocks and eggs were healthy, the government's action in killing them would nevertheless be legal but the government would have to pay just compensation.[2]

Life During Epidemics

Is there a different relationship between the government and private property during an emergency such as war, raging fire or pandemic? Yes.

It's not because the government has new powers during emergencies — although there are statutes that have been enacted during wars or in connection with government-directed acquisition of supplies. The Defense Production Act, for example, authorizes the federal government to jump the customer line or direct allocation of resources.[3]

But separate from statutory increases in power, the government has been accorded greater scope in the exercise of police power because of the greater willingness to determine that something is an impediment to the achievement of paramount societal goals.

At the turn of the last century, the U.S. Supreme Court upheld the authority of the states to take measures in the interests of public health during an epidemic. Anti-vaxxers of their day argued that the state could not compel people to get vaccinated in the effort to eliminate smallpox, but the Supreme Court upheld the state's right to compel vaccination.[4]

In rejecting the opponents' argument that the individual's liberty to decide for himself should prevail, the court wrote:

Upon the principle of self-defense, of paramount necessity, a community has the right to protect itself against an epidemic of disease which threatens the safety of its members.[5]

Another difference during epidemics has been the need for speed.[6] In a typical exercise of eminent domain, a highway project may be under development for years before the government gets to the exercise of eminent domain. During an epidemic, the tendency has been "take first, ask later," so that an emergency can be met expeditiously. Compensation, if required to be paid, can be addressed later.

Thus, during an earlier epidemic, the government destroyed a building infected with smallpox without paying compensation to the owner (and without notice to the owner) because such a building was deemed to be a nuisance whose removal was required to protect the public health.[7] The owner had the later right to contest the designation of his property as a nuisance and, if the owner prevailed, be entitled to payment for the appropriation of his property.

Pressing Property into Service

The government may seize property by physically occupying it and by changing the use of the property to meet the needs of the emergency. When such actions result in a contractual agreement between the government and the owner for the use of the property, the owner is probably without an additional remedy for damages.

Thus, in 1901, authorities in Everett, Massachusetts, found a case of smallpox in a family that was renting quarters in the plaintiff's house. The government quarantined the house and turned it into a smallpox hospital.

Because the government executed a lease for the house, the plaintiff could not complain about the use as a smallpox hospital — even though the plaintiff stated that she didn't understand the effect of the government's act and even though the plaintiff's property was known thereafter in the community as "the pest house."[8]

A question that has arisen — and will arise — in circumstances where the government takes property to use during an epidemic is whether the owner can recover as damages the impact on the property's so-called reputation because of its use during the epidemic. If the owner can show that after the property was used during the epidemic the rental value of the property was diminished, the owner should be able to present that case to the jury in a proceeding to determine compensation.[9]

Unique Valuation Issues

Many, if not most, of the eminent domain issues that are arising during the time of this pandemic will involve temporary takings. The government will be securing or appropriating property for the duration of the emergency or need, and then returning the property to the owners.

Temporary takings present nuanced valuation issues, and an owner must be creative and prepared to fight to recover what the owner is owed when the government takes its property for temporary use.

At its most basic, the government is liable for the market value of the property used — think of it as market rent for the duration of the taking. But temporary takings also involve ripple effects on both the residual value of the property and the balance of the owner's property not taken for use.

In the former category, as discussed above, there may be damage to the property's reputation which continues even after the government returns the use of the property. Will renters pay the same rent after as they did before for a warehouse that contained a temporary morgue for COVID-19 victims?

There may also be effects on the balance of the owner's property not taken by the government. In a permanent-takings case, the concept is labeled "severance damages," — that is the damage caused to the whole property when a portion is taken or severed by the government.

In permanent cases, there is a before-and-after analysis, which looks at the market value of the assembled lot before and the market value for the remainder portion once a piece is taken.

But in a temporary-takings case, there may be another twist on the valuation issue. Imagine a mixed-use building that contains retail or industrial condos on the first two floors and residential condos above. If the government takes the first two floors for uses associated with the pandemic for a year, does that affect — at least for the year — the value of the residential condos on the fifth floor? Assuming that someone with appropriate standing to seek payment can bring that claim, there may be compensation due for the impact on the residential components of the building.

Another aspect of temporary takings may involve the appropriation by the government of someone's business operations. In that setting, the owner may be entitled to more than simply the rental value of the property taken. The paradigm of this issue is the World War II-era case of Kimball Laundry v. U.S.[10]

Acting under the authority of the War Powers Act, the U.S. condemned the property upon which the family-owned Kimball Laundry ran its business. The U.S. Army operated the laundry business for soldiers, even hiring the Kimball employees to run the plant. The Kimballs' own business, however, was suspended until the Army returned the plant to its owners after the war.

Under traditional just-compensation theory, an owner whose business property is taken permanently by the government does not receive a separate award for loss of business or loss of profits. In theory, a fair market value appraisal of taken property would include whatever components of profitability are embedded in the market value of the property (factors such as location, unique suitability of a site, development rights attached to the real estate).

But, as the Kimball Laundry court recognized, during a temporary taking the owner does not have the ability to relocate or to start a second business because, at the end of the taking period, it is getting its property back. The owner's investment remains trapped and inaccessible during the taking.

So although the standard of valuation remains a market valuation — what would someone in the market pay for the transferable assets it is using for the period of the taking? — the owner may also be able to recover increments of value for being deprived of the ability to continue in business during the period of the taking, what might be called the trapped going-concern value that the business owner had built up over the years.

So, too, in our pandemic setting. If the government takes over part of a building and operates its own business there for a period of time, does the displaced business owner have a claim for taking of going-concern value? Is that calculation affected by whether there is any other market use for the property during the emergency?

Conclusion

Owners who are or may be affected by actions that state, federal or local governments take to address a pandemic have to make sure that they are analyzing carefully the scope of the government's action, whether the impact of the action is compensable as a taking or not compensable, and how best to analyze and present valuation of the owner's damages.

There are precedents in how the law has dealt with pandemics or war in the past but (fortunately) the courts have not had to deal with these issues recently or on the scale that the current COVID-19 pandemic appears to present. Unfortunately for owners, the issues here are unusual and interesting — something most people don't want their legal issues to be — and there will be a need for careful and thoughtful approaches to recovery.

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Paul Kiernan is a partner at Holland & Knight LLP.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] Case v. USDA , 642 F.Supp. 341, 343-44 (M.D. Pa. 1986), aff'd, 829 F.2d 30 (3d Cir. 1987).

[2] Cebe Farms, Inc. v. U.S. , 116 Fed.Cl. 179, 200-202 (2014).

[3] For a useful overview of the DPA, see Holland & Knight's webinar, "Defense Production Act and COVID-19: What Companies Need to Know," April 6, 2020.

[4] Jacobson v. Massachusetts , 197 U.S. 11 (1905).

[5] 197 U.S. at 27.

[6] As the court wrote in Brown v. Pierce County , 28 Wash. 345, 68 P. 872, 874 (1902), in allowing someone not specifically authorized by statute to act: "In times of pestilence action must be promptly taken, and health boards may not be able to meet quickly for formal action. Some one should therefore have power to act."

[7] See, e.g., Sings v. Joliet , 237 Ill. 300, 86 N.E. 663 (1908). The decision can also be explained by the fact that the "diseased" building had little market value even if the owner were entitled to compensation.

[8] Sallinger v. Smith , 192 Mass. 317, 78 N.E. 479 (1906).

[9] See, e.g, Hersey v. Chapin , 162 Mass. 176, 38 N.E. 442 (1894) ("the fact that the premises had been used as a hospital for patients sick with smallpox might naturally diminish their rentable value"). In Brown v. Pierce County , 28 Wash. 345, 68 P. 872, 874 (1902), the city of Tacoma, Washington, converted a dwelling into a hospital for smallpox victims. After the use was ended and the place fumigated, the owner argued that no one wanted to rent or occupy the building, notwithstanding the fumigation. The court instructed the jury that their verdict should reflect the fair rental value of the property during the period of the government's use, that is "what damage the property sustained by reason of having been used for a pest house."

[10] Kimball Laundry v. U.S. , 338 U.S. 1 (1949).

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