Opinion ID: 2405402
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Heading Rank: 1

Heading: determination and allocation of damages for leased property

Text: As related to the leased parcel, and the determination of the respective damages of the landowners and the lessees, the evidence in this case was directed in a loose way towards application of the method outlined in City of Ashland v. Price, Ky., 318 S.W.2d 861. The key to this method is to ascertain the present fair rental value, compare it with the rent stipulated in the contract and allow the aggregate difference for the period of the unexpired term of the lease (318 S.W.2d 863). Aside from the fact that the foregoing method furnishes no criterion or basis for determining the lessee's damages where only part and not all of the leased property is taken, we have come to the conclusion after thorough reconsideration that the method is completly unsound, unfair and unworkable. Let us use an illustration that is not far afield from the actual facts of this case: The property as a whole, if sold free and clear of the lease, would have a value of $100,000. The fair rental value would be $12,000 per year (there is testimony in this case that 12% rent is fair for commercial property). The lessees have contracted to pay only $6,000 per year. Their lease has 20 years to run. The state condemns the entire tract. By applying the method outlined in the Ashland case, the lessees would be damaged $120,000 ($6,000 per year for 20 years) or $20,000 more than the whole property was worth. This is so patently absurd as to establish beyond any question the fallaciousness of the method. The foreging illustration is not at all inappropriate because in the instant case the lessees were paying $7,200 a year rent; they said the fair rental was $14,400 a year; their lease had 15 years to run; therefore their damage was $108,000. Yet they testified that the leased property as a whole was worth only $120,000 (one said it was worth only $105,000) and the state took less than one-fourth of the area and none of the structures. We think that this Court was led into acceptance of the method advanced in the Ashland case by a failure to adhere to the basic touchstone of property damage measurement, namely, fair market value, and by a mistaken, vague idea that somehow a lease interest can be damaged more than outright fee interest. As concerns the latter proposition, it would seem obvious that if 25% of the market value of property worth $100,000 is taken away from the fee owner, his damages can not exceed $25,000. If, then, the property is leased, how can the total damages rise above $25,000?  There seems to be some idea that the lessee is entitled to compensation for the intrinsic value of his lease, or for loss of business values, or for damages to the particular kind of business operation he is carrying on. The opinion in the Ashland case so indicates. But the landowner himself is not entitled to loss of profits, Newport Municipal Housing Commission v. Turner Advertising Co., Ky., 334 S.W.2d 767. Nor is he entitled to any loss attributable to impairment of the particular business he has chosen to carry on; he is limited to loss of market value. For example, if the owner of land is carrying on a restaurant business and the state condemns such portion of the land as to make it no longer suitable for restaurant purposes, he cannot claim damages for loss of his restaurant business  he can claim only the depreciation in market value of the tract. See Commonwealth Dept. of Highways v. Smith, Ky., 358 S.W. 2d 487. There is no reason why the same rule should not apply to leased property. If the condemnation taking makes the property unsuitable for the particular business of the lessee, the lease may still have market value for some other purpose, so the lessee has lost only the difference between the former market value of his lease and the after market value. Some of the confusion seems to have arisen from the idea that leases ordinarily are not bought and sold, and therefore their market value is not ascertainable. We are not sure that this idea is correct, because many kinds of commercial leases are sold, but regardless of that, property often is sold subject to a lease, so the market value of the lease can easily be ascertained by determining what the whole property would sell for free of the lease, and what it would sell for subject to the lease  the difference is the value of the lease. (Of course, if the lease were disadvantageous to the lessee it would have no value, because the land would not sell for less subject to the lease, but for more. ) At this point we deem it necessary to warn against a possible misinterpretation of the opinion in Korthage v. Commonwealth, Ky., 296 S.W.2d 476. It is that in valuing the property as a whole, as if in unqualified fee ownership, an actual existing lease should be considered as an element of the value of the land. That such is not the rule is shown by the quotation in that opinion from 2 Lewis on Eminent Domain (3rd Ed.), Sec. 716, p. 1253: When there are different interests or estates in the property the proper course is to ascertain the entire compensation as though the property belonged to one person and then apportion this sum among the different parties according to their respective rights. The value of the property cannot be enhanced by any distribution of the title or estate among different persons or any contract arrangements among the owners of different interests. Whatever advantage is secured by one interest must be taken from another, and the sum of all the parts cannot exceed the whole. (Our emphasis) Under the quoted rule we think that if the owner of land has negotiated a lease that is advantageous to him (at a rental higher than the fair rental value), and therefore the property would sell for more than its normal market value, the excess over the normal market value must be considered a profit for which he is not entitled to be compensated in condemnation proceedings. He must be restricted in recovery to fair market value of the fee; otherwise he is being allowed to enhance the value of the property by distribution of the title among different persons. A comparable situation would be where the owner of land had contracted to sell the land to another person for more than its fair market value. If he were held entitled to damages based on the sale price the anomalous situation would be presented  of his being compensated on that basis, but if the land were condemned from the buyer the latter could be compensated only on the fair market value. It is our opinion that strict adherence must be had to the fair market value measure of damages in condemnation, regardless of any contracts affecting the amount of profit a particular person might realize from the property. Returning to the question of apportionment of damages between the landowner and the lessee, we find that other courts have recognized that the proper measure for determining damages to a leasehold interest in condemnation proceedings is the difference in the fair market value of the leasehold before and after the taking. But because they have felt that the fair market value is difficult or impossible to ascertain they have invoked all kinds of formulas and theories in an effort to find an equivalent of fair market value or to reach equitable results. See Annotation, 3 A.L.R.2d 286. As hereinbefore indicated, however, we think that the fair market value of the leasehold (if any) can be ascertained by simply subtracting the fair market value of the land as a whole if sold subject to the lease, from the fair market value of the land as a whole if sold free and clear of the lease. We also think that any departure from this strict rule of fair market value can result only in hopeless confusion. After thorough deliberation we have worked out what we consider to be the most reasonably fair and workable method for determining compensation in cases of condemnation of property that is under lease. Under this method the proof should be directed towards showing, and the instructions should require the jury to find, only the following three values: A. The fair market value of the leased tract as a whole immediately before the taking, giving consideration to the fact that it has rental value but evaluating it as if free and clear of the lease. (This will be factor A. ) B. The fair market value of the leased tract as a whole, immediately before the taking, if sold subject to the existing lease. (This will be factor B. ) C. The fair market value of so much of the leased tract as remains immediately after the taking, giving consideration to the fact that it has rental value but evaluating it as if free and clear of the lease. (This will be factor C. ) (Of course, if the entire tract is taken by the condemnation, this value will be zero and need not be found by the jury, but for the purpose of the following computations C will be considered to be zero.) After the jury has fixed the foregoing three values the judge will compute and apportion the damages as follows: (1) Subtract C from A. The result is the total damages payable by the condemnor. (2) If B is the same as or more than A, ignore B. In this situation all of the damages will go the landowner, because the leasehold had no value, by reason of the fact that the existence of the lease has not impaired the market value of the tract. (3) If B is less than A, subtract B from A, and then divide the difference by A. The result will be the percentage of ownership interest the lessee is deemed to have had in the leased tract before the condemnation. (4) Multiply the total damages, found under (1) above, by the percentage found under (3) above. The result will be the lessee's share of the total damages. Subtracting his share from the total damages will leave the landowner's share. It is proper for the foregoing computations to be made by the judge because they involve only mathematical computations and not a determination of disputed facts. It would confuse the jury to require them to make the computations. We believe the foregoing method is fair because it fixes a market value on the lease and then gives the lessee damages in the  same proportion that the entire property is damaged. As pointed out by Nichols, The award stands in the place of the land and the owners of each interest may recover out of the award the same proportionate interest which they had in the land condemned. 4 Nichols on Eminent Domain, Sec. 12.42, p. 290. The method of course is based on the assumption that the lease value depreciates in the same ratio as the sale value of the entire property, which we feel is a legitimate assumption when it is considered that a commonly accepted method of determining property values is by capitalizing rental values. It is true that the lease value to the particular lessee for his special purposes might depreciate more, but the lessee can protect himself against loss from that factor by assigning the lease to someone who will rent the property for a different use. The method is fair because if the lessee is compensated for the percentage of interest he had in the property taken, by virtue of his advantageous lease, he still retains the same percentage of interest in the remaining tract, which presumably he can realize upon by assigning his lease. Under our view it is immaterial whether the lessee, after the condemnation, will be allowed a reduction in rent in proportion to the reduction in total value of the leased tract, or will be required to continue to pay the originally agreed rent, or will have the privilege of surrendering his lease and being relieved to rent entirely. By virtue of the condemnation, the lessee who originally had an advantage (or the equivalent of an interest in the property) by reason of a favorable rental price, will lose that advantage in the same percentage that the whole value of the leased tract is reduced, whether or not he is allowed a reduction in rent. If by operation of law or by special terms of his contract he is required to continue to pay the same rent he loses more (as between him and the landowner but not as between him and the condemnor), but to give him a larger share of the damages paid by the condemnor would be in effect to relieve him in part from his obligation to the landowner to pay full rent; therefore, it would be improper to give him a larger share. If the lessee exercises a privilege to surrender the lease and be relieved of rent entirely, the result will be that he has lost all of the original advantage he had from his favorable lease, instead of only a portion of such advantage, but the extra loss is due to his election to surrender the lease and not to the condemnation. (Presumably he could assign his lease, for a consideration, to another person who would have a use for the property in its changed condition, and thus avoid the extra loss.) The landowner cannot be damaged more in such a situation, because he has been freed of a lease that was disadvantageous to him. Whether as a matter of law a lessee, after condemnation of part of the leased tract, should be allowed a proportionate reduction in rent is a matter we need not decide. However, see 32 Am.Jur., Landlord and Tenant, Sec. 492, p. 493; Annotations, 43 A.L.R. 1182, 3 A.L.R.2d 330; 1 Orgel on Valuation Under Eminent Domain, Second Ed., Sec. 121, p. 522. We are dealing in the instant case with a short-term lease involving property the buildings on which were constructed by the landowner. However, we see no reason why the method or formula we have outlined would not work in case of a long-term (99-year) lease, or in a case where the lessee constructed a building which at the end of the lease term would revert to the landowner. (In the latter case the lessee would be paying a much lower rent than if the landowner had constructed the building, so the lessee's advantage would be great in applying the formula.) Special complications might arise in a case where the lessee erected structures on the land which by express provisions of the lease he was entitled to remove at the end of the term, but we believe those complications could be met by requiring such structures to be valued separately from the land. As a final word on this phase of the case we say that in applying the formula in the  instant case the restaurant parcel should be treated as in independent tract, separate and apart from the remainder of the 12-acre tract. This is because the application of the formula would be confusing if the leased land and the land not leased were treated as a single unit.