Opinion ID: 210344
Heading Depth: 2
Heading Rank: 4

Heading: Need To Consider the Nexus Between the Investment and the Expectation

Text: Finally, the Court of Federal Claims erred in its treatment of the investment-backed expectations prong of the Penn Central analysis. See 438 U.S. at 124, 98 S.Ct. 2646. In Cienega VIII, we explained that, in determining whether the plaintiffs had a reasonable investment-backed expectation, we start with an analysis of the . . . [p]laintiffs' actual expectation because we require actual expectation of, or reliance on the government not nullifying the . . . [p]laintiffs' contractual and regulatory rights as a threshold matter. 331 F.3d at 1346. If the plaintiffs demonstrated a subjective reliance on the prepayment provision, the court was then required to determine whether a reasonable developer in the . . . [p]laintiffs' circumstances would believe that the twentieth-year prepayment right was guaranteed by the regulations and that HUD `authorized' and endorsed mortgage contracts expressly including it. Id. at 1348 (internal citation omitted). As with the other factors, the burden is on the owners to establish a reasonable investment-backed expectation in the property at the time it made the investment. Forest Props., Inc. v. United States, 177 F.3d 1360, 1367 (Fed.Cir.1999). We find no error in the Court of Federal Claims' conclusion that the owners subjectively expected to have the option to prepay their mortgages after twenty years. However, we do think the Court of Federal Claims erred in part in its analysis of the reasonableness of the plaintiffs' expectations. One important aspect of investment-backed expectations is whether, in the regulatory environment, it would be expected that the law might change to impose liability. The test in this respect was set forth at length in Commonwealth Edison Co. v. United States, 271 F.3d 1327 (Fed.Cir. 2001) (en banc). [21] There we explained that [t]he reasonable expectations test does not require that the law existing at the time of [entering into the program] would impose liability, or that liability would be imposed only with minor changes in then-existing law. The critical question is whether extension of existing law could be foreseen as reasonably possible. Id. at 1357. Conducting an analysis under Commonwealth, we explained in Cienega VIII that [w]e have no evidence that the housing programs involved here were part of such a highly regulated field that the owners' expectations were necessarily unreasonable. 331 F.3d at 1350. We concluded that the plaintiffs could not reasonably have expected the change in regulatory approach. Id. ; see also Chancellor Manor, 331 F.3d at 904. We see no basis for revisiting this issue. However, the reasonable expectations prong also requires that the expectations be investment backed, and in this regard further analysis is required. The first step of the analysis is to determine the actual investment that the general and limited partners made in the property. The second step is to determine the benefits that the owners reasonably could have expected at the time they entered into the investment. The third step is to determine what expected benefits were denied or restricted by the government action. (The latter two have been discussed earlier in this opinion.) In other words, it is impossible to determine whether the owners' expectations were reasonable without knowing the total value of the investment; its relationship to the benefits available to the owners, including any tax benefits; and the anticipated benefits that were denied or restricted by the government action. [22] Finally, the claimant must establish that it made the investment because of its reasonable expectation of receiving the benefits denied or restricted by the government action, rather than the remaining benefits. The importance of this analysis is confirmed by the cases. For example, in Penn Central, the Supreme Court explained that the takings analysis requires consideration of the extent to which the regulation has interfered with distinct investment-backed expectations. 438 U.S. at 124, 98 S.Ct. 2646. The Supreme Court noted that a taking does not lie where the restriction did not interfere with interests that were sufficiently bound up with the reasonable expectations of the claimant, id. at 125, 98 S.Ct. 2646, but that a . . . statute that substantially furthers important public policies may so frustrate distinct investment-backed expectations as to amount to a `taking.' Id. at 127, 98 S.Ct. 2646. The Court determined that the relevant investment in Penn Central was the purchase of the property before the zoning regulation was enacted and that the expectation was that it would be used as a rail terminal. Thus the New York City law [did] not interfere in any way with the present uses of the Terminal. Its designation as a landmark . . . contemplate[d] that appellants [could] continue to use the property precisely as it ha[d] been used for the past 65 years. Id. at 136, 98 S.Ct. 2646. The Court concluded that the zoning restriction did not interfere with what must be regarded as Penn Central's primary expectation concerning the use of the parcel. Id. at 136, 98 S.Ct. 2646 (emphasis added); see also MacLeod v. Santa Clara County, 749 F.2d 541, 547 (9th Cir.1984) ([I]t is clear that the denial of the permit did not interfere with MacLeod's primary `investment-backed expectation' concerning the use of the parcel.). Based on Penn Central, the government argues that a taking will not lie where multiple uses can be expected of property, but the law does not interfere with an owner's `primary' investment-backed expectation. Chancellor Manor Appellant's Br. at 56 (emphasis added). The owners disagree with the government's formulation of the reasonable investment-backed expectations test, and argue instead that an expectationeven if not the `primary' oneis nonetheless `investment-backed' if an investor would not have invested but for the expectation. Cienega Gardens Appellees' Br. at 52. While the government's view appears to be supported by Penn Central, we need not determine at this stage in the proceeding whether the reason for the investment must be the primary expectation or simply that reasonable owners would not have invested but for the expectation for as yet the owners have not established either standard. In addressing this question on remand, it is particularly important that the Court of Federal Claims first determine the precise scope of the benefits denied. The owners were not, as discussed earlier, entirely denied the right to prepay; rather that right was denied for a short period, and rents were frozen for a period after prepayment. The Court of Federal Claims must determine on remand whether the rights thus denied were the primary or but for cause of the investment. At this stage, the plaintiffs have not established that a reasonable owner's expectation of an unrestricted right of prepayment after twenty years would have satisfied either standard. The substantial benefits that the owners received, other than the absolute prepayment right, may well have been such that the absolute prepayment right might not have been either the primary or but for reason that a reasonable owner would have invested in the property. Indeed, it is not even clear that a reasonable owner would rely on any aspect of the prepayment right in making the investment, much less that a reasonable owner would rely on an unrestricted right to prepayment. In determining whether expectations of prepayment were reasonably investment backed, it is necessary to inquire as to the expectations of the industry as a whole. Here the expert testimony on this issue was conflicting and, unfortunately, was limited to the expectations as to the general prepayment right rather than the expectations as to the limited restrictions actually imposed by the statute. On one hand, at trial the government presented the expert testimony of Kenneth Malek, an expert in tax accounting and tax-advantaged investments. He testified that neither the general partners nor the limited partners considered residual value [of the property] to be a significant motivation. Chancellor Manor J.A. 102633. This was because [t]he dividends that could be paid as operating cash flow distributions to the investors were limited, and so the benefits that made a material impact on the project from the standpoint of the present value of those benefits were the tax benefits and the . . . front end cash flow to the developers. Id. at 102637. He concluded that the twenty-year prepayment right was not a material incentive. Id. at 102806. On the other hand, William Dockser, Deputy Assistant Secretary of HUD and FHA Commissioner from 1969 to 1972, testified that the ability to discuss an exit strategy in 20 years . . . was a reason why people would undertake to do these programs and a reason why people would invest in the programs. Id. at 500105. The actual contemporaneous offering memoranda appear to provide more reliable evidence of industry expectations with respect to the general prepayment right (though even those do not consider the possibility of the limited restrictions imposed by the statute). Unfortunately the record contains few examples of such memoranda. But those few that are in the record are revealing. For example, when Skyline View Gardens was syndicated, the owners circulated a prospectus that touted the tax benefits of owning the property. While the prospectus assumed that the restrictions would be lifted after twenty years, it also indicated that the owners placed little value on the right to sell the property (or in the absence of a sale, the right to prepay the mortgage). The schedules demonstrating the tax benefits were based on the assumption that the partnership would sell the property after twenty-one years for only $1. Other private placement memoranda did not even assume that the property would be sold after twenty years. For example, the private placement memorandum for Gateway Investors only states that the property is subject to a forty-year mortgage without mentioning the prepayment date. These few contemporaneous documents suggest that the owners entered the programs without relying on the ability to prepay after twenty years. The plaintiffs argue that the prospectus only described the expectations of the limited partners and not the partnership as a whole. This argument is unavailing. Under the securities laws the prospectuses were required to be truthful. See 15 U.S.C. § 77 l (a)(2). In this respect, the prospectuses are particularly reliable. Under the securities laws, the prospectus cannot contain any untrue statement of a material fact or omit[ ] . . . a material fact. Id. This includes misstatements and omissions about the general partner's interest in the properties. See Currie v. Cayman Res. Corp., 835 F.2d 780, 783 (11th Cir.1988) (finding material misrepresentations and omissions under 15 U.S.C. § 77/(a)(2) regarding a general partner's interest in a partnership). Accordingly, the prospectuses must contain any material information about both the limited and the general partners' interest in the properties, and are the most reliable indication of the relative importance of the anticipated benefits. On remand, it is important that the parties provide the Court of Federal Claims with sufficient contemporaneous documents for the court to determine the actual investment and the expectations of the industry at the time that LIHPRHA was enacted.