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Appeals Court Says: Can't Backdoor Developer's Approach to Valuing Property by Calling it Business Goodwill Loss

By: Bradford B. Kuhn, Rick E. Rayl
12/12/08

After years of little attention, business goodwill recently seems to be a hot topic for the appellate courts (see Mesdaq and Aklilu). Just this week, the California Court of Appeal rejected a creative effort to turn a real estate claim into a claim for lost business goodwill.

On December 5, 2008, the Court in City and County of San Francisco v. Coyne (December 5, 2008, A118222) __ Cal.App.4th ___, confirmed that only "ongoing" businesses operating on the property being condemned can recover business goodwill losses. The Court of Appeal also confirmed that developers of raw land cannot recover anticipated future development profits by characterizing those profits as goodwill losses; the Court equated this theory to the traditionally disapproved "developer's approach" to valuing real estate.

The Decision:

In Coyne, developers of raw land sought to recover the fair market value of their property, along with the future profits of their proposed development. The developers claimed that the development's anticipated future profits fit within the definition of business goodwill. The Court of Appeal rejected this claim, finding that:

(1) the developers did not operate an "ongoing" business on the property, a threshold requirement for recovering business goodwill;

(2) the developers' anticipated future profits were encompassed in their recovery of the fair market value of the real estate; and

(3) the developers' appraiser's attempt to re-coup these "losses" through the label of "goodwill" amounted to a back door attempt to recover profits through the disallowed developer's approach to valuation.

The Background:

In Coyne, real estate developers were in the process of developing a multi-unit residential and commercial complex. They were substantially through the entitlement process when the City and County of San Francisco decided the property was better utilized as open space, and filed an eminent domain action to condemn the property.

In addition to seeking recovery for the property taken, the developers crafted a creative argument that they were also entitled to goodwill losses. In particular, the developers claimed that because goodwill is based on the present value of anticipated future profits, the developers' future profits from leasing the residential and commercial units constituted goodwill. In valuing the "goodwill losses," the developers' appraiser determined the anticipated revenue generated from the development, and subtracted out commissions, project costs, the fair market value of the land, and an expected rate of return. The residual value, according to the developers' appraiser, constituted goodwill. The developers' appraiser calculated these goodwill losses at more than $2 million.

The trial court found that because no units were ever marketed or sold, the developers were not the owners "of a business conducted on the property taken." The Court of Appeal confirmed, holding that the developers could not recover goodwill losses because the developers did not have an "ongoing business" located on the property taken. The Court of Appeal also explained that the developers' "goodwill" theory amounted to little more than a creative attempt to circumvent California's longstanding preclusion of valuation predicated on the so-called "developer's approach."

The developer's approach values raw land based on a specific plan of development, where the costs of improving the land, laying out streets, paying taxes and interest, etc., are subtracted out from the ultimate money the development would generate from the sale of finished units. Courts have found this approach too speculative of a method for valuing raw land. (See Contra Costa Water District v. Bar-C Properties (1992) 5 Cal.App.4th 652, 657-658.) In Coyne, the developers attempted to get around this hurdle by using this developer's approach, but claiming that it was being used to value "goodwill losses." The Court of Appeal found this argument "novel" -- but flawed -- explaining that the developers were attempting to double-dip and receive compensation for lost profits when those losses should be part of the developers' recovery for the real estate. The Court went on to explain that permitting the developers to recover anticipated future profits through goodwill valuation would be "allow[ing] developers of raw land to achieve through the back door precisely what California case law has long denied them at the front, a recovery rooted in a specific development plan."

Thus, while the developers scored points for creativity, their effort to transmute some of their real property claim into a business goodwill claim fell flat. If they had focused their creative efforts on finding ways to maximize the real property value, as opposed to manufacturing a new type of goodwill claim, one can speculate they may have obtained a better result.

Brad Kuhn is a member of Nossaman's Eminent Domain and Valuation Practice Group and specializes in business and commercial litigation with an emphasis on eminent domain, inverse condemnation and other real estate disputes. He can be reached at bkuhn@nossaman.com or 949.833.7800.

Rick E. Rayl is a Partner in Nossaman's Eminent Domain and Valuation and Real Estate Practice Groups and is an experienced trial attorney dealing with eminent domain, inverse condemnation and other real estate and business disputes. He can be reached at  rrayl@nossaman.com or 949.833.7800.

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