Court of Appeal Holds that a Condemnee is Not Always Entitled to Fair Market Value – But is that Really What the Court Means?

A fundamental underpinning of our eminent domain law is the idea that the property owner is entitled to receive "fair market value" for the property being taken.  But a recent decision by the Court of Appeal seems to find an exception to this fundamental rule where the taking is for an easement across an existing railroad line.

In City of San Jose v. Union Pacific Railroad (2010 Cal.App. LEXIS 864), the city sought to condemn an easement across a strip of land owned by the railroad company in order to widen an existing street.  The court held that the railroad was entitled to only nominal compensation for the portion of the property actually used for the rail line, explaining that a special rule applies in such circumstances pursuant to a 1925 California Supreme Court decision. 

But when one examines the case in detail, it does not depart from fair market value principles; rather, it provides an example of a situation in which the fair market value is essentially nothing.  The bottom line is that sometimes an easement interest has virtually no impact on the value of the underlying fee, resulting in only a nominal award.  This is neither new, nor surprising, despite the court's apparent belief that its decision qualifies as an aberration dictated by stale Supreme Court precedent. 

Case Background

In City of San Jose v. Union Pacific Railroad, the city had an existing road that traversed the railroad's right of way.  It wanted to widen the road, and it sought to condemn additional right of way.  The issue was the amount of compensation to which the railroad was entitled.  The city argued that the railroad should receive only nominal compensation under the decision in City of Oakland v. Schenck (1925) 197 Cal. 456.  The railroad, on the other hand, argued that it was entitled to fair market value for the property based on its highest and best use which, it argued, was not necessarily for a rail line. 

The trial court split the difference.  The court concluded that the railroad was entitled to only nominal value for the property actually required to operate the existing rail line, but that it was entitled to a higher value for the property outside that area.  The court reasoned that the higher compensation was due to the fact that the railroad could theoretically use the additional property for storage or some other, non-railroad use – an option the court deemed unavailable for the property required for the actual operation of the trains. 

Both parties appealed.  On appeal, the court upheld the decision, concluding it was bound by the Schenck decision.  In so doing, the court explained that Schenck resulted in a "different" formula for compensation of easements across existing railroad tracks than traditional fair market value rules.

Did the Railroad Receive Fair Market Value?

Upon further analysis, it appears that the railroad received fair market value, and that the Schenck rule amounts to a particular application of a highest and best use test involving an existing rail line. 

When valuing property in a condemnation action, the appraiser must establish the property's "highest and best use," and then must establish a value that takes that highest and best use into account. 

For property devoted to an existing rail use, it is difficult to imagine any highest and best use analysis that could involve changing the property's existing use.  The very nature of a railroad right of way means that one cannot change the use on one property without disrupting the entire rail line.  Except in situations involving abandoned, or about-to-be-abandoned, rail lines (where one would expect a different analysis and a different result), it is likely that the cost of changing the use on a single property will always dwarf the added value that might be realized by changing that property's use.  In other words, any use other than a rail use will flunk the highest and best use test. 

Because of this, the measure of compensation will derive from the impact the take has on the use of the property as a rail line.  Where the agency is condemning only an easement across the rail line for a street, it is easy to imagine that the taking will have no economically measurable impact on the value of the underlying fee.  And, since eminent domain law measures the value of the property taken from the perspective of what the owner has lost, an award of only nominal compensation is appropriate. 

In the end, the case would not be of much interest except for the fact that the court itself seems to think it is applying a rule that results in an award of less than fair market value.  As it turns out, however, the court got the answer right – and awarded fair market value – despite appearing a bit confused about what it was doing. 

Rick E. Rayl is the Chair of Nossaman's Eminent Domain and Valuation Practice Group and a member of the Firm's Real Estate Practice Group. Mr. Rayl is an experienced trial attorney dealing with eminent domain, inverse condemnation and other real estate and business disputes. He is also editor of the blog, "California Eminent Domain Report." He can be reached at rrayl@nossaman.com or 949.833.7800.