Section Review

As market rates drop, landowners seek judicial determination of 'Prudent Investor' interest rates in eminent domain litigation

Masterman
James D. Masterman is a partner at Masterman, Culbert & Tully, LLP in Boston. The firm is the sole Massachusetts and a founding, charter member of Owners Counsel of America, a national association of eminent domain and property rights lawyers. The author acknowledges the valuable contributions of Richard D. Vetstein, Esq. to this article.
By law, interest arises automatically upon entry of judgment. The clerk calculates interest in accordance with the statutory rate. Mass. Gen. Laws ch. 79, ß37. That, usually, is the end of the discussion. See Roberts v. Worcester Redevelopment Authority, 54 Mass. App. Ct. 454, 457 (2001). Later this year, however, the SJC is expected to decide two cases that question ministerial application of the statutory interest rate on judgments in eminent domain cases. See Liberty Square Dev. Trust v. Worcester Redev. Auth., App. Ct. 03-P-0075; and M.B. Claff, Inc. v. MBTA, App. Ct. 00-P-1679.

Owners of property taken by eminent domain have long complained that interest on the money owed by the government (in addition to the pro tanto, Mass Gen. Laws ch. 79, ß8A) during the period of delay between the date of taking and date of judgment, must reflect the return the owner otherwise would have received from the real estate market had there been no taking.

Now with an ever-widening disparity between statutory interest, set in accordance with market rates payable for investments in certain commercial grade paper, and the higher rates of return garnered by real estate investors generally, trial judges are being asked to award rates of interest comparable to the return on a real estate investment during the same period. In federal court condemnation, judges routinely set interest rates. The District Court awarded 7 percent in a recent pipeline taking tried by this office. See Portland Natural Gas Transmission System v. 19.2 Acres of Land, 318 F.3d 279 (1st Cir. 2003). But Massachusetts trial judges have not been as receptive, notwithstanding the typical three- to five-year delay between the date of taking and the entry of final judgment.

When there is a delay between a taking and the payment of just compensation, the owner is constitutionally entitled to interest on the damages for the period of delay as an element of Fifth Amendment just compensation. Verrochi v. Commonwealth, 394 Mass. 633 (1985). Interest "serves to compensate for the loss of the use of money due as damages from the time accrued until judgment is entered, thereby achieving full compensation for the injury." Schneider v. County of San Diego, 285 F.3d 784,789 (9th Cir. 2002). Because interest is an element of just compensation and ascertainment of just compensation is a judicial inquiry, the determination of the proper rate of interest is a judicial function. Verrochi, citing Miller v. U.S., 620 F.2d 812 (1980); See also Lopes v. City of Peabody, 430 Mass. 305, 315 (1999).

Effective July 1, 1993, the Massachusetts eminent domain statute was amended eliminating the then statutory rate of 10 percent per annum on all sums recovered above the pro tanto. Statutory interest is "at the annual rate equal to the coupon issue yield equivalent… of the average accepted auction price for the last auction of 52-week United States Treasury bills settled immediately before the date of the taking" but no more than 10 percent. Mass. Gen. Laws ch. 79, ß37. For example, a taking made on Sept. 1, 2003, bears the interest for the 52-week T-bills sold at auction during the week of Aug. 22, 2003. There are two problems with this approach. First, the U. S. Treasury suspended the issuance of the 52-week T-bill effective in February 2001 when the rate was 4.442 percent. Technically, that is the last auction "immediately before the date of taking," but it is not clear whether that rate will be used. What had been a ministerial function for the clerk merely to apply a published rate, now requires interpretation of the statute or for the parties to agree. Second, even if that T-bill were still being sold, or that rate applied, interest rates tied to this instrument are less than the rates of returns real estate investors have earned during the same period for similar risk. Landowners who fail to receive full, fair market value at the time of the taking, are effectively loaning the government money at rates of return lower than they otherwise would have received had there been no taking. Moreover, the interest rates being used are even lower than had the same money been invested not in real estate but in virtually risk free commercial paper.

The Prudent Investor theory: The statutory rate is presumptive only

There are a number of financial and real estate companies who compile data on appreciation (and depreciation) in residential and commercial real estate. Opinions vary as to the returns earned, but it is fair to say that investment in real estate for the last five (10? 20?) years is likely to have resulted in a greater return than that of government securities, generally accepted as the benchmark for interest rates. If it is assumed that Massachusetts will use 4.4 percent (last auction of 52-week T-bill) or a lower rate in accordance with post-judgment interest rates now used by the federal courts (28 USC ß1961), the disparity between that rate and a market return on a real estate investment is evident when other investment opportunities are considered, particularly when it is generally accepted that investments in real estate are more risky and, therefore, require a higher rate of return in order to attract capital. No prudent investor would invest in real estate if the same returns were available for less risk.

A legislative determination of interest is to be accorded due deference, but it is presumptive only; it is not binding on the court. The legislative rate sets a floor, not a ceiling, on the interest to be paid. The constitutional right to just compensation, and thus the right to an appropriate and adequate rate of interest, cannot be limited or diminished by statute. The adequacy of a statutory rate is to be judged and the proper rate of interest is to be determined with reference to the economic circumstances prevailing at the time of the taking. Just compensation is achieved if the total interest awarded is substantially what could have been earned by a reasonably prudent person investing funds so as to produce a reasonable return while maintaining safety of principal, also taking into account that such a prudent investor would likely diversify his or her investment portfolio. What would the prudent investor have earned had the money been invested in a portfolio with similar risk and within a range of similar returns? This is not a clerical function.

For the trial judge to set the appropriate rate, an evidentiary hearing should consider prevailing rates over the course of the period of delay for investments of varying length and risk, including short-, medium- and long-term government and corporate obligations. This approach has been effective in other states. See Redev. Agency of Burbank v. Gilmore, 700 P.2d 794 (Cal.1985) (standard applied and instruments considered); In re City of New York, 449 N.E.2d 399 (1999) (midterm public securities); Georgia-Pacific Corp. v. U. S., 640 F.2d 328 (Ct. Cl. 1980) (reviewing Court of Claims decisions); U.S. v. 97.19 Acres, 511 F. Supp. 565 (D. Mass. 1981) (monetary instruments; Moody's); U. S. v. 319.46 Acres, 508 F. Supp. 288 (W.D. Okla. 1981) (government/private securities with varying maturities). In Verrochi, the court discussed with approval the trial court's consideration of a variety of instruments in assessing the adequacy of the statutory rate, including government securities varying in maturity from three months to three years, one-year T-bills, prime CDs and various public and private short-term instruments.

Comparison with other returns demonstrates that the statutory rate used in Massachusetts is not commensurate with available market rates. The interest on Moody's AAA rated corporate bonds, the standard favored by the Court of Claims (the court of choice for federal regulatory taking claims), averaged 7.27 percent in 1997, 6.53 percent in 1998, 7.05 percent in 1999, 7.62 percent in 2000, 7.08 percent in 2001 and 6.49 percent in 2002.

Moody's BAA rated corporate bonds averaged higher returns for the same period. Rates on 30-year treasury bonds averaged 6.61 percent in 1997; 5.58 percent in 1998; 5.87 percent in 1999; 5.94 percent in 2000; 5.49 percent in 2001; and 5.43 percent in 2002.

Purchase of a five-year treasury note in 1995 yields 6.38 percent; 6.16 percent in 2000; 4.56 percent in 2001; and 3.82 percent in 2002.

A 10-year treasury note bought in 1995 yields 6.57 percent; 6.03 percent in 2000; 5.02 percent in 2001; 4.69 percent in 2002.

The prime rate averaged 8.44 percent in 1997; 8.35 percent in 1998; 8 percent in 1999; 9.23 percent in 2000; 6.91 percent in 2001; and 4.97 percent in 2002. See Federal Reserve Bank Web site (www.federalreserve.gov/releases).

The inequitable treatment of the landowner is further illustrated by interest on judgments obtained by other prevailing litigants. Judgments in contract and tort accrue 12 percent interest per annum. Mass. Gen. Laws ch. 231, ß6B & 6C. Overdue workers' compensation payments are subject to a 10 percent interest rate. Mass. Gen. Laws ch. 152, ß50. Interest on abatements of real estate tax is 8 percent. Mass. Gen. Laws ch. 59, ß69. Moreover, cities and towns pay more money to their bondholders than they do to property owners whose land has been taken. Municipal bonds pay higher rates of interest to those who voluntarily invest than to landowners who become involuntary lenders.

Compounding

A successful real estate investment is measured over time. Returns on a year-to-year basis are informative, but rarely enter into the buy-sell analysis. A real estate investment builds on itself from year to year compounding the return. But in eminent domain, Massachusetts awards only simple interest. Simple interest is calculated by the clerk post-judgment, MRCP 54(f), and no Massachusetts eminent domain decision has ruled that compounding (e.g., interest on interest) is required, though in other areas of the law, compounding has been recognized. But see Scott v. Boston Housing Authority, Suffolk CA No. 88-5555-E (Lauriat, J., July 2003), an employment case. It is within the discretion of the court to compound interest when justice so requires. Sarrouf v. N. E. Patriots, 397 Mass. 542, 554 (1986). And to reflect the reality of the real estate market, and to make the landowner whole after a taking, compounding is required.

Massachusetts courts have failed to follow a recognizable trend in awarding compound interest in eminent domain cases that more accurately reflects market conditions. In several jurisdictions that have dealt with the issue, there is ample support. In Bowles v. U.S., 31 Fed. Cl. 37 (1994), the Court of Claims held that "[w]hile compound interest ordinarily does not run against the government without its consent, this prohibition on interest against the government does not apply in fifth amendment cases. Simple interest cannot put the property owner in as good a position pecuniarily as he would have occupied if the payment had coincided with the appropriation because it under values the [property's] worth." Id. at 52. In awarding compound interest, it was held that "[t]he economic reality is simply that if the full value of just compensation had been [awarded] contemporaneously with the filing of the declaration of the taking the landowner would have been able to earn compound interest. Thus, prohibiting the landowner from recovering compound interest on the deficiency acts to retroactively reduce the value of the just compensation …by undervaluing its present worth. U.S. v. 319.46 Acres, 508 F. Supp. 288, 291 (W.D. Okla. 1981). There are several other cases in the eminent domain context that hold the same, Salton Bay Marina, Inc. v. Imperial Irrigation Dist., 218 Cal Rptr. 839 (1985); Borough of Westwood Crest v. Smith, 563 A. 2d 73 (N.J. 1988) (following U.S. v. 429.59 Acres, 612 F.2d 459 (9th Cir. 1980)); Lea Co. v. N.C. Transp. Bd., 345 S.E. 2d 355 (N.C. 1986) (rejecting statutory interest, adopting prudent investor and compound interest); Wilson v. Fayetteville, 838 S.W.2d 366 (1992) (remanding for consideration of compounding).

Constitutional just compensation incorporates concepts of indemnification for the loss. Compounding an adequate, judicially determined rate of interest consistent with real estate market conditions is the true measure of Fifth Amendment just compensation.

©2014 Massachusetts Bar Association