Condemnation, Tax Certiorari — Determining Functional Utility
By M. Robert Goldstein and Michael Rikon
This column is a follow up to our column of Feb. 25, 2009, with respect to Matter of City of New York (Melrose Commons URA/Kaiser Woodcraft Corp., 11 NY3d 353 (2008)). The Court of Appeals elucidated on its decision in Rose v. State of New York, 24 NY2d 80 (1969), where it had noted that there was a more recent fourth test of what constituted a compensable trade fixture, i.e., substantial loss of value on removal, than the traditional three noted in the case law and cited in the Rose decision. The trial court and Appellate Division had equated that loss to a monetary loss of value. The Court of Appeals disagreed, equated the loss of value to loss of 'functional utility' and sent the case back for a re-determination by the trial court, based upon that criterion.
Examination of the claimant's brief before the Court of Appeals shows that the issue related solely to the fourth test enunciated in Rose and did not make the argument that loss of value, rather than being an independent test was proof of an intention of permanence in that no rational person would install equipment only temporarily if on removal it would bring but a fraction of its value in the second-hand market. We had written articles on this in previous columns. (The authors represented the claimant in Kaiser Woodcraft.) How the trial court would have ruled based on the decision we will never know as the case was then settled. Nor do we know how the Court would rule if the argument was based on proof of intention of permanence rather than an independent fourth test under Rose.
We suspect that it would have made no difference in that before even getting to that point, the Court was putting on claimant the burden of proving an attempt to mitigate damages by relocating its equipment to its new premises (assuming the condemnation had not forced it out of business) and it did not have 'functional utility' there.
We noted in our prior column that we were perplexed with exactly what the Court meant and surmised, based on Rose and cases following it, that a claimant was obligated to relocate his equipment to his new location unless precluded by the 'business necessity' referred to in Rose or the 'economic considerations' referred to in City of Buffalo v. Clement Co., 28 NY2d 241 (1971) and in Matter of Phase II of Stage III of Fulton Park UR (Thatford Cabinet Co.), 57 AD2d 954, 396 NYS2d 99, 100 44 NY2d 974 (1978).
For more than 59 years, we have been involved with clients who have had to deal with the issue of whether equipment should be relocated to a new location and the issues they face in making that decision, i.e., does the equipment have 'functional utility' to them. While easily said, that decision is one of the most difficult a business faces as the result of a condemnation. If an owner should decide to leave his equipment in place and build an entirely new plant with new equipment, by definition, he must be substantially out of pocket. By definition, the amount of an award must be less than his cost. The valuation in place will be new cost, less depreciation, but he will be paying a new cost without that deduction for depreciation. Then he will have to pay attorney's and appraiser's fees, reducing his payment still further as well as take the risks of litigation.
But, then, where does he get the money? He can count on the fact that the advance payment will be low and that it may take years before he gets his full award. Banks will not lend based on the security of a condemnation award. Financing machinery comes at a high compounded interest rate. That rate will be higher than the interest on the award.
Valuation will be as of the date of taking, and purchase of the equipment will probably come substantially later at an increased price, creating a further disparity between what he gets for an award and what he must pay for replacement machinery. Everything else being equal, it would make more economic sense to relocate whatever equipment it can rather than opt for a condemnation award. If for no other reason than the above, we assume if equipment is not relocated, there were other very valid economic considerations.
Well, if the prices are so low in the second-hand market, why not buy second-hand equipment? It is the same problem as with fill. When you want to sell, there are no customers and when you want to buy, there is none available—which is why machinery is valued as a specialty, there is no market. There are not sufficient sales of used equipment to indicate a market value, if they sell at all. Which is also why seeking to sell used equipment will bring prices of from 5 percent to 15 percent of value of the entire plant. Which is also why the usual buyer is not a user but a machinery dealer who will buy an entire plant and must in his price account for the cost of disassembly, transportation and reassembly, plus warehousing until he finds a customer and the risk of not finding any at all, plus the cost of the money he spends until he can find a buyer.
Then you have the problem of buying unknown equipment—will it work the way it is supposed to? Suppose it's faulty? If so, your production suffers to the point that anything gained in opting for used equipment at a lower price is lost and far more. The equipment that is working fine in one plant may not after it has been disassembled for moving and reassembled in a new location. Even with your own equipment, this is a problem, but someone else's unknown equipment, for most, is just not worth taking the risk, even considering a lower initial cost.
Well, suppose, despite the higher costs against the potential award, the owner persists in buying new equipment for his relocated plant. Where does he get the money? He will have bought new equipment long before he gets a condemnation award. Borrowed money, assuming its availability for such purposes, poses, comes at a high cost. This is where the rubber meets the road. The one fact we have impressed on clients over the years, based on our experience, is that shortage of funds is the largest single factor in the failure of a relocated plant, whether with new or relocated equipment. Time after time we have witnessed the bankrupting of what were successful businesses before the condemnation dying for lack of adequate financing for the new plant.
But there are other problems. The proper ty has been condemned and the tenant is facing a time deadline to get out. Assume instead of moving his equipment, he opts to buy new equipment for his plant. Now, he has the worry of machinery deliveries. He cannot be assured of any certain, much less lengthy, tenure at the condemned premises. If new equipment is to be purchased, it rarely is in stock and must be built to order. Delivery times are lengthy and uncertain. There is always the risk that an occupant will be forced out before the new plant is ready to start up. The losses could be ruinous.
So why does he not move his equipment to the new location? Thus far, it appears to be a no brainer, particularly when he would be paid for the cost of the move either under Rose or under the Uniform Relocation Assistance and Real Property Acquisition Policies Act of 1970, as amended (Public Law 91-646) which applies to federally subsidized projects. There is another side to this equation.
The moving of a business and setting up in a new location, then getting the assembled equipment to work properly and in synchronization with the entire plant so as to get production going, very often involves a substantial amount of time. During that time, there is little, if any, production. Not only does overhead continue but so must salary of personnel (that is those who will move with you). The owner's time is fully taken up with the move and start up. He has no time for getting business or handling customers.
Meanwhile, for practical purposes, the plant is out of business. Orders are not being taken or filled and customers are being lost. If it is a competitive business, and very few are not, there will be, because of the shutdown, only the most loyal customers left to resume business with and they may be a fraction of those the business had before the move. Most customers will give their business elsewhere if the business ceases to service their accounts. It cannot service it if it is out of production. When it is finally in production, it will be like a new business just starting out with few, if any, customers. Of course, any profits that could have been made have been lost and the owner can be thankful if he has not lost his business as well. He may lose money by building a new plant but at least he has his business intact. One must assume if something can go wrong, it will go wrong.
He has still other worries. Machinery and equipment, properly serviced, repaired, renewed and taken care of will continue to work in a plant for an indefinite period of time. Most new models of machines put out do not change from basic design concepts of older machinery. Thus older plants continue to operate as well as newer ones and are competitive with them. Further, most operating plants are upgraded as time goes on. But to move this equipment, especially if it has been operating for some time, very often results in it not operating right again. It may be months of trial and error until it does.
If essential to his operation, the result may be drastic. In the meanwhile, he has waived his claim for its value and opted instead for its relocation cost. The rational decision is to only relocate equipment that you are certain will not cause a problem.
These are not easy choices under the best of circumstances. But come condemnation, they must be faced, answers found, and usually under pressure with little time to find solutions. And suppose, having weighed these options, you choose not to relocate your equipment, whether because the risks are too great and you go out of business or rebuild an entirely new plant, where does loss of 'functional utility' fit into this scenario?
Well, in all the three cases we cite herein, other than Kaiser Woodcraft, where no answers as to compensability is given, the Court awarded compensation to the non-relocated equipment as not being relocated because of either 'economic considerations' or 'business necessity.' In all of the cited cases, based on the facts stated therein, the courts presumed it was because of 'economic considerations' or 'business necessity' and awarded compensation. Knowing the problems a claimant faces, it is the only presumption one can make.
Reprinted with permission from the April 29, 2009 edition of the New York Law Journal © 2011 Incisive Media Properties, Inc. All rights reserved. Further duplication without permission is prohibited.