March 01, 2002

Property Rights After Palazzolo (2002, 16:02)

Property Rights After Palazzolo: When What You Know Can Hurt You

Probate and Property, March/April 2002, Volume 16, Number 2

By David L. Callies

In Palazzolo v. Rhode Island, 121 S. Ct. 2448 (2001), the U.S. Supreme Court addressed the effect that "notice" of an existing land-use regulation has on the two principal classes of regulatory takings: partial and total. The Court held that acquisition of title after the effective date of a regulation does not automatically bar either one.  

 

In Palazzolo v. Rhode Island, 121 S. Ct. 2448 (2001), the U.S. Supreme Court addressed the effect that "notice" of an existing land-use regulation has on the two principal classes of regulatory takings: partial and total. The Court held that acquisition of title after the effective date of a regulation does not automatically bar either one. The Court also lowered the ripeness barrier to bringing regulatory takings claims and clarified the meaning of "economically viable use." Equally important are the issues that the Court foreshadowed but left undecided: the denominator, or relevant parcel, issue; the meaning of investment-backed expectations in partial takings cases; and the application of its notice rule in such partial takings situations.

Palazzolo’s significance is particularly clear when read against the background of the law of takings up until now. It is divided into two principal parts: physical and regulatory. The first—eminent domain, compulsory purchase, or condemnation—occurs when government physically takes an interest in land. There is no "notice" rule here (what a landowner knew or should have known has nothing to do with his entitlement to compensation under the Fifth Amendment). This is important because in the second category, regulatory takings, the U.S. Supreme Court compares total, or per se, takings to physical takings. In all regulatory takings, if a land-use regulation goes "too far" in reducing the use or value of a parcel of land, it is a taking in accordance with the rule of Pennsylvania Coal Co. v. Mahon, 260 U.S. 393 (1922). In Lucas v. South Carolina Coastal Council, 505 U.S. 1003 (1992), the Court set out its per se or categorical rule for total regulatory takings: if a regulation leaves an owner without economically beneficial use of the land, then the owner is entitled to compensation as if the property were physically taken, with two exceptions. If the offending (in a constitutional sense) regulation either seeks to eliminate a nuisance or reflects a background principle of a state’s law of property, then the regulation is valid regardless of its effect on the landowner’s parcel, because the landowner did not have these rights (to perpetrate a nuisance or act contrary to such background principles) as part of his bundle of property rights in the first place. The Palazzolo decision deals with the background principles exception as well.

Far more common is the partial regulatory taking, in which the owner retains some beneficial use of the land. Here, the Court in Lucas (and ultimately in Palazzolo) refers for guidance back to its 1978 decision in Penn Central Transp. Co. v. New York, 438 U.S. 104 (1978). There, according to the Court, it is necessary to engage in a multi-factor inquiry into the nature of the governmental action and the economic effect of the regulation on the landowner, particularly the extent to which the regulation interferes with the distinct, investment-backed expectations of the landowner. As discussed below, the Court in Palazzolo leaves partial takings for another day.

Palazzolo’s Claim

In 1959, Anthony Palazzolo and some associates formed Shore Gardens, Inc., to purchase and hold three undeveloped parcels on Winnapaug Pond in Westerly, Rhode Island. Much of the land was salt marsh, requiring considerable fill to stabilize the land for development. Beginning in 1962, Shore Gardens submitted several proposals to the Rhode Island Division of Harbors and Rivers, all of which the Division rejected. As a result, the parcel sat idle for more than a decade after its purchase.

In 1971, Rhode Island designated all salt marshes as "coastal wetlands," significantly limiting the scope of permissible development. Any filling of or building on Winnapaug Pond or adjacent lands required a "special exemption" from the Council, a state agency charged with the duty of protecting the state’s coastal property. To qualify for an exemption, the statute provides that "the proposed activity must serve ‘a compelling public purpose which provides benefits to the public as a whole as opposed to individual or private interests.’ " Palazzolo, 121 S. Ct. at 2456.

In 1978, Shore Gardens’s corporate charter was revoked for failure to pay income taxes, and title to the property passed to Palazzolo alone as the sole shareholder. Palazzolo then resumed development efforts and filed an application in 1983 to dredge and fill 18 acres. When the Council denied that application as being too substantial, Palazzolo submitted a new—and significantly smaller—development proposal two years later. The Council rejected the second application as well, concluding that the proposed development could not proceed under any circumstances because it did not serve a "compelling public purpose" and, therefore, was inconsistent with the regulatory standard for a special exemption.

Finding no relief in his appeal of the administrative decision, Palazzolo filed a takings claim, alleging that the regulation had deprived him of all economically viable use of his property. This allegation brought his claim within one of the two discrete categories of regulatory actions that Lucas recognized as compensable takings without a case-specific inquiry: (1) regulations that compel the property owner to suffer a physical "invasion" of the property and (2) regulations that deny all economically beneficial or productive use of the land. 505 U.S. at 1015.

The Rhode Island Supreme Court rejected Palazzolo’s claim on three grounds: (1) that the takings claim was not ripe; (2) that Palazzolo was precluded from challenging any regulations that existed before he acquired title to the property; and (3) that Lucas was inapplicable because the parcel retained economically viable use despite the restriction. On appeal, the U.S. Supreme Court agreed that Palazzolo’s claim failed to meet the test for a per se taking under Lucas, but the Court held that the claim could still be considered under the multi-factored Penn Central analysis. In so holding, the Court concluded that Palazzolo’s claim was ripe and that he was not barred from challenging the regulation even though it pre-dated his acquisition of the property. Accordingly, the case was remanded for the state courts to make the Penn Central determination.

Ripeness

In ruling on the ripeness question, the U.S. Supreme Court rejected the state court’s application of the standards enunciated by the Court in Williamson County Regional Planning Comm’n v. Hamilton Bank, 473 U.S. 172 (1985), and MacDonald, Sommer & Frates v. Yolo County, 477 U.S. 340 (1986). Under the Williamson County test, a regulatory takings claim is not ripe until "the government entity charged with implementing the regulations has reached a final decision regarding the application of the regulations to the property at issue." 473 U.S. at 186 (emphasis added). The MacDonald case held that a takings claim was unripe when the claimants had submitted only a single grandiose plan for development and had not demonstrated that less ambitious plans also would be rejected. 477 U.S. at 351. Applying these standards, the Rhode Island Supreme Court held that Palazzolo’s claim was premature because he had not demonstrated that a more modest proposal also would have been rejected.

The U.S. Supreme Court found the MacDonald standard inapplicable in Palazzolo’s case. The Court noted that cases like MacDonald "arose when an owner challenged a land-use authority’s denial of a substantial project, leaving doubt whether a more modest submission or an application for a variance would be accepted." 121 S. Ct. at 2459. Conversely, the Court stated that a takings claim is likely to have ripened "once it becomes clear that the agency lacks the discretion to permit any development, or the permissible uses of the property are known to a reasonable degree of certainty . . . ." Id.

Applying this test, the Court found that the Council had in fact made a final decision regarding the development of Palazzolo’s property. The Court based this decision on the "unequivocal nature of the wetland regulations at issue and . . . the Council’s application of the regulations to the subject property." Id. at 2458. The regulation provides that no development would ever be permitted on or near Winnapaug Pond—or any other "Type 2 water"—without a special exemption from the council, and the council refused to grant such an exemption unless a "compelling public purpose" would be served. Given the council’s clear ruling that neither of the proposed developments qualified for the exemption, the Court easily concluded that Palazzolo’s claim was ripe for review. The Court further concluded that the evidence established that the council had interpreted its regulations as prohibiting fill for any purpose. Without fill, no development could proceed and, consequently, further applications would have been pointless.

The Court’s interpretation in Palazzolo restores a reasoned approach to ripeness issues, assuring fair access to federal courts for takings challenges when the proposed development is reasonably complete and the denial reasonably final. In making ripeness determinations, the Court said, it is important to bear in mind the basic purpose of the final decision requirement:

Our ripeness jurisprudence imposes obligations on landowners because "[a] court cannot determine whether a regulation goes ‘too far’ unless it knows how far the regulation goes." Ripeness doctrine does not require a landowner to submit applications for their own sake. [A claimant] is required to explore development opportunities on his upland parcel only if there is uncertainty as to the land’s permitted use.

Id. at 2460.

Pre-acquisition Regulations

The most significant aspect of the Palazzolo decision was the Court’s analysis of the effect of regulations that pre-date the claimant’s acquisition of the property. Before Palazzolo, a number of lower courts had barred regulatory takings claims when the property owner had notice that the property was subject to the regulation. In Good v. United States, 189 F.3d 1355, 1361 (Fed. Cir. 1999), for example, the court said that "[o]ne who buys with knowledge of a restraint assumes the risk of economic loss." See also Gazza v. New York State Dep’t, 679 N.E.2d 1035, 1037–41 (N.Y. 1997) (no taking occurred because Gazza purchased the property with the knowledge that he would need a variance, and thus he had no right to build anything and no cognizable property interest); Grant v. South Carolina Coastal Council, 461 S.E.2d 388, 391 (S.C. 1995) (no taking because a permit to fill tidelands was required when claimant acquired the property).

Following the reasoning of these courts, the Rhode Island Supreme Court held that the post-regulation acquisition of title was fatal to Palazzolo’s takings claim, whether total (categorical or per se under Lucas) or partial (under Penn Central). The state court reasoned that a purchaser is deemed to have had notice of a regulation that was in effect at the time of acquisition. The regulation, therefore, had become a background principle of state law, which constituted an exception to the takings claim under Lucas. 505 U.S. at 1028–32.

Lucas provided an exception for regulations that merely duplicate land-use prohibitions that already exist under background principles of state law of property. As the Court in Palazzolo observed, "a landowner’s ability to recover for a government deprivation of all economically beneficial use of property is not absolute but instead is confined by limitations on the use of land which ‘inhere in the title itself.’ " Palazzolo, 121 S. Ct. at 2464 (citing Lucas, 505 U.S. at 1029). The Court rejected the application of this exception in Palazzolo’s case, however, stating that a regulation does not become a background principle of law merely by its enactment. Id. Similarly, a regulation that is otherwise unconstitutional absent compensation is not transformed into a background principle of the state’s law simply because the regulation pre-dated the claimant’s acquisition of title. "A regulation or common-law rule cannot be a background principle for some owners but not for others[,]" the Court stated. Id. This is the most important holding in the case. Many commentators and several courts had engrafted such a "notice" rule on regulatory takings jurisprudence, particularly per se takings under the Lucas rule. There is, of course, no such language in Lucas, nor could there be, given the direct analogy of the rule there to the law of eminent domain.

This addendum to the "notice" rule issue emphasizes, but does not resolve, the importance of the categorical exceptions in Lucas. The Court signals in Palazzolo that wetlands protection is not a nuisance but leaves untouched the increasing use of the public trust doctrine and customary law as potential "background principles," as found in some state court decisions. See, e.g., In re Water Use Permit Applications, 9 P.3d 409, 494 (Haw. 2000) (asserting that the state holds water rights in public trust and, therefore, denial of water permit was not a taking); Stevens v. City of Cannon Beach, 854 P.2d 449, 456–57 (Or. 1993) (holding that "the doctrine of custom as applied to public use of Oregon’s dry sand areas" is a background principle of the state property law). The Court’s decision in Palazzolo also leaves the door open to some—but not all—legislative enactments, such as those codifying existing public trust rights previously recognized as limitations on private land titles.

Although Palazzolo’s claim was not categorically barred by the existence of the regulation pre-dating his acquisition of the land, there was dissension on the Court as to whether that knowledge was a relevant fact to be at least considered under the Penn Central partial taking analysis. In a concurring opinion, Justice O’Connor stated that "[t]oday’s holding does not mean that the timing of the regulation’s enactment relative to the acquisition of title is immaterial to the Penn Central analysis. Indeed, it would be just as much error to expunge this consideration from the takings inquiry as it would be to accord it exclusive significance." 121 S. Ct. at 2465. Justice O’Connor reasoned that a landowner’s knowledge of a regulation has a bearing on the landowner’s "investment-backed expectations" under the Penn Central inquiry. "[T]he regulatory regime in place at the time the claimant acquires the property helps to shape the reasonableness of those expectations." Id. at 2466. Justice Breyer agreed, adding: "Ordinarily, such expectations will diminish in force and significance—rapidly and dramatically—as property continues to change hands over time." Id. at 2477.

Justice Scalia, in contrast, reasoned that the existence of a regulation before the landowner’s acquisition of title had no bearing, except as a background principle of property law or nuisance. In his view, "[t]he ‘investment-backed expectations’ that the law will take into account do not include the assumed validity of a restriction that in fact deprives property of so much of its value as to be unconstitutional." Id. at 2468.

The upshot of this debate is that the state courts, on remand, must make an educated guess as to whether Justice O’Connor’s or Justice Scalia’s viewpoint will prevail with respect to partial takings. Although Justice Stevens’s dissenting opinion suggests that he might side with Justice O’Connor, the views of the remaining five Justices are unclear. Accordingly, litigants must tread with caution in this area until a more definitive ruling emerges.

The Denominator Issue

Turning to the merits of Palazzolo’s claim, the Supreme Court concluded, as did the state court, that Palazzolo could not establish a Lucas taking because he had not been deprived of all economically beneficial use of his property. The Court noted that Palazzolo had conceded that his parcel retained at least $200,000 in development value because it could be used for construction of a residence on the upland part of the property. The Court observed that "[a] regulation permitting a landowner to build a substantial residence on an 18-acre parcel does not leave the property ‘economically idle.’ " Id. at 2465.

Palazzolo also argued that the upland parcel was distinct from the wetlands and, therefore, it should not be considered when determining whether the property retains economically viable use. Common to both total and partial takings analyses, this raised the redoubtable "denominator issue": what is the extent of the landowner’s property interest to be considered in deciding whether the interest allegedly damaged is partially taken—is it just the part of the property affected by the regulation or is it the entire parcel owned by the claimant? If Palazzolo were correct, he could have avoided the Court’s conclusion that there was no total per se taking of his property as a whole because part of it—the upland portion—could be used to construct a $200,000 residence. Thus, the property as a whole would not be devoid of economically beneficial use.

In Penn Central, the Court held that the denominator included the entire value of the company’s holdings in the area. 438 U.S. at 130–31. Lucas, however, expressed discomfort with this rule, referring to it as "an extreme—and, we think, unsupportable—view of the relevant calculus. . . ." 505 U.S. at 1016 n.7. Legal commentators have since echoed this comment. See Palazzolo, 121 S. Ct. at 2465.

The Court declined to decide the denominator question in Palazzolo because the issue had not been raised in the state courts. The tenor of the Court’s opinion suggests, however, a willingness to revisit Penn Central’s "entire parcel" theory when that issue is properly before the Court. Meanwhile, the law with respect to this issue is therefore still best stated by the Federal Circuit, which discussed the denominator issue in the context of denials of dredge and fill permits by the Army Corps of Engineers under the Clean Water Act. See Loveladies Harbor, Inc. v. United States, 28 F.3d 1171 (Fed. Cir. 1994). Out of 250 acres owned by the claimant, the court was willing to consider only the devaluation of 12.5 acres for which the Corps had denied a permit. Id. at 1180–82. With the difference being $2.7 million before the permit denial and $12,500 thereafter, the trial court awarded the $2.7 million, which the Federal Circuit affirmed. Id. at 1173–75, 1182–83; see also Palm Beach Isles v. United States, 208 F.3d 1374 (Fed. Cir. 2000) (holding that the relevant parcel for takings analysis purposes was 50.7 acres rather than 311 acres, then later separating out a 1.4 acre parcel in a subsequent decision).

A Partial Taking

Although Palazzolo was unsuccessful in his total taking claim under Lucas, the Court concluded that Palazzolo still had a potentially viable claim under Penn Central. The Court was unable to reach the merits of that claim, however, because the state courts had rejected both the Lucas claim and the Penn Central claim on the notice issue and, therefore, had not engaged in the requisite factual inquiry to determine whether a partial takings had occurred. Having reversed the state court on the notice issue, the U.S. Supreme Court remanded the case for further proceedings, consistent with its opinion, to address the partial taking issue. On remand, the Supreme Court of Rhode Island must balance these Penn Central factors to determine whether denying all construction—except for a single family home on an 18-acre parcel—is indeed a partial taking of property without compensation.

Conclusion

Palazzolo gives property owners and their attorneys a sharper image of the U.S. Supreme Court’s regulatory takings jurisprudence. The Court’s ripeness ruling relieves claimants from the burden of submitting repeated applications for scaled-back development plans when it is clear that the regulatory agency would not approve such plans. The Court also held that claimants are not categorically barred from bringing an action when the disputed regulation pre-dates the claimant’s acquisition of the property. The decision also casts considerable doubt on the broad application of a statutory exception to per se takings under Lucas as background principles of a state’s law of property. Left unresolved, however, is the precise role of custom and public trust as such background principles. Also, whether the landowner’s knowledge of the regulation has an impact on the landowner’s "investment-backed expectations," and, therefore, should be considered as at least one element of a partial takings inquiry. How the Court resolves these questions will have considerable effect on the manner in which takings jurisprudence is applied to regulatory disputes between government and landowner.

David L. Callies is Kudo Professor of Law, William S. Richardson School of Law, The University of Hawaii, and a past chair of the ABA Section of State and Local Government Law.