EXPROPRIATION: A legal and valuation perspective OVERVIEW Expropriation is commonly understood to be the compulsory acquisition of property by statutory authority. Expropriation law does not exist at common law and is considered to be entirely a creature of statute – federal, provincial or territorial.1 Expropriation powers may be exercised by governments as well as by a host of statutory bodies and institutions, including municipalities, hospitals, universities and public utilities, all of whom have expropriation powers delegated to them by legislation. Privately owned pipeline companies may acquire expropriation powers under the National Energy Board Act or under certain provincial legislation. These expropriating bodies are usually called the "expropriating authority." Expropriation legislation encompasses interests in land, some interests falling far short of complete ownership. Interests in land include not only the fee simple, but also mortgage interests, interests in tenancies, formal and informal easements, licenses, and the like. Almost any interest in land recognized in law is capable of being expropriated, despite any informalities that may surround the creation of the interest.2 Expropriation usually transfers ownership of the expropriated property effective the date of registration of the expropriation documents in the appropriate registry of deeds. However, the expropriating authority need not expropriate the fee simple in a property. Often, it expropriates an interest less than fee simple. Pipeline expropriations are an example, where the pipeline company normally expropriates an easement or right of way under the National Energy Board Act or provincial pipeline expropriation legislation. In the end, all persons having legal interests in land are considered to be "statutory owners." Many expropriation statutes permit expropriated owners to object to the fact of expropriation. Nevertheless, such provisions may be more window dressing than real. It is not often that an aggrieved owner can successfully challenge the fact of an expropriation. The issue thus comes down to one of compensation. If the landowner's claim cannot be resolved by informal negotiation, the process in most jurisdictions requires the expropriating authority to launch a formal expropriation by filing the notice of expropriation in the registry of deeds, and serving the notice on all those who have an identifiable interest in the property. Within a limited time (usually 90 days), the expropriating authority must serve a "statutory offer" upon the expropriated owner. The statutory offer is a "without prejudice" offer of compensation (in whole or in part) that the owner is entitled to retain while still exercising his right to claim more under the expropriation legislation. The statutory offer is accompanied by the expropriating authority's formal appraisal of the interest expropriated. Some statutes require the offer to be based on the fair market value of the property expropriated. Other jurisdictions require the offer to be based on the fair market value plus the injurious affection. After rejecting the statutory offer, the owner may launch legal proceedings by filing a notice of claim or other originating document with the tribunal assigned to settle compensation issues under the expropriation legislation. The matter then proceeds very much as ordinary litigation, including document exchanges and discovery examinations. The Tribunal In some jurisdictions, expropriation claims are heard by permanent administrative tribunals.3 In other jurisdictions (e.g., Canada, New Brunswick, Manitoba), a superior court judge acts as the compensation tribunal. There may be significant differences in the frequency of cases heard, degree of expertise and knowledge about expropriation matters in compensation tribunals from one jurisdiction to another. A permanent compensation tribunal may acquire considerable expertise in dealing with compensation matters, reducing the need for lengthy and detailed explanations from the experts about standard valuation techniques and procedures. A superior court judge sitting as the compensation tribunal, on the other hand, may deal only occasionally with expropriation matters and may be quite unfamiliar with such techniques and procedures. Types of Compensation Claims In "market value" jurisdictions, there are three or four different types of damage or heads of claim that may be advanced: 4 1. Fair market value of the property taken. 2. Injurious affection (i.e., severance damage or diminished value) to the owner's remaining property caused by the construction or public work following from the expropriation. In some jurisdictions, injurious affec- tion may also include personal and business losses and other consequential damages, whether or not land is taken.5 3. Disturbance damages, i.e., the losses, costs or expenses involved in a dislocation of the expropriated owner or tenant from her property due to a complete or almost complete taking of the property. 4. Loss of a special economic advantage (in some jurisdictions) which accrued to the owner personally and was not an attribute influencing the market value of the property itself. Market Value Defined A helpful definition of market value is provided by the New Brunswick Court of Appeal in Henderson v. Minister of Tourism: 6 "Market value is defined herein as being the highest price in terms of money which a property would bring if exposed for sale on the open market, allowing a reasonable time to find a prudent, fully informed purchaser, buying with knowledge of all the uses to which the property could be adapted or capable of being used, and purchasing from an equally prudent and informed vendor, with neither party acting under duress." Under the USPAP Guidelines, 7 market value is defined: "the most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby: 1. Buyer and seller are typically motivated; 2. Both parties are well informed or well advised, and acting in what they consider their best interest; 3. A reasonable time is allowed for exposure in the open market; 4. Payment is made in terms of cash in Canadian dollars or in terms of financial arrangements comparable thereto; 5. The price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale." Injurious Affection Injurious affection claims include the reduced market value of the unexpropriated property as well as damages from construction or use where part of the land is taken. Where no land is taken, a claim may be made for the reduction in market value and personal and business damages arising from the construction. Injurious affection claims generally provide two sets of rules, each with a different rationale, depending on whether some or no land is taken: 1. Partial taking – deemed to be a willing buyer and seller in a notional market setting: 2. No land taken – the loss is limited to construction only, not the use. These claims are based on tort principles (e.g. trespass, nuisance, negligence). Such claims are not based on principles of vendor and purchaser. The claims deal with the interference with enjoyment of land. Compensation is given as a substitute for damages at civil law. Injurious affection claims where no land is taken are an anomaly under expropriation law in that they make available the procedure appropriate to an expropriation claim available for in effect a civil wrong. According to some authors, these injurious affection claims do not properly belong in expropriation law, but are there for convenience. The courts have set out the legal elements required for such a claim to succeed, i.e. the claimant must prove the following: " (1) The damage must result from an act rendered lawful by statutory powers of the person performing an act; (2) The damage must be such as would have been actionable under the common law, but for the statutory powers; (3) The damage must be an injury to the land itself and not a personal injury or an injury to business or trade; (4) The damage must be occasioned by the construction of the public work, and not by its use." 8 Loss of Access Loss of access claims (a form of injurious affection) are based upon the impairment of the common law right of access to property. It is an actual loss of an incident to property, but not necessarily of a registerable right. Therefore, there may be no formal expropriation proceeding taken by the authority. The loss can be very serious, including landlocking property, or bypassing and re-routing traffic past a commercial district. 9 Excess Mileage Costs In another common form of injurious affection, the severance of a farm or commercial property by a major highway may cause excess operating costs associated with increased travel distances for machinery and equipment. The excess cost of certain altered operations may need to be identified by a consultant. That cost must then be present-valued if it is to continue into the future without a reasonable prospect of mitigation. Disturbance Damages Disturbance loss claims generally refer to those losses suffered by an owner by reason of having to vacate the expropriated property, including a claim for goodwill if the business cannot be relocated. The range of disturbance claims can be infinite, from the costs of moving an entire factory to the purchase of new drapes for the office. If the loss is created as a direct result of the expropriation or in anticipation of expropriation, it is recoverable. Security Holders Normally, security holders are entitled to be paid out according to the terms of their security agreement or to be paid a "bonus" for early retirement of their loan. Registered judgement creditors are not considered security holders unless covered in the statute and are entitled to be paid out in full upon the taking of any property of the judgement debtor. Valuation of Tenancies Tenants are considered to be statutory owners and are entitled to be paid for injurious affection, disturbance and relocation costs, and loss of income. They are also entitled to be paid the loss on the tenancy, i.e., the present value of the remaining term of the lease below the current market value for the lease of a similar property. Income and Property Tax Implications Under the Income Tax Act, an expropriation is a deemed disposition of property. Either on a fair market basis or an equivalent reinstatement basis, there is likely to be some adjustment of the undepreciated capital cost of the fixed assets, and income tax implications related to the recovery of any business losses. Taxes are payable on recapture of capital cost allowances. Business losses recovered are taxable as income. While corporate taxes payable on expropriation compensation are not normally claimable, there may be a claim made for tax liabilities which have been accelerated because of the expropriation.10 As well, if the tax liability arising out of business loss recovery is greater than that arising out of the recapture of capital cost allowance, it may be in the owner's interest to allocate the proceeds of the claim to asset values instead of income values, to the extent that this is possible. The advice of an accountant or tax lawyer should be sought. In addition to income tax implications, there may well be property tax implications where the business or home is relocated from a comparatively low property tax regime to a high tax regime. The increased property tax payable in the new location is an item of disturbance damage which must be recovered by the homeowner or the business because the owner's income or revenue is not necessarily increased by virtue of the relocation. Costs Costs are recoverable by the owner if he succeeds in recovering at least the amount offered by the statutory authority. Otherwise, the costs are at the discretion of the court or tribunal hearing the matter. QUANTIFICATION OF BUSINESS LOSSES IN AN EXPROPRIATION SETTING The Legal Basis for Awarding Business Losses The object of expropriation is to provide full and fair compensation to persons whose land is expropriated. Compensation is payable for all losses provided the loss is not too remote and is the natural and reasonable consequence of the expropriation. This will include losses suffered in anticipation of expropriation even before the actual or formal expropriation takes place.11 The legal rules for measuring business losses take into account the requirement that plaintiffs claim damages once and for all, even though the prospective loss has not yet occurred at the time of assessment and may never materialize.12 While risk and contingencies are familiar notions to the commercial world, their implications are not necessarily understood in the same way in the judicial arena. The legal principles followed in assessing business losses in general, apply to the evaluation of those losses in an expropriation setting. Experts must, of course, understand the legal principles imposed upon them in the valuation assignment, because they may need to consider a set of unfamiliar legal concepts. Even though they have followed the accepted precepts of their own profession, their opinions may be rejected because they are inconsistent with some legal rule that limits or governs the measurement of the losses in the instant case. If experts do not understand the special rules, their opinions may go terribly awry. While experts are normally taken to know the law pertinent to their calling, it is the responsibility of legal counsel to acquaint the experts with the appropriate legal principles that will affect their valuation conclusion. The principles of valuation are equally applicable to expropriation claims where there has been a business loss either as a result of injurious affection or because of a partial or complete dislocation of the business. There are, however, statutory restrictions on the quantification of such losses, which may vary somewhat from one regime to another. Valuators and appraisers must be familiar with the expropriation laws of the jurisdiction in which the claim arises.13 In measuring business losses in any litigation setting, we are generally bound by decided cases, which may not add much to the process of quantification because they were either wrongly decided at the time or would no longer be decided in a similar fashion today. Professional knowledge of valuation techniques continues to improve with the result that current valuation theory and practice may no longer support many earlier decisions. Decisions of a certain vintage must be carefully scrutinized for accuracy and relevance in light of present knowledge and practice. Mitigation When business losses occur, legal doctrines of mitigation raise limits to the defendant's liability to compensate for loss, even where fault and causation are not in question. Doctrines of mitigation are equally applicable in expropriation cases. In general, a claimant will be denied recover with respect to those losses that he reasonably could have avoided. The question whether or not the landowner satisfied the duty to mitigate is a legal question to be decided by the tribunal. However, the question as to the measure of the mitigation may well be a valuation problem, an issue of fact.14 Measuring Past and Future Losses By the time damages are assessed by the expropriation tribunal, many years may have elapsed since the date of expropriation. Some of the losses have already occurred or the anticipated losses have not in fact materialized. As to the approach the court or tribunal should take in assessing damages for past and future lost profits, see the decision of Justice McLachlin in Houweling Nurseries, supra: "In order to recover damages for breach of contract, a Plaintiff must establish two things. First, he must prove on a balance of probabilities that the Defendants breach of contract resulted in the damages claimed. Second, he must establish that the damages are not too remote—that is, that they represented a type of loss which was reasonably foreseeable to the Defendant when the contract was made... What constitutes proof of loss of profits on a balance of probabilities? The Defendant says the element of the loss must be established with reasonable certainty, and must not be speculative or conjectural. It goes so far as to contend that damages for loss of future business must be confined to contracts existing at the time of breach and cannot be awarded for future contracts... That proposition is not in accord with the general tenor of English and Canadian authority, which has long recognized the right to recover damages for the loss of future business which have not been established with specific certainty..." She went on to say: "Assessment of damages for lost profits caused by a breach of contract is, in this respect, analogous to assessment of damages for personal injury resulting from a tortuous act. In so far as mathematical figures and calculations can aid in arriving at a fair and realistic estimate of damages, this should be used. At the same time, it must be recognized that aspects of the claim may not be capable of precise mathematical calculation; this is particularly true of claims for losses in the future. Even when this is the case, however, mathematical calculations may serve as a useful guide. In this case, the parties having based their cases on precise mathematical calculations, it was essential that the trial judge consider the validity of the factual assumptions upon which the calculations were based."15 There is usually little conceptual difficulty in measuring past losses of profit (i.e., losses incurred between the date of the expropriation and the time of assessment), although there may be substantial arguments as to what that loss actually was. In assessing past losses, the damage issues may concern questions about causation, remoteness and legal obligations of mitigation. Past loss of profits are dealt with generally in the following manner: - Anticipated profits as if no expropriation; - Less earned profits despite expropriation to date of assessment (mitigation). - Plus statutory interest (usually 6% per year) on lost income, if applicable16. The calculation of future losses, on the other hand, may have many more dimensions. The quantification of future businesses losses has many of the same features of some types of market valuations in that both are normally forward looking, based on the prospect of earning or replacement of a future stream of earnings or expenses, which may or may not materialize. As one court described the dilemma, equally apt in the measurement of future business losses: "Value, under any plausible theory of capitalized earning power, is necessarily forward looking. It is an expression of the advantages that the owner of the property may expect to secure from the ownership in the future. The past earnings are therefore beside the point, save as a possible index of future earnings."17 Generally, the process for evaluating future losses is the following: - Anticipated profits as if no expropriation during the future; - Less anticipated earned profits despite breach during future period; - Multiply by a discount rate or a capitalization rate, depending on the expected timeframe for the losses, to arrive at a present value. Quantification of Business Losses Business losses related to expropriation can be experienced under a number of circumstances. For example, a business may experience a loss prior to relocating due to the diversion of management's time to expropriation related matters or a business may experience a loss subsequent to its relocation as a result of the disruption of the move and related circumstances. It may also be found that there is a permanent change to the business' operations such that the losses are expected to continue into the future. Business loss quantification is becoming increasingly sophisticated and requires inter-disciplinary understanding on the part of the valuator. To properly fulfill the mandate of a business loss engagement, the valuator must have an understanding of the legal issues or compensability of the claim, restrict the quantification to those damages which demonstrably flow from the expropriation or for which causation can be proven, and must consider the impact of business, economic, and industry conditions on the conclusion reached. To ensure the compensability of the claim, it is imperative that the valuator be familiar with the relevant legislation and discuss any questions as to compensability, heads of damage, and quantification issues with counsel at the earliest possible stage of the process. This will enable counsel and the valuator to proceed to a successful resolution of the matter in the most efficient and effective manner. With regards to an expropriation, the relevant legislation would be the expropriation act for the particular province involved. For example, in Ontario, section 19(1) of the Ontario Expropriation Act states that "where a business is located on the land expropriated, the expropriating authority shall pay compensation for business loss resulting from the relocation of the business made necessary by the expropriation..." Factors to be Considered in the Quantification of a Business Loss A business loss claim must include only those losses attributable to the expropriation. The causation and common sense aspects of business loss quantification are somewhat intertwined. An overly simplistic, mechanical approach to the claim may result in a host of factors unrelated to the expropriation being included in the quantification, none of which are compensable. The legitimate component of the business loss claim may then be dismissed due to the tainting of the entire claim, or the inability to segregate the valid portion when the unrelated circumstances are revealed. In quantifying a business loss, consideration must be given to a number of factors including: a) the circumstances of the expropriation, both from a chronological and physical effect point of view; b) the financial impact of the expropriation, through review of the company's financial results both before and after the expropriation; c) the nature of the business, its operations, and the industry in which it operates at the time and over the duration of the loss or anticipated industry and operational conditions in the case of future business losses; and, d) the state of the economy at the time and over the duration of the loss or anticipated economic conditions in the case of future business losses. It is this knowledge, when properly documented, which will demonstrate the business rationale of the claim and take the quantification out of the realm of a mechanical exercise. Quantification Techniques and Considerations The term business loss is generally defined as the "loss of profit" or the profit not realized due to a shortfall between actual operating profit and the profit that could have been reasonably anticipated had the expropriation not occurred. The determination of the reasonably anticipated profit can be fraught with difficulties, and involves the application of all of the business, industry, and economic knowledge gathered in the valuation process to demonstrate that the expectations are not mere speculation or the result of an arithmetic exercise. Loss of profit is a "net" calculation, that is after consideration of revenues and expenses. The first step usually involves the examination of the revenues of the business both before and after the expropriation to assess the impact, if any, of the event. Following the determination of the effect of the expropriation on the revenues of the business, consideration is then given to the effects on the expenses incurred by the business. The expenses of the business must be analyzed having regard to their nature (e.g. variable, semi-variable, or fixed) and integrated into the business loss claim accordingly. Those expenses which are determined to be "saved" or not incurred as a result of lower revenues relating to the expropriation (i.e. generally variable expenses) must be deducted from lost revenues in quantifying loss of profit. The techniques used to quantify the impact on revenues up to the assessment date can include the following: Review of Actual Revenues/Trend Analysis This involves review of the pre-expropriation revenues to determine if a certain trend was apparent, and then applying this trend to determine what the post-expropriation revenues may have been had it not been for the expropriation. An arithmetic calculation of the indicated shortfall, if any, would then be made. Review of Forecasted Revenues This involves comparison of forecasted revenues for the period subsequent to the expropriation versus actual revenues for the same period, resulting in an arithmetic calculation of the indicated shortfall, if any. Regression Analysis Regression analysis is a statistical technique used to develop a functional relationship between two variables. For example, the revenues of an auto-parts manufacturer would likely be related to automobile sales. In this case, revenues would be defined as the dependent variable and automobile sales would be defined as the independent variable. The relationship between the dependent and independent variables is determined during an "unaffected" or pre-expropriation time period, and provided the relationship between the variables is sufficiently strong and statistically valid, the relationship is then applied to the post-expropriation period to project the "what-if" results. The advent of computers and statistical programs have made regression analysis applications relatively easy, however it may also result in a misinterpretation of the results. An in-depth understanding of the assumptions underlying the technique is critical. It is advisable to support the conclusions derived from the regression analysis by other means, particularly for presentation to a court or other tribunal, due to the complexity of the technique and its infrequent use. Comparable Company Analysis This involves comparison of the subject company's revenues before the expropriation to a "comparable" company's (e.g. a competitor) revenues over the same period to determine if there is a relationship between the two. If a relationship is found to exist, the "comparable" company's post-expropriation operating results may be used to project what the subject company's revenues may have been had the expropriation not occurred. In using this technique it is important to ensure that the companies are truly comparable. For example, if the expropriation involved a retail store, the valuator should ensure that the subject store and the "comparable" store have similar demographics as between the locations, that the stores are of similar size, configuration, and parking availability, such that practical capacity issues would not be exceeded in the projection, and that there were no changes in the relative markets serviced by the two locations which occurred before or after the date of the expropriation. For example, if additional competition entered the market of only one of the locations during the projection period, the relationship existing prior to such occurrence likely would not remain and the model would not produce valid results. Often combinations of the above methodologies are considered in determining the loss of revenues of a company. For example, regression analysis may be used to determine if a relationship existed between the subject company's revenues and a "comparable" company's revenues prior to the expropriation. Once the valuator has determined the loss of revenues attributable to the expropriation, he/she will perform a similar analysis to determine the expenses that should be deducted from the lost revenues in quantifying the business loss. For example, the valuator would likely review the company's historic cost structure, forecasted expenses, and "comparable" company expenses both before the expropriation and during the period of loss (if such information was available). Internal and External Factors That May Impact the Business Loss Claim It is imperative that the valuator's knowledge gained through discussion with management of the subject company with respect to changes, if any, in the operations of the business over the loss period and his/her review of economic and industry conditions both before and over the loss period be integrated with the results of the above analyses so that the impact of factors unrelated to the expropriation are excluded from the claim. Factors unrelated to the expropriation may be internal or external to the company's operations and can include, but are not limited to, the following: Internal Factors - A change in the company's management during or just prior to the loss period which either positively or negatively impacted the financial results of the company; - An increase or decrease in raw material costs during or just prior to the loss period, thereby impacting the gross margins of the company; - A loss of a key customer of the business unrelated to the expropriation. For example, the customer may have experienced financial difficulty due to the economic or other conditions unrelated to the expropriation; and, - Personal expenses, non-market remuneration, or other non-arm's length expenses or revenues being recorded in the company's financial statements in the period prior to and during the loss period. These must be adjusted to arm's length amounts so that the pre-expropriation and post-expropriation financial results are comparable and the loss reflects an economic loss. External Factors - A change in the economic conditions in which the company operated just prior to or during the loss period (e.g. a recession); - A change in the company's marketplace such as the entrance or exist of a competitor just prior to or during the loss period; and, - A change in the industry conditions in which the company operated during or prior to the loss period. For example, the industry may have experienced an increase or decline in demand due to the nature of the product/service offered by the company or a duty related to the company's product may have been increased or decreased just prior to or during the loss period. Quantification of Future Business Losses Unlike past business losses, future business losses are expected to continue past the date of assessment and often represent a permanent change to the operations of the business as a result of the expropriation. A first step in an assessment of future losses is to determine the lost cash flows that will be brought to a present value. Whether determining fair market value or assessing business losses, value flows from the prediction of future earnings/cash flows. In estimating the fair market value of a business interest, the traditional approach is to extrapolate from an average of its past earnings/cash flows after adjusting for known changed circumstances. When the financial statements are adjusted according to accepted principles, and the effects of abnormal events are removed from the earnings/cash flows, the earnings/cash flows are then capitalized or discounted, as the case may be, to arrive at fair market value. In a business loss determination, however, the claimant's capital structure is fixed, with whatever interest costs or costs of capital this entails. Taxes may need to be paid on the amount recovered.18 If the claimant was enjoying higher than normal remuneration or other benefits of ownership, he is entitled to recover them without "normalizing" the income, as one might otherwise do in a market valuation. In its obligation to make the claimant whole, the expropriating authority cannot argue that the claimant's profits or operating costs are excessive, compared to the industry. In law, the authority takes the claimant as it finds him, business perks and all,19 and is required to make him whole. The Time Value of Money A discounting or capitalizing process value is required to bring the future lost profits to a present value, taking into account the time value of money. Compensation for future losses in expropriation (or, any commercial loss) cases must be awarded in a lump sum, although they have yet to be earned or incurred and, in any event, would have been earned or incurred over a period, usually of years. There is no authority for a court or tribunal to award compensation on a periodic basis.20 Thus, the time value of money must be determined and adjustments made to the lump sum damage award to avoid overcompensation. In determining future pecuniary damages in civil actions, the courts in some provinces21 use a 2.5% discount rate mandated by statute or by rules of court where the only factors are the price inflation rate and the interest on future investments. The Court may, however, depart from the 2.5% discount if, "there is evidence, one way or the other, on the factors other than future investment rates and price inflation rates."22 Evidence of this type must be very specific to the facts of the case and the profile of a plaintiff's loss. Generalities based upon the average industrial wage will not suffice.23 Expropriation tribunals may feel themselves free to adopt this discount rate where the rules of the superior court of the province are adopted as the residual rules of the tribunal. In one of the famous "trilogy" cases, Andrews v. Grand and Toy, the Supreme Court of Canada concluded that a discount rate of 7% was appropriate. This rate was arrived at by using the then existing 10% rate of return on long term investments (the so-called "nominal" rate) and subtracting the effect of long term inflation, which was then estimated at 3.5%.The Court warned however, that the discount rate would be reviewed, depending on the evidence produced at trial. As Justice Dickson said in Lewis v. Todd, another of the trilogy: "...It would be irresponsible for this Court to make an immutable pronouncement on a complex issue on the basis of such limited evidence (of an actuary and economist). The findings made herein should, in justice, only bind the parties to the present litigation. The principle remains that, absent legislation ... which directs the manner of calculating discount rates (e.g. by setting a figure or by paying the interest rate to return on specific investment vehicles and inflation to a particular index), the discount rate will vary according to the expert testimony lead at trial." One may argue that the uniformity predicted by Justice Dickson in Lewis has now produced a discount rate of 2.5% as the effective measure of the time value of money used by our courts. It has been enshrined in legislation or regulation in several provinces.24 In all other jurisdictions where the discount rate has not been set by the rules of court or by regulation, the court is expected to set the rate based upon the evidence presented to it.25 In determining future pecuniary damages, the courts in most Canadian jurisdictions use a 2.5% discount rate where only the price inflation rate and the interest on future investments are taken into account. This is based on a view of interest rates that, over time, the difference between the nominal rate of interest and the rate of inflation, the so-called "real" rate of interest, is 2.5%. Historically, a 3% discount rate was taken by economists and others to be the "real" rate of return after deducting current inflation from current nominal interest rates.26 Adding some confusion to the concept of the discount rate as a function of the time value of money, the Supreme Court has said that courts may depart from the 2.5% discount rate if "there is evidence one way or the other on the factors other than future investment rates and price inflation rates". Evidence of this type must be very specific to the facts of the case and the profile of a plaintiff's loss. In making such pronouncements, the courts have introduced the 2.5%, inadvertently perhaps, as the discount rate reflective of the time value of money and of risk (of which more will be said). Uncertainty in Proof of Damages The quantification of loss is often the most difficult aspect of a business loss claim. Difficulty with the measurement of business losses stems, in part, from the need to measure the damages once and for all. A claim for lost profits almost always involves a degree of conjecture about what might have happened if the contract had been performed, the tort not committed or the property not expropriated. And this is so whether the loss is a loss of past profits (at the time of assessment) or a future loss of profits. A future loss may require the tribunal to assess expert opinion evidence as to what the future holds, to consider the time and the risk elements and their effects on damage awards. It has been long recognized that a party has a right to recover damages for future business losses even though they cannot be established with certainty. Courts are quite prepared to deal with evidence that is uncertain. However, the more uncertain the future losses or future earnings, the more moderate will be the recovery. In other words, the greater will be the reduction for contingencies. Courts have said repeatedly that the conjectural nature of a claim for lost profits does not deprive the plaintiff of a right of recovery: "The fact that damages can not be assessed with certainty does not relieve the wrong doer of the necessity of paying damages for its breach of contract."27 The risks involved in a business loss quantification are not necessarily the same as those associated with a fair market valuation of a business or even the evaluation of an internal investment decision of the business.28 Nor are they the same for an individual as compared to a corporation. The risks associated with a going concern business continuing to earn certain cash flows or continuing to incur certain expenses may be much different than the risks associated with the business continuing to earn its total cash flows as would be assessed in the fair market valuation of that or a similar business. Where no sale, notional or real, is involved, the claimant usually continues in business; there are no synergies to be achieved by a prospective purchaser, which might influence the capitalization or discount rate. Losses in the near term are likely to be less risky than over the long term. Risks inherent in management may be better understood in an ongoing business, compared to one that is being valued for acquisition. In the past, courts have been more familiar with the concept of "contingency" rather than "risk". The courts have described contingencies in the commercial arena, rightly or wrongly, as the "vicissitudes of the market place, the measurements being competition and swings in business cycles."29 It has been a common practice for courts to reduce a present value calculation, discounted for time, by a lump sum usually expressed as a percentage reduction, to account for contingencies, instead of introducing a risk component into the discount or capitalization rate. This contingency factor is expressed as a percentage of the total loss and its selection is a matter of estimation by the court, supposedly from a consideration of the evidence. Unfortunately, such decisions are seldom accompanied by sufficient explanation as to why a particular percentage was chosen. Often, the reduction is a significant amount; 20 to 25% is not uncommon. It becomes obvious that lump sum contingency reductions are arbitrary in the sense that there is no explicit basis for choosing one figure over another. While there may be an intuitive basis for the judge's choice, there is no apparent rational basis for making such calculations. The contingency factor is not to be confused with the time value of money. As used by the courts, it is apparent that contingency factors are intended to measure very different things. Contingencies may be either positive or negative, either increasing or decreasing a plaintiff's loss of prospective earnings. It is not sufficient that a defendant merely assert that there are contingencies that ought to be taken into account to reduce the damage award (apart from the normal contingencies of life that generally afflict individuals). The defendant must lead evidence regarding specific contingencies if it wishes to reduce the claim substantially. Robert B. Munroe describes the various kinds of contingencies, including general contingencies.30 General contingencies have been interpreted in Graham v. Rourke31 as those future events which are "likely to be the common future of all of us" (e.g., illness, chance of promotion, layoff). In such cases, the degree to which a general contingency would affect a given plaintiff is difficult to prove. The court may take general contingencies into account to adjust a pecuniary award upwards or downwards. "...(W)here the adjustment is premised only on general contingencies, it should be modest." In such cases, the defendant does not have to prove such contingencies by evidence. These are common to us all and the court will take judicial notice of them. The advantage to the claimant of this method is that it compels the expropriating authority to lead proof of special contingencies, which will have a negative impact on the future cash flow generating capacity of the Claimant, over and above the normal contingencies of life. It also allows the owner to lead specific evidence indicating positive contingencies, e.g. tangible asset backing, superior management skills, health, etc. Measuring the Risk The problem facing the valuator and the tribunal is to determine what discount or capitalization rate is appropriate to present value the series of future losses faced by the claimant in this case, absent the usual objective indicators of value usually available in a market valuation where we do not need to consider the peculiar circumstances of this claimant. Market derived capitalization and discount rates may not be appropriate when assessing the risk associated with this landowner continuing to enjoy the benefits of the business that have now been lost to him as a result of expropriation. How capitalization rates or discount rates are arrived at is the subject of much controversy among those involved in the quantification of business losses. Generally, when the only concern is to adjust the size of the claim for the time value of the money, it is appropriate to discount; probably using a statutory or regulated rate,32 or a real rate of return, if not regulated. Otherwise, the capitalization or discount rate for measuring business losses should reflect the business risk associated with the realization of the estimated cash flows, which is usually greater than the risk-free rate of return (e.g. 2.5%) and which may be different from the market risk on a purchase and sale of the business. In a fair market valuation, it is appropriate (and the courts would say, preferable) to derive the capitalization or discount rate from the sale of comparable businesses and properties, adjusted for differences with the subject business or property. The same sources are not usually available when quantifying a business loss unless the loss is total (i.e., the business ceases to operate). Otherwise, the assessment of business losses is not equivalent to a fair market valuation and the adjustments needed to bring so-called comparables into line with the subject property would result in assumptions too numerous for serious consideration. The expert's opinion as to the acceptable discount or capitalization rate depends on the expert's understanding of relevant facts and selection of key assumptions, both of which impact on risk. Because they bear on the result, the experts' judgements are likely to be critically examined by the court. Courts have a judicial reluctance to accept the opinion of even the most illustrious expert where it is based on, in the court's view, an unseemly number of assumptions. Many evaluations founder because they depend upon too many assumptions for their validity. Determination of Goodwill In a situation where it is "not feasible for the business to relocate", the business has effectively been terminated by the expropriation, and the relevant compensation is up to the amount of goodwill of the business. Feasibility to relocate will depend on the specific facts in each situation. Feasibility may relate to business licenses, environmental considerations, financial issues, and even the age of the owners. Depending on the nature of the business, feasibility may be restricted in a geographic sense to the "trading area" of the business. A retail store that closes in a downtown location may still be a termination, even though the owner opens a suburb location due to the reasonable trading area of the business. In other words, both locations could co-exist due to trading areas and the suburb location is therefore, a "new" and not a "replacement" location. Goodwill is an accounting concept, and generally represents the excess of the fair market value of the business viewed as a going concern over the value-in-use of the underlying tangible assets (working capital and fixed assets). In this regard, the fair market value of the business typically would be determined on the basis of the earnings and cash flow being generated by the business. THE ROLE OF EXPERTS IN AN EXPROPRIATION MATTER Expropriation matters can require the services of real estate appraisers, Chartered Business Valuators, economists, engineers, equipment appraisers and various industry experts. It generally depends on the nature of the property that is to be expropriated and the type of business(es) that use the property. The expert has a significant role to play in guiding the court toward calculation of damages and giving the court a framework to analyze the evidence supporting the compensation claim. It is a cardinal rule that expert witnesses must base their value conclusions on justifiable assumptions. Expropriation law does not require that an expert have any formal qualifications or training. Although experts usually become qualified through formal study and professional certification processes, it is sufficient that the expert be able to express opinions about certain matters beyond the common understanding of most lay people or of the tribunal itself by virtue of the expert's practice, experience and study in the field in which he gives his expert testimony. Indeed, for many experts, there is no formal professional structure by which he becomes certified as an expert. The law does not distinguish between the ways in which expertise is acquired. A lay person or non-expert may give opinion evidence based upon facts within his personal knowledge on matters of common experience, e.g., speed of cars, apparent age, drunkenness and sobriety, the value of every day objects, and the like. An expert, on the other hand, is called upon to give opinion evidence about material issues, which are beyond the ordinary experience and understanding of the average person, including that of the court or tribunal. In expressing his opinion, the expert is entitled to take into consideration all sources of information commonly referred to or accepted by professionals in his field, including hearsay evidence, and other evidence not in itself admissible at the trial or hearing in which the expert is testifying. He may, for example, rely on textbooks, journals or articles which are considered authoritative in his field, and which he accepts as authoritative, in arriving at his conclusions. CONCLUSION After having been immersed in the technical and detailed aspects of the business loss quantification exercise, it is incumbent upon the valuator to pause and review his conclusion in light of its compensability, his ability to demonstrate that the loss is attributable to the expropriation, and to assess its reasonableness from a common sense perspective. Ultimately, it is only through the valuator's accumulation and application of the knowledge of the business and the industry and the economic environment in which the business operates that the business loss quantified will be consistent with reality and attributable only to the causal event. —Douglas A. Caldwell, Q.C. Patterson Palmer Hunt Murphy, —Paula D. Frederick, C.A., C.B.V. Low Rosen Taylor Soriano [This paper was originally presented to the Eastern Regional Conference of The Canadian Institute of Chartered Business Valuators in July, 1999.] ––––––––––––––––––––––––– 1. There may be important differences in expropriation legislation from one jurisdiction to another and owners and practitioners are urged to consult the legislation governing the expropriation. 2. In Hill v. Nova Scotia (1997), 157 N.S.R. (2d)81, the Supreme Court of Canada recognized even an equitable (unwritten) easement over the Transcanada Highway as an interest capable of being expropriated. 3. The Ontario Municipal Board, the British Columbia Expropriation Compensation Board and the Nova Scotia Utility and Review Board are examples. 4. It will vary from one jurisdiction to another. As well, Quebec, Saskatchewan and Prince Edward Island are not considered to be market value jurisdictions. 5. See, for example, the Ontario Expropriation Act, R.S.O. 1990, c. E.26 s.1(1)(a)(ii); Nova Scotia Expropriation Act, R.S.N.S. 1989, c. 156, s.3(1)(h)(i)(B). 6. (1981), 23 L.C.R. 30 at p. 53 (P.C.B.), aff'd (1982), 25 L.C.R. 291 (N.B.C.A.). 7. The Uniform Standards of Professional Appraisal Practice, published by The Appraisal Foundation of the U.S., now appears to be the professional guideline for most Canadian fee appraisers in property valuation assignments. 8. The Queen v. Loiselle (1962), 35 D.L.R. (2d) 274, (1962) S.C.R. 624: 9. See Jespersons Brake & Muffler Ltd. v. Chilliwack (1992), 47 L.C.R. 172; affirmed 52 L.C.R. 95 (B.C.C.A.). Held that the claimant's property was injuriously affected when an overpass was constructed which significantly decreased the existing access to the claimant's property. 10. See Williams v. Nova Scotia (1996), 59 L.C.R. 81 (N.S. Court of Appeal). 11. Toronto Area Transit Operating Authority v. Dell Holdings Ltd., (1977) 1 S.C.R. 32. 12. Except in pipeline expropriations, where an arbitration panel may make an award of periodic payments. 13. The principle of "anticipated value", for example, prevents the owner from profiting from any increase in value due to the existence of the statutory project. 14. See Costello v. Calgary (1997), 41 M.P.L.R. (2d) 155 (Alta.C.A.). 15. This approach was accepted in Regina Sticks v. Saskatchewan Government Insurance. 16. Interest is not applicable in the case of loss of goodwill, which is an element of disturbance damages, and is not applicable in the case of a business loss related to disturbance. Statutory interest applies only to a loss of business income relating to injurious affection. See, for example, s.33(1) of the Ontario Expropriation Act, R.S.O., 1990, C.E.26, which is typical of other jurisdictions. 17. Roberts and Bagwell v. The Queen (1957), 6 D.L.R. (2d) 305 (S.C.C.). See also Vern Krishna, "Determining the Fair Value of Corporate Shares", (1987-88), 13 C.B.L.J. 132. 18. Recovery in expropriation proceedings is treated as an imputed sale or disposition of the property and is taxable as such. Recovery of business losses may be fully taxable as income in the year received. If the recovery of a lump sum causes an increase in the owner's tax rate, that accelerated income tax must also be recovered in the claim. 19. It is open, however to a defendant to argue that there would ultimately be no future profits either because the plaintiff is in imminent danger of insolvency or has entered into an improvident contract. Defendants are not guarantors of the plaintiff's business folly. 20. Except under federal expropriation legislation under the National Energy Board Act. 21. Nova Scotia and Ontario are two examples. 22. See Lewis v. Todd, (1980) 2 S.C.R. 694, 115 D.L.R. (3d) 257. 23. See Mortimer v. Cameron (1992), 9 M.P.L.R. 185 (Gen. Div.), reversed in part, 111 D.L.R. (4th) 428 (Ont.); Leave to Appeal to S.C.C. refused 19 O.R. (3d) XVI. 24. Ontario, Nova Scotia, Saskatchewan, Manitoba and B.C. all have statutory or regulated discount rates. 25. See reference to the discount rate in the text by W.H. Charles, Charles' Handbook on Assessment of Damages in Personal Injury Cases, 2nd Edition, 1990, Carswell. 26. Whether this view remains realistic in light of global economic turmoil in 1998-1999 remains to be seen. 27. Chaplin v. Hicks (1911), 2 K.B. 786 (C.A.) 28. Where "internal rate of return" is a common measure of time and risk in investment decisions. 29. Nathu, supra, at p. 757. 30. An Overview of Pecuniary Damages in Personal Injury Claims, (1995), Special Lectures LSUC at p. 52. 31. (1990), 74 D.L.R. (4th) 1 (Ont. C.A.). 32. Such as the 2.5% discount rate found in the rules of court of some of the provinces, e.g., Ontario and Nova Scotia.

This article appears in the OEA FALL 1999 NEWSLETTER

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