The Curse of 'Penn Central'

The Takings Clause of the Constitution says with commendable directness: “Nor shall private property be taken for public use, without just compensation.” The Clause offers no definition of private property, nor does it indicate whether all forms of private property should be treated in the same fashion. Those ambiguities mean that an accurate reading of the Clause necessarily turns on the original public meaning of the key terms, as understood at the time of the Constitution’s adoption. Accordingly, two features dominate any originalist analysis. The first was that property, in the form of any single object—a plot of land, a gold goblet—derived much of its utility from being broken into smaller units of private property—leases, mortgages, options, easements. Second, these divisions are driven by a single theme. The gain from the property division must be more than sufficient to cover the costs of these rearrangements, and that task is facilitated in every legal system first by using requirements to solidify and clarify the arrangement between the two (or more) parties, and second the recordation of that transaction on some public site, so as to give notice to the world of any change in the ownership of these rights.

There is also a key public dimension to the creation and defense of these arrangements. The State must not, through the independent exercise of its general police power, impose any increased burdens on the parties that could take away the joint gains that animated the transaction in the first place. The dominant constraint here in the typical case, where the rearrangement of rights does not create either nuisance or antitrust externalities (think cartels), is that it does not strip the gain from a prospective transaction that could turn an anticipated net positive into a net negative, so that once bitten, no other parties will attempt to replicate that earlier transaction.  

Yet just that happens every day in the United States ever since the fatal embrace of the test famously articulated in Penn Central Transportation Co. v City of New York (1978), which is said to apply to “regulatory” as opposed to “physical” takings—itself a distinction with no constitutional or logical pedigree. With regard to the physical takings involving the government’s taking property or authorizing its transfer into the hands of a third party, the correct formula (often messed up in practice) is simple: The more the government takes, the more the government has to pay, so that there are no annoying kinks and discontinuities that result in the senseless dissection of private transactions. Bound by that linear compensation formula, the government will tax only when the public gains exceed the private losses to all parties, thereby preventing the government from generating inefficiencies by shifting costs to private parties if dealing with externalities.  

There is no reason not to extend this formula to all cases in which smaller interests in property are taken, including the air rights over the Grand Central Terminal in Manhattan owned by the Penn Central Transportation Company. There, the government took all those rights but successfully claimed that it owed the company no compensation because Penn Central was left in possession of the terminal, with no restrictions on its current uses or on its revenue, which, at the time, covered its expenses. The air rights were thus worth zero. To reach that result, it rejected the simple formula that forces the government to pay the market value for what it takes, no matter how much it leaves behind. Instead, it adopted a balancing test that required weighing how much was taken against how much was left behind. An earlier decision, Armstrong v. United States (1960), had set out the correct rule.  

The Fifth Amendment’s guarantee that private property shall not be taken for a public use without just compensation was designed to bar the government from forcing some people alone to bear public burdens which, in all fairness and justice, should be borne by the public as a whole. 

Thus, when the government sailed its naval vessel out of Maine waters to break a valid mortgage lien on the property for services rendered by a subcontractor on the vessel, it had to pay cash equal to the amount of that lien, no excuses allowed. But the wisdom of the Armstrong per se rule was flatly rejected in ^{Penn Central} with a new mysterious formula, which read:

In engaging in these essentially ad hoc, factual inquiries, the Court’s decisions have identified several factors that have particular significance. The economic impact of the regulation on the claimant and, particularly, the extent to which the regulation has interfered with distinct investment-backed expectations are, of course, relevant considerations.  So, too, is the character of the governmental action. A “taking” may more readily be found when the interference with property can be characterized as a physical invasion by government, than when interference arises from some public program adjusting the benefits and burdens of economic life to promote the common good.

No one knows what distinguishes a “distinct investment-backed expectation” from a property taking. Faced with needless ambiguity, ad hoc rules should always be disfavored, including here, where it offered no protection to air rights that were fully protected under state law, under which those rights could be sold, leased, and mortgaged to any third party, along with the needed support rights. It was a simple matter for the City first to buy those air rights and then to decide whether to retire or sell them. Use these two market transactions, and the correct balances are preserved. But the floodgates were opened now that the government could just take the rights if the above formula were satisfied, so long as that government action could not be characterized as a “physical taking”. At the time, the key issue was whether there was any environmental impact on the “character” of the neighborhood—i.e., the views along Park Avenue—that tipped the balance. But even if that change was needed, the traditional police power contains rules that addressed various kinds of nuisances that threaten health and safety and could justify regulation, none of which are remotely present here.

But the real danger associated with this test is its relationship to the modification of financial instruments as in Armstrong, which came up in connection with the ill-fated case of King v United States, now before the Supreme Court, in which a brief urging reversal was filed on my behalf by Gabriel Latner and the Manhattan Institute through its lawyers Trevor Burris and Ilya Shapiro, which was then opposed by the government. In King, the key question concerned the petitioners’ challenge to a new statute by Congress: the 2014 Multiemployer Pension Reform Act, which held that the plaintiff class, who had fully vested pension rights, could be undone by legislation when it was discovered that, after these rights had been vested, there were not sufficient funds available in the trust to satisfy the claims of later participants in the original plan. But in its initial move, the government stripped the claimants of a substantial fraction of their holdings to fund the later claimants in an obvious case of robbing Peter to pay Paul. It made no difference that Congress, years later, decided to fund part of those obligations but not all, for in cases of a taking, a “full and perfect equivalent for the property taken” has been the order of the day since Monongahela v. United States (1893). Thus, the partial payment only reduces the amount owed but does not negate the simple fact that full compensation was not made for the property taken.

When the plaintiffs sued the government, they were met with one of the worst arguments in the history of takings law: Judge Timothy Dyk conceded that if the trust assets were subject to a particular claim by the plaintiffs in this case, such as the lien in Armstrong, they would have been protected. But those pension rights did not attach to particular assets in the trust, but were only a floating lien that hovered over all assets until the payments to the plaintiffs were in default, and thus were, in his view, a second-tier security interest that was not entitled to the same level of protection as a standard mortgage. Economically, the point is wholly incorrect because the floating lien is routinely used in two situations. It gives the firm flexibility in handling assets, like inventory or stocks that are frequently bought and sold to improve the overall performance of the portfolio, without crimping the protection of the various claimants or lenders. The technique is a creative response needed in just these situations and should thus receive the same constitutional protection as a mortgage on either a factory or a home.  

In those cases, it is widely understood that these liens are protected by the per se rule of physical takings, for once the lien is foreclosed, or once there is a sale in lieu of foreclosure, the government either gets the property or directs its transfer to a third party, which is a classical taking under the rule in Loretto v. Teleprompter (1982). There is no possible sequence in the ordinary case in which Penn Central is applied to cases involving views up and down Park Avenue that could affect the character of the physical neighborhood. Since those environmental effects were out of the picture, it does not matter in any foreclosure proceedings whether the valid lien either floats or sits.

But once Judge Dyk holds to the contrary, it is off to the races. No longer, he insists, is there any “investment-backed expectation” that loans will be repaid, and he refuses to deal with the case most directly on point, Lynch v. United States (1934), which holds that the various contract rights created by floating liens are property rights that deserve full protection. He then explains why his insistence that floating liens are covered by Penn Central allows him to cut up to half of the lien’s value, given the regulatory takings test that compares the size of the loss to the amount that remains. That is the wrong test in any context, and for that reason, the same rules that govern physical takings should govern all Penn Central cases because there is no reason to use a different measure of damages, whether the air rights start with the ground or build over an existing structure, which may or may not turn a profit. But the danger of meddlesome abuse is vastly greater when floating liens, with their major efficiency advantages in the marketplace, should be reduced to a subordinate position in the constitutional hierarchy. The narrow solution reverses King only with respect to financial instruments. But a Supreme Court that has undone Roe v. Wade and Chevron should be willing to remove the curse of Penn Central by just overruling the case.

Richard Epstein is a senior research fellow at the Civitas Institute at the University of Texas at Austin. He is also the inaugural Laurence A. Tisch Professor of Law at NYU School of Law, where he serves as a Director of the Classical Liberal Institute, which he helped found in 2013.