Compulsory purchase and compensation update - 2007

Citation

Sams, G. (2007), "Compulsory purchase and compensation update - 2007", Journal of Property Investment & Finance, Vol. 25 No. 4. https://doi.org/10.1108/jpif.2007.11225dab.002

Compulsory purchase and compensation update - 2007

Compulsory purchase and compensation update - 2007

In terms of quantity the last 12 months have not been a vintage year for legal decisions in the compensation field, either in the lands tribunal or the Court of Appeal. In this year’s briefing I therefore concentrate on two lands tribunal cases which I feel make up for the this in terms of quality. One concerns all aspects of a disturbance claim, including support for an approach to assessing compensation for goodwill which throws considerable doubt on the traditional approach, preferred by the tribunal for time immemorial.

The second does not particularly break new ground, but involves a review of over 150 years of statute and case law. It concerns a claim under s.10 of the 1965 Compulsory Purchase Act, probably the most complex of all the compensation provisions, and is a rare example of a successful claim under s.10, resulting in a substantial entitlement to compensation.

Disturbance compensation and a short leasehold interest

Crowley & Jarvis v. Liverpool PSDA Ltd and Liverpool City Council (2007) raised a number of interesting questions in respect of compensation for land taken and disturbance. It concerned the compulsory purchase of a large discount store operating from leasehold premises in Liverpool. The business traded as Contraband Discount Stores and had two other branches, including one nearby in Birkenhead. The valuation date was 1 October 2004, at which time the lease had two years unexpired.

Valuation of the short leasehold interest

Therefore, the first question to be considered by the lands tribunal was the compensation to be paid for the loss of the short leasehold interest. The property was being acquired for a large comprehensive redevelopment scheme. The acquiring authority argued that, although it is necessary to disregard this scheme, the area was in such great need of redevelopment that, in the absence of this specific scheme, an alternative redevelopment scheme would inevitably take place. The property was, therefore, blighted in both the scheme and no scheme worlds, and therefore the short leasehold interest had no value. This argument was rejected by the tribunal, which considered that any no-scheme redevelopment of the area was likely to be more gradual, and would also affect the only comparable to the same extent that it would affect the subject property.

The tribunal noted that the valuation of short leasehold interests is notoriously difficult. In the market place, any premium paid for a lease with two years unexpired is more likely to reflect a “key money” payment to obtain occupation in a desirable property, rather than a quantification of the remaining profit rent. Where demand is low, no premium is likely to be achievable regardless of the financial benefit of a low rent for a short period’ and a reverse premium may even be paid. Regardless of this the tribunal chose to adopt the traditional approach and assessed the profit rent at £19,000 which is capitalised at YP 2 years @10 per cent & 3 per cent tax @ 40p. It then added a 40 per cent premium to reflect a key money payment. This dual rate approach, adjusted for tax, appears particularly theoretical, and divorced from practice in the real world.

Total extinguishment or notional relocation?

The value of land taken was, however, marginal to the claim: the main dispute concerned the compensation to be paid for disturbance, and in particular, goodwill or permanent loss of profits. The claimant argued that after making an extensive search, which identified a number of potential alternative properties, none of these had proved suitable, and that it had no alternative but to close the Liverpool business. Not only that, but with the closure of Liverpool, the Birkenhead branch had also been rendered unviable due to the loss of storage space and facilities for making joint deliveries from both branches. Compensation should, therefore be paid for the total extinguishment of both the Liverpool and Birkenhead stores.

The acquiring authority argued that suitable alternative premises were available, perhaps involving renting external storage space elsewhere, and that compensation should therefore be assessed on the notional cost of relocating the Liverpool branch. No compensation should be paid for the closure of the Birkenhead branch because it would not have been left in isolation if Liverpool had relocated, and in any event it was trading unprofitably and would probably have closed anyway.

The lands tribunal first referred to Director of Buildings and Lands v. Shun Fung Ironworks Ltd (1995) and Bede Distributors Ltd v. Newcastle upon Tyne Corporation (1973) which established the principle that “the acquiring authority bears the burden of proving that, on the balance of probabilities, the claimants have failed reasonably to mitigate their losses by not reasonably pursuing opportunities to relocate their business”. It considered the steps taken by the claimant to identify suitable properties and commented that “I am satisfied that the claimant’s actions from the outset have demonstrated a real desire to continue trading in Liverpool city centre”. It also noted that in spite of the time available for preparation in advance, “they had a preciously narrow window (12 weeks from confirmation of the CPO) during which they would be able to actually commit to new accommodation”. The member also criticised a witness employed by the developer whose evidence “contained a number of pejorative remarks and unqualified opinions that, in my view, demonstrated a prejudice against them (the claimants) and went far beyond his remit as a factual witness”. The tribunal concluded that the claimant had acted reasonably in rejecting the available alternative premises, and that compensation should be assessed on the basis of total extinguishment. After one or two rare cases which were found in favour of the acquiring authority on this question (e.g. Kwik Save Stores v. Stockton (2004)) this reaffirms the traditional view that the claimant is almost always better placed to decide on the viability of his business than an acquiring authority, which can have no knowledge or expertise in that field.

With regard to Birkenhead, however, the tribunal noted the poor trading performance of that branch and that “there was no realistic prospect of profitability being restored”. It decided that compensation was not available for the closure of that business as the closure was due to its trading performance, rather than to the CPO.

The valuation of goodwill

Perhaps the most interesting aspect of this case is the approach which was adopted to calculate the compensation payable for total extinguishment of the business. The traditional approach has been to look at the profits shown in the accounts, preferably for the last three years. These are adjusted for exceptional and personal items, directors remuneration, notional rent and interest on capital employed. The resulting average adjusted net profit is then capitalised at a multiple (or YP), which is usually between two and five. This approach can be criticised for being self-perpetuating as it is based more on previous lands tribunal decisions than on market evidence. In support it is arguable that disturbance compensation should be based on value to the owner, not market value, and that comparable market transactions can be analysed in this same way, with the results being applied to the subject valuation. A subjective uplift can then be applied to reflect the difference between market value and the value to the owner.

In this case the average adjusted net profit was agreed, but a different approach was adopted to calculating the value of the business by the expert witnesses for each party, both of whom were accountants rather than surveyors.

The claimant’s expert adopted a complex Price/Earnings (P/E) approach which involved deducting notional owners wages and the profit rent from the average adjusted net profit. A further deduction was made for tax, and the resulting figure capitalised at a multiple (known as the P/E multiple) of 18.9, calculated by reference to the P/E multiples of similar companies listed on the stock exchange, in this case including Poundstretcher and Woolworths. He then made a deduction of 35 per cent to reflect the fact that the subject business was much smaller than these listed companies, and cancelled this out by then applying an uplift of 35 per cent (the control premium) to reflect the fact that the subject business was not subject to the restrictions which apply to public companies.

The accountant for the acquiring authority accepted that the approach was valid in principle, but considered that the large number of adjustments rendered the comparison virtually worthless. She preferred a straight multiple or between 3 and 8 based on sale prices for small, owner managed businesses. She also analysed a schedule of asking prices, turnover and net profits of privately owned businesses which were being offered a sale on an internet site. Businesses with a similar turnover to Contraband showed an average multiple of 2.6 and she applied this to her valuation. From the resulting figure she deducting the value of the net assets of the business, including stock and the value of the lease.

The tribunal was therefore faced with two approaches, neither of which follow tradition, though that of the acquiring authority was somewhat closer. It commented on the failings of the traditional approach, and noted that an alternative approach was adopted in Optical Express (Southern) Ltd v. Birmingham City Council (2005) 2EGLR 141. It was in this case that the tribunal commented that “the figure of YP is usually fixed by reference to settlements and decisions of the tribunal, which becomes self-perpetuating within a particular range without any guidance or cheque from the market”. In the Optical Express case an EBITDA approach (which the experts here considered inappropriate) was adopted. This gave a multiple of 7.6, which equated to 11.0 on the P/E basis.

The tribunal expressed concern about the approach adopted by the acquiring authority “taking the average of the apparent YPs on businesses that were for sale and about which the information was scant”. It considered that on this approach a YP of 4 to 5 would the more appropriate. It preferred some aspects of the approach adopted by the claimant’s expert, but was unhappy with the comparison with national chains, and the huge subsequent adjustments which had to be made. It preferred a multiple of 12.3 to the 18.9 used for the claimant. It then deducted 35 per cent to reflect the smaller size of the subject business and added back only a 20 per cent control premium. This produced an effective multiple of 9.6, and a figure very similar to that arrived at using the acquiring authority’s approach. The final award of goodwill compensation was summarised in Table I.

Table I

The final award of goodwill compensation

From this figure it deducted the net assets of £147,200 and the value of the leasehold interest at £29,000.

It appears from this decision that the traditional approach to valuing goodwill will no longer be accepted by the lands tribunal, at least in respect of larger businesses, and that this part of the assessment of compensation will become more and more the province of the accountant, rather than the surveyor.

Injurious affection where no land is taken

It is one of the more hackneyed truisms of compulsory purchase that a claimant should move heaven and earth to ensure that he has at least one a square yard of land taken from him, rather than having to rely on the provisions which apply where no land is taken. This is peculiarly so where are claimant does not meet the qualification rules for a claim under Part I of the Land Compensation 1973 Act, and therefore has only section 10 of the 1965 Compulsory Purchase Act as a potential route to a claim. It is a rare that the claimant is able to meet the qualification rules for section 10, and even if he does so, it is unlikely that he will be fully compensated for the loss he has suffered. The four rules for a claim under section 10 were set out in the case of Metropolitan Board of Works v. McCarthy (1874). So far as qualification is concerned the main obstacle is rule 2, which requires that the injurious affection must be such that, if not for statutory authority, it would have given rise to a course of action in the tort of nuisance. This requirement will normally only be satisfied where there is interference with a private right of way. Even if a claim can be established, compensation is limited to depreciation in land value (therefore excluding consequential losses and disturbance). Furthermore, the depreciation must arise from the execution of the works, rather than their subsequent use, and must arise from the actions which would have given rise to a claim, rather than any other effects of the execution of the works.

Moto Hospitality Ltd v. Highways Agency (2006) is a rare example of a claim which not only meets these exacting requirements, but which is likely to result in an extremely large compensation payment. The exact amount of compensation is not yet known, as the case concerned only the preliminary question of whether the claimant was entitled to claim compensation under section 10. It concerned the Cherwell Valley Motorway Service Area (MSA) at junction 10 of the M40 in Oxfordshire. Compensation was claimed for the adverse effects of junction alterations carried out by the Highways Agency during 2001 and 2002.

Two issues were in dispute. The acquiring authority first argued that any loss suffered by the claimant arose from the stopping up of slip roads, rather than the actual junction improvement works themselves, and that this did not constitute “the works” within the definition of section 10. Only works taking place on land actually within the CPO could give rise to a claim. Second, rule two of the McCarthy rules was not met because the claimant had not suffered particular damage which would have given rise to a claim in the tort of public nuisance, but for the statutory authority.

Meaning of “the works”

On the first point the tribunal decided that the acquiring authority was wrong to argue that compensation was limited to injurious affection caused by the carrying out of works on land that the special Act had authorised to be acquired. The obstruction of each of the four slip roads had the potential to found a claim under section 10. To come to this conclusion, it went all the way back to the wording of the 1845 Lands Clauses Consolidation Act, and decided this would be an additional limit to those originally imposed by that Act. In the view of the tribunal the works for the purposes of which the CPO was made consisted of the entirety of the works of highway construction and improvement that were to be carried out, and were not confined just to those parts of the works to be carried out on land actually acquired under the CPO. The acquiring authority argued about the tribunal was bound by the Court Of Appeal decision in the case of Joliffe v. Exeter Corporation (1967), to accept that only works carried out on land included in the CPO could give rise to a claim under section 10. In the opinion of the tribunal the circumstances in Jolliffe were different, and to accept the authority’s argument would require the tribunal to take into account some slip road closures, which took place on the CPO land, and ignore others which did not. “Such an odd result might be regarded simply as ‘part of the inscrutable legacy of section 68 and the 1845 Act’ (see Carnwath LJ in Westminster City Council v. Ocean Leisure (2004) RVR 219 at paragraph 35), but it would be avoided if the special act and the works are identified in the way I have concluded is correct”.

Particular damage or injury

The second issue was always likely to be more difficult; the tribunal noting from Benjamin v. Storr (1874) LR 9 CP that “an action to damages for public nuisance can be brought if the claimant can show that he has sustained particular damage or injury other than and beyond the general injury to the public, and that such damage is direct and substantial”. A number of cases from the depths of history were considered, including not only McCarthy, but Caledonian Railway Co. v. Walker’s Trustees (1882) 7 App Cas 259.

Given its conclusion that works did not have to take place on land actually in the CPO, the tribunal had to consider how close to the CPO land such works had to be. It concluded that:

The effect of McCarthy and Walker’s Trustees is that, to found a claim under section 10 where a highway giving access to premises has been obstructed under statutory powers, the obstruction must be proximate to the premises but need not be immediately outside them. It is the loss of access… or interference with access… that constitutes the particular damage… Here the obstructions complained of were all local to the subject land. In terms of distance, therefore, I do not think that they were incapable of causing particular damage to the claimant.

It was also argued by the acquiring authority that, as access to the motorway service station was maintained throughout, there had been no interference with a legal right of access. The tribunal did not accept this argument; the critical point being that a motorway service station is located where it is for the specific purpose of enabling services to be provided to motorists on the motorway, and it is this that gives particular value to the land.

Access to or from the motorway is of particular importance to the claimant’s land for this reason, and it is this that distinguishes the position of the claimant from that of the generality of landowners in the area and other users of the interchange. If such access is obstructed in a way that causes a diminution in the value of its interest, the claimant will have suffered particular damage.

Tribunal therefore found in favour of the claimant on both issues and concluded that “any reduction in the value of the land during the period of construction is compensatable provided that it was the result of obstructions to routes of access between the motorway and the MSA.”

It is therefore likely that there will be a further referral to the tribunal in the future concerning the amount of compensation payable under section 10. This will itself be interesting as any damage caused by the works was purely temporary. Compensation under section 10 is restricted to depreciation in the value of an interest in land and I have never managed to fully grasp the concept of temporary depreciation.

The importance of the decision is to demonstrate that section 10, which holds the enviable distinction of being the most complex and uncertain provision, in an extraordinarily complex and uncertain field of law, is not entirely without practical application.

Gary SamsPenwortham, Preston, UK