A winery which planned to increase sales revenues by developing a flagship estate cabernet wine using grapes grown on its own vineyard land, but has never been profitable in the past, does not have a claim for compensation for lost goodwill when the State acquires a portion of the vineyard land for a highway widening. A court of appeal recently held that in an eminent domain proceeding, a business owner is entitled to a jury trial on the amount of goodwill lost to a government taking of property only if the owner first establishes that the business had goodwill to lose. (The People ex rel. Department of Transportation v. Dry Canyon Enterprises, LLC (--- Cal.Rptr.3d ----, Cal.App. 2 Dist., November 28, 2012).
Dry Canyon Enterprises, LLC (Dry Canyon) makes wine, which it blends mostly from grapes it purchases from other vineyards. To a lesser extent, Dry Canyon uses grapes it grows on land it owns in Madera and Paso Robles, California. Dry Canyon’s business plan provided that it planned to develop a flagship wine, an estate cabernet that it would market under the label of “Chumeia.” The estate cabernet would be made from grapes grown on the Paso Robles land. Dry Canyon blended and sold a few vintages of Chumeia but it had yet to turn a profit by 2009 due to persistent financial problems.
The State Department of Transportation (“State”) initiated eminent domain proceedings in 2009 against a strip of land abutting Highway 46 on Dry Canyon’s Paso Robles property so that the State could widen the highway. That strip of land contained 1,466 vines, or approximately 21 percent of Dry Canyon’s vines that were to be used for the estate cabernet. The State agreed to pay Dry Canyon $203,500 for the value of the land and vines.
The only issue left for the jury was the amount by which the State’s taking of Dry Canyon’s property diminished its business goodwill. The State’s expert concluded that Dry Canyon was not profitable, its liabilities exceeded its assets, and that Dry Canyon never had any goodwill prior to the taking and therefore it experienced no loss of goodwill.
Dry Canyon’s expert concluded that Dry Canyon lost $240,000 in goodwill. Dry Canyon’s expert used two methodologies to reach this figure—the “cost to create” methodology and the “premium pricing” methodology. Pursuant to the “cost to create” methodology, the expert viewed the lost goodwill as equal to the cost incurred in creating the goodwill in the first place. The expert added up every expense Dry Canyon incurred in the first four years of its operations in both Paso Robles and Madera and then divided the costs by four because one-fourth of the vines destined for the estate cabernet were subject to the eminent domain proceedings.
The “premium pricing” methodology was invented by Dry Canyon’s expert. Under this methodology, the expert estimated the price that the estate cabernet would one day sell for, which he concluded would be “$10.62 more per bottle than a hypothetical but inferior, Madera-grown wine.” The expert multiplied the lost premium by his estimation of the number of bottles of estate cabernet that would not be produced over the next 15 years due to the taking and then he labeled the total as “lost goodwill.”
The State asserted Dry Canyon had not proven it had any business goodwill to lose and asked the trial court to grant judgment in its favor instead of submitting the issue to the jury. The trial court granted judgment in favor of the State because Dry Canyon failed to present evidence of preexisting goodwill.
A property owner has a constitutional right to just compensation when the State condemns its property. The constitutional right to just compensation does not include a right to compensation for the loss of goodwill. The California Legislature created a statutory right for business owners to obtain compensation for loss of goodwill. The Legislature defines goodwill as “the benefits that accrue to a business as a result of its location, reputation for dependability, skill or quality, and other circumstances resulting in probable retention of old or acquisition of new patronage.” A business owner has the right to have a jury determine the amount of goodwill lost. Affirming the decision of the trial court, the court of appeal concluded that a court may determine a business has no goodwill to lose so that the matter does not have to be submitted to a jury.
Code of Civil Procedure section 1263.510, subdivision (a), provides that a business owner must show that the loss of goodwill is caused by the taking of the property, the loss cannot be reasonably prevented by relocation of the business or taking other reasonable steps to preserve goodwill, and that there will be no double recovery through relocation expenses or other compensation. The court of appeal concluded that it should “add proof of preexisting goodwill to this list of qualifying conditions.” The court held “that a business owner is entitled to a jury trial on the amount of goodwill lost by a taking only if he or she first establishes, as a threshold matter, that the business had goodwill to lose.” The court concluded, “the existence of goodwill itself is necessarily an implicit, but essential, precondition to recovery.”
The court noted that although there is no single acceptable method to value goodwill, “the methodologies used to value goodwill are by and large based on a business’s profitability.” Goodwill is the amount a business’s value exceeds the value of its assets “due to a recognizable brand name, a sterling reputation, or an ideal location.” Because goodwill almost always goes hand in hand with profitability, experts look to profitability as a gauge for determining the value of a business’s goodwill.
It is possible for a business to have goodwill when it has no profit, such as where a business was profitable for four of the six years before nearby construction made access to the business difficult. In such a case, it would be permissible to equate the costs incurred in creating the goodwill with the value of the goodwill. The cost-to-create methodology should only be used if there is clear proof of preexisting goodwill coupled with a total loss of the goodwill. The court concluded that “unless there is independent proof that a business possessed goodwill in the first place, the cost-to-create methodology does not reflect the cost of creating any actual goodwill.” Here, Dry Canyon failed to bring forth evidence that it had goodwill before the taking.
The court found that the “premium pricing” methodology, which was created by Dry Canyon’s expert, does not withstand scrutiny because it is inherently subjective. Also, the statute that provides for goodwill compensation is not designed to compensate for potential or hypothetical goodwill. The court of appeal concluded that the trial court properly rejected the “premium pricing” methodology.
If you have any questions concerning the content of this Legal Alert, please contact the following from our office, or the attorney with whom you normally consult.
William T. Chisum or Jeffrey L. Massey | 916.321.4500
Jon E. Goetz | 805.786.4302