A Condemnation Action is Looming -- What are a Landlord's Disclosure Obligations to Potential Lessees?
Posted in Court Decisions

Before an eminent domain action is filed, public infrastructure projects involve years of planning, environmental approvals, design, and property negotiations.  During this time, property owners and real estate agents/brokers are often faced with deciding what to disclose about the potential condemnation to prospective tenants when attempting to lease out space.  It is a difficult position to be in, as (i) disclosing too much makes it extraordinarily difficult to find a tenant willing to pay market rents with the looming "cloud" of condemnation, and (ii) disclosing too little exposes the landlord or broker to a potential concealment or fraud claim.  This situation recently played out with a commercial property owner facing Caltrans' I-5 freeway widening project, and a Court of Appeal decision in DNI Food Service v. Kim (2017) Cal. App. Unpub. LEXIS 199 provides some guidance to landlords.

In DNI Food Service, the owner of a multi-tenant retail building received a notice from Caltrans that its property would be impacted by an upcoming project.  After Caltrans sent a "Notice of Decision to Appraise," identified the permanent and temporary construction easements to be acquired, and had its appraiser inspect the property, the landlord proceeded to lease space to a restaurant without disclosing the upcoming project.  Shortly thereafter, Caltrans filed an eminent domain action, which was the first time the restaurant tenant received notice about Caltrans' taking.  In the condemnation action, the tenant filed a cross-complaint against the owner and the real estate agents, claiming they should have disclosed information related to Caltrans' planned freeway expansion that would affect the property.  The tenant asserted that had the proper disclosure been made, it would have never leased the space or spent time and resources remodeling and equipping the restaurant.

In analyzing the tenant's claims, the court explained:

a property owner is under a duty to disclose material facts affecting the value or desirability of the property, if it is known that such facts are not known to or within the reach of the diligent attention and observation of a buyer. . . .  When the seller's real estate agent or broker is also aware of such facts, "he [or she] is under the same duty of disclosure."

The court went on to explain that "a fact is material if it has an effect on the value or desirability of the property."

Here, the property owner and agents knew about the planned Caltrans taking and failed to disclose that fact while simultaneously touting the property's excellent location and convenient proximity to the freeway.  Sounds like a slam dunk concealment case, right?  Surprisingly, the court denied the tenant's claim, concluding that the scope of Caltrans' acquisition -- which primarily involved a small piece of landscaping at the opposite end of the commercial development -- had such a minimal impact on the value of the lease that it was not a material fact giving rise to a duty to disclose.

In reading between the lines, it appears the tenant's business was failing regardless of Caltrans' acquisition.  The court further concluded that even if there was a duty to disclose, the restaurant tenant failed to demonstrate causation and damages, as the restaurant shut down within months of learning of the eminent domain proceeding, but before any construction had started.  This may have been an underlying driving factor in the court's decision.

While the property owner and real estate agents/brokers were let off the hook in this particular case due to Caltrans' taking being deemed "immaterial," it is a good reminder on landlord disclosure obligations with a future acquisition looming.  Landlords should not leave it up to chance to determine what is and what is not material, and should instead take the cautious approach and disclose.  If the landlord is worried about not being able to find a tenant or accepting below market rent due to the pending project, one suggestion is to consider entering into a lost rents agreement with the public agency.  This has the benefit of putting rent in the landlord's pocket, while keeping the space vacant and avoiding a large goodwill or relocation claim for the public agency.

California Eminent Domain Report is a one-stop resource for everything new and noteworthy in eminent domain. We cover all aspects of eminent domain, including condemnation, inverse condemnation and regulatory takings. We also keep track of current cases, project announcements, budget issues, legislative reform efforts and report on all major eminent domain conferences and seminars in the Western United States.

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