Takeovers and Takings in the Next Economic Crisis

Nestor M. Davidson is Professor of Law at Fordham Urban Law Center. This post is based on Professor Davidson’s recent article, available here.

Economic crises can reverberate in the legal system long after they end. One potential echo from the last recession involves Takings Clause challenges to the federal government’s rescue of several failing companies. As I explain in a recent essay, Resetting the Baseline of Ownership: Takings and Investor Expectations After the Bailouts, perhaps the most significant aspect of these cases is what they signal for investors going forward: the federal government has tremendous latitude to respond to economic crises, a power it may well deploy in the next economic crisis. As I explain in the essay and summarize below, the iterative nature of “regulatory” takings law means that a court’s assessment of an investor’s reasonable expectations will reflect government actions; when the government responds as it did, this may well serve as notice to investors about the potential for a similar response the next time around.

At the height of the economic crisis that began around 2007, the federal government nationalized some of the country’s largest companies, most notably Fannie Mae, Freddie Mac, and the American International Group (AIG). In each case, the government invested significant resources to stabilize and revitalize enterprises whose failure could have harmed the global economy. In subsequent litigation challenging these actions, shareholders have asserted that in the course of rescuing these companies, the federal government “took” their ownership stakes and other corporate rights in violation of the Fifth Amendment’s prohibition of taking private property for public use without just compensation. As Julia Mahoney recently noted in this Forum, these suits have proven anything but frivolous, although so far the government has been prevailing (albeit at times on grounds other than takings).

The litigation is still unfolding, but if the cases ultimately confirm the latitude of the federal government to intervene in this way, it could well be salient for any future investor challenges. In takings law, if the government directly expropriates private property, say by taking title to a part of someone’s backyard to build a road, the main legal question tends to be the measure of just compensation. In the last economic crisis, however, the federal government did not exercise its power of eminent domain in this way. Instead, it generally asserted control of companies through means that, shareholders claim, had the collateral effect of harming their property rights.

In this context, where the assertion is that government action consequentially limits or harms private property, the doctrine of “regulatory takings” tests the extent of that interference with what the Supreme Court calls “reasonable investment-backed expectations.” This makes intuitive sense: if a developer buys land that comes with a height limit on building, such a restriction should reasonably factor into the extent of takings protection the owner can claim. Regulatory takings doctrine also recognizes that “background principles” of property law that inherently limit any particular type of ownership may similarly limit takings claims. No owners, for example, should be able to claim compensation for restrictions that merely make explicit what was already an implicit limitation on their ownership. Again, it is easy to see that if an owner decides to start discharging toxic waste, and the government tells them to stop, the owner should understand that they never had the right to harm their neighbors in this way. These two legal concepts in essence capture the idea that when someone invests in property, the existing regulatory landscape, while not necessarily dispositive, certainly shapes how an owner should understand the value and nature of his or her investment.

With that frame in mind, one can see how the current cases may shape expectations moving forward. If the investors challenging the nationalizations of the last decade continue to lose—again still an “if”—this may influence how courts evaluate any similar claims the next time an economic crisis hits and the federal government again has to step in. To the extent that there was ambiguity about what the nationalization of systemically important companies facing failure might mean for investors in those companies, the fact that investors challenged the last wave and lost should reasonably shape the “investment-backed expectations” of investors going forward and might even eventually be considered a “background principle” of this particular kind of ownership. Like building restrictions and inherent constraints on using property in ways that poison neighbors, investors should factor in the possibility that a company whose failure might cause macroeconomic harm could be rescued by the federal government in ways that affect shareholder rights.

This is, to be sure, a limited proposition. To say that investors must be cognizant of this particular risk is not to resolve any of the many complex questions of the federal government’s legal authority to act, factual predicates for acting, or responsible stewardship once in control that are deeply context specific. But it does bear importantly on how we might think about the legitimacy of this kind of public intervention. In the end, takings law under whatever doctrinal rubric is about the fundamental fairness of asking some owners to bear a particular burden in the name of the public good. If the crucible of the last crisis recognizes that this is a legitimate avenue available to the federal government, then that baseline should be a little clearer when the next crisis hits.

The complete essay is available here.

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