The Lost Profits Theory Isn’t All It’s Cracked Up To Be

by Elizabeth Wydra, Chief Counsel, Constitutional Accountability Center

As we reported yesterday, the Federal Circuit did the right thing in its Rose Acre Farms v. United States ruling, refusing to compensate Rose Acre Farms, Inc. for the profits it lost as a result of complying with temporary government regulations aimed at preventing salmonella-tainted eggs from reaching and sickening the public. It would have been outrageous for the appeals court to have found otherwise, i.e., that the Constitution’s Takings Clause requires taxpayers to compensate a company for not being able to sell a dangerous product.

But the Federal Circuit’s Rose Acre opinion goes beyond reaffirming the common sense that underlies this correct reading of the Takings Clause. In an extensive, unanimous decision, the court dealt a significant blow to theory that lost profits should be the measure for whether a government regulation has effected a compensable “taking” under the Fifth Amendment, which forbids that “private property be taken for public use without just compensation.”

Regulatory takings jurisprudence generally looks to the property owner’s loss of value in the property as a measure of the extent of a challenged regulation’s economic impact. This is in part because the court is trying to match “regulatory takings” as closely as possible to the classic takings paradigm of “physical takings.” In other words, “regulatory takings” are more likely to be compensable the more they start to look like the classic physical takings case in which the government directly appropriates private property or kicks the owner off his property. If the economic impact on your property wipes out any and all value, you could argue that the effect is the same as if the government had directly appropriated your property.

This is undoubtedly why Rose Acre tried to focus only on the farms affected by the food safety regulations (3 out of 9 Rose Acre farms) and those farms’ loss in profits. Unsurprisingly, during the time the government was trying to keep Rose Acre’s salmonella-tainted eggs from those 3 farms off the market, the 3 farms lost significant profits. By manipulating the relevant property parcel and looking at the impact on profits of just those farms, Rose Acre was able to suggest that the economic impact of the government’s food regulations was intolerably severe: a loss of profits of 219%! As Rose Acre’s trial expert noted, it is a marvel that Rose Acre was able to survive.

But Rose Acre’s bad eggs weren’t the only things nobody was buying—the Federal Circuit wasn’t buying Rose Acre’s lost profits argument either. The court explained in its opinion yesterday that its suggestion in an earlier Rose Acre appeal—this case has been bouncing around in the courts since 1992—that a lost-profits analysis might be appropriate in this case was “unfortunate dicta.” The court explained that loss of profits is an inherently relative term, and the results of a lost-profits calculation will depend upon a company’s initial profit margin. As we argued in our amicus brief, using a loss-in-profits analysis in takings cases would reward inefficient, fly-by-night firms that operate on thin profit margins. The Federal Circuit agreed, and, by demonstrating the inherent arbitrariness of this mode of analysis through factual examples, the court’s opinion goes a long toward rendering the lost profits theory practically obsolete.

Instead of looking at Rose Acre’s lost profits, the court properly focused on the impact of the government’s food safety regulations on the value of the 135 million dozen eggs affected by the regulations. Because Rose Acre was able to continue selling these eggs, albeit to the less lucrative “breaker” market where salmonella does not pose the same risk, the loss in value to the eggs was only around 10%–hardly a severe economic impact.

The 10% loss in value was particularly underwhelming when weighed against what was gained by the government’s emergency salmonella-prevention regulations. In a wide-ranging portion of the court’s opinion—and by wide-ranging I mean ranging from Pliny the Elder’s views on prepared foods in ancient Rome, to Upton Sinclair’s description of death-by-vat-of-lard in The Jungle, to a 1914 court’s ruling on a “wee beastie” drowned in a Coca-Cola bottle—the Federal Circuit affirmed that it is undoubtedly appropriate to consider the harm-preventing character of a government action when considering an alleged regulatory taking. In this case, the court concluded that “the law of regulatory takings does not generally compensate property owners when a regulation’s economic impact is slight and temporary but the potential for physical harm to the public is significant. Here, infected eggs could have caused serious illness and possibly even death.”

The court’s ruling yesterday bolsters the government’s ability to protect the public from a broad range of unsafe products through restrictions and product recalls. As we explained in our amicus brief in Rose Acre, for more than 100 years, government officials have promoted the public good by restricting the sale of certain commercial products without incurring takings liability, even when the restriction reduced profitability. The Rose Acre decision continues this line of jurisprudence, and we are extremely gratified that the Federal Circuit refused to stretch the Constitution to cover corporate profits at the expense of the public welfare.