September 21, 2023

When Regulatory Oversight Becomes Inverse Condemnation

Posted on September 21, 2023 by Jeffrey Haynes

The Michigan Court of Appeals issued a decision that may upend our usual notion that environmental regulation does not ordinarily give rise to an inverse condemnation claim. In Krieger v. Dep’t of Environment, Great Lakes and Energy, the court denied the state of Michigan’s motion for failure to state a claim, which argued that plaintiffs’ claims arising from the catastrophic failure of a dam on the Tittabawassee River failed to properly allege the elements of inverse condemnation. Unless reversed, the decision may open the floodgates (so to speak) to inverse condemnation claims from everyday permitting and regulation. And paradoxically, the decision may tighten regulation of projects such as hydroelectric dams that risk disasters upon failure.

The facts illustrate typical operator lethargy combined with mixed regulatory goals. The dam’s operator ignored FERC’s requests to upgrade the dam, resulting in FERC revoking the operator’s license. Shortly after, pursuant to statute, a Michigan court established a fixed level for the dam’s impoundment.

Upon obtaining jurisdiction over the dam following the FERC revocation, the Michigan regulators faced conflicting regulatory demands. On the one hand, they oversaw dam safety. In their complaint, plaintiffs alleged that the Michigan agencies knew of deficiencies in the dam’s spillways to handle high water flows and need for repairs to the dam. On the other hand, the regulators were charged with protecting the environment of the impoundment and its curtilage.

After the operator drew down the impoundment level without authorization, the regulators sought to enforce the court-ordered level in order to reduce environmental and aquatic impacts from the improper drawdown. Then, following an intense rainstorm of the type that occurs all too frequently in our era of global warming, the dam burst, causing a downstream dam likewise to burst and flooding downstream homes, businesses, and land. (See a slideshow of the dam collapse.)

The court’s analysis of inverse condemnation turns on the loosest possible interpretation of the legal test that governmental actions must be “directly aimed” at the plaintiffs. In Michigan, inverse condemnation requires government conduct that is a “substantial cause” in the decline in property value and governmental abuse of powers “in affirmative actions directly aimed at the property.” On its face, this test requires some intention and fits nicely with regulatory takings cases, but not so easily with ordinary regulation of projects that might pose foreseeable risks to neighbors.

The court found that allegations of the state’s knowledge of the inadequate spillway, enforcement actions to restore the water level, and concealment of risks amounted to “more than mere regulatory actions” and put downstream properties in “the direct line of harm,” and therefore were directly aimed at plaintiffs. But one searches in vain for any discussion in the opinion that plaintiffs’ complaints alleged that the state’s regulatory oversight intended to damage or occupy downstream properties.

Along with its loose interpretation of “direct,” the court stretched to the breaking point the meaning of “public use” required in inverse condemnation cases. The court found that the state’s regulatory actions amounted to “operational control” of the dam, thus becoming “public use” that caused harm to plaintiffs’ properties. Traditionally, public use requires a showing that the government enhances its economic position by the taking, as explained by Professor Joseph Sax in his seminal 1964 article Takings and the Police Power. But the court here conflated regulation with the government participating in the project. Protecting environmental and resource values means government mediates between competing values—here the operation of the dam and protection of the resource—rather than becoming a partner with the permitted operator.

The natural consequence of equating government regulation with operating permittees’ businesses will be to cause governments to insulate themselves from liability by requiring full indemnity from operators, thus internalizing the cost of projects rather than foisting the externalities of project failures on taxpayers. This indemnity may take the form of financial assurance mechanisms such as surety bonds, insurance, or letters of credit. These financial assurances will likely be prohibitively expensive, with the result that such projects likely will not be built. And it is only a matter of time before state legislatures, and perhaps Congress, begin requiring such financial assurances from existing operators and permittees.

It is likely that the state will appeal the decision, but its fate on appeal to the Michigan Supreme Court is anything but certain. The state starts in a disadvantageous position because the opinion rests on inverse condemnation claims allowed by the supreme court in the Flint water crisis litigation. Michigan practitioners have noticed that Michigan environmental regulators became much more cautious following the Flint debacle. Krieger will likely cause regulators to be reluctant even to issue permits and licenses without increased protections for the state.