Southern Pacific Transportation Co. v. Santa Fe Pacific Pipelines, Inc., A079430

• Citation: 88 Cal.Rptr.2d 777,74 Cal.App.4th 1232
• Decision Date: 15 September 1999
• Docket Number: No. A079430,A079430
• Court: California Court of Appeals
• Parties: , 99 Cal. Daily Op. Serv. 7696, 1999 Daily Journal D.A.R. 9749 SOUTHERN PACIFIC TRANSPORTATION COMPANY, Plaintiff and Appellant, v. SANTA FE PACIFIC PIPELINES, INC., Defendant and Appellant.

Page 777

88 Cal.Rptr.2d 777

74 Cal.App.4th 1232, 99 Cal. Daily Op. Serv. 7696,

1999 Daily Journal D.A.R. 9749

SOUTHERN PACIFIC TRANSPORTATION COMPANY, Plaintiff and Appellant, v. SANTA FE PACIFIC PIPELINES, INC., Defendant and Appellant.

No. A079430.

Court of Appeal, First District, Division 4, California.

Sept. 15, 1999.

Brobeck, Phleger & Harrison, Gary S. Fergus, Thomas M. Peterson, San Francisco, Michael B. Green, Los Angeles, V. Elise Bigelow, for plaintiff and appellant.

Mayer, Brown & Platt, Neil M. Soltman, Michael F. Kerr, Anthony G. Graham, Los Angeles, Margaret S. Giles, for defendant and appellant.

REARDON, J.

This is a valuation case, coming by way of a complaint for order of general reference of dispute. The dispute concerns the amount of rent payable to plaintiff railroad by defendant pipeline company ¹ for a series of noncontiguous pipeline easements spanning approximately 1,863 miles and running beneath the railroad's right-of-way.

By stipulation the parties charged the referee with determining "the amount of the rent increase payable, if any, in accordance with the 'fair market value of the easement[s]' as of January 1, 1994."

The parties prepared for the reference proceeding with expert opinions using a valuation method known as the "across-the-fence" (ATF) method. Yet, in a rare usurpation of the parties' role in molding the issues, the trial court orchestrated the displacement of this method with one relying on "comparable" rents. In the end, it was a shutout victory for the pipeline company. The trial court rejected virtually all the railroad's exhibits. So, too, it refused to engage in any interpretation of the agreements to determine the formula for establishing rent, let alone consider extrinsic evidence pertinent to the question. The judgment--for less than one-third of the rent initially proposed by plaintiffs--must be reversed in favor of the railroad. ²

I. FACTUAL BACKGROUND

Southern Pacific operates in the states of California, Arizona, Nevada, New Mexico, Oregon and Texas. The relevant history begins in the mid-1950's. At that time, the railroad and Southern Pacific Pipelines, Inc.--the predecessor of Santa Fe--were sister subsidiaries of Southern Pacific Corporation. The pipeline company had the right to install pipelines along the railroad's right-of-way pursuant to two master agreements. The agreements provided for the creation of pipeline easements on the right-of-way property.

In 1983 the two companies entered into a new master agreement whereby the railroad granted to the pipeline company perpetual, nonexclusive easements and the right to construct and operate underground hydrocarbon pipelines on its rights-of-way. The 1983 agreement set forth the amounts to be paid for existing pipeline easements through 1993.

Also in 1983 the parent companies of the Southern Pacific and Santa Fe railroads announced a merger. The combination went forward but Southern Pacific Transportation Company--the railroad--was held in a trust and remained separate from the other newly combined entities. The Interstate Commerce Commission ultimately disapproved of the consolidation of the two railroads and required Southern Pacific to be sold to a third party. ³ Meanwhile, the pipeline company became Santa Fe Pacific Pipelines, Inc. The railroad and pipeline companies were no longer sister subsidiaries. Rents for pipelines constructed by Santa Fe were established through separate agreements.

In 1991 the railroad sued Santa Fe and related entities, alleging that the 1983 master agreement should be rescinded because it was not negotiated at arm's length and set artificially low rent for the pipeline easements. (Southern Pacific Transportation Company v. Santa Fe Pacific Corporation (Super. Ct. San Francisco County, No. 937641).) The parties settled the lawsuit in April 1994. Pursuant to the settlement agreement, the 1983 master agreement was rescinded; the easement agreements of the 1950's were revitalized; the pipeline company's perpetual easement rights were confirmed and the easement locations were modified, reducing the width of the easement at many segments.

The parties compromised the existing claims. As to future rent, the settlement agreement provided as follows: "Beginning January 1, 1994, and every ten (10) years thereafter, SPT may seek an increase of rent to fair market value.... If the parties hereto are unable to agree upon the amount of the rent increase, if any, for any such ten (10) year period on or prior to the commencement date of any ten (10) year period, then upon request of either party the parties shall within 30 days thereafter enter into a stipulation pursuant to Rule 244.1 of the California Rules of Court for an order directing a judicial reference proceeding pursuant to California Code of Civil Procedure § 638 et seq. by a single referee ... to establish the amount of such rent increase in accordance with the fair market value of the easement."

In July 1994 the parties entered into an amended and restated easement agreement which reiterated the procedure and mechanism for determining rent increases. Exhibit E to the amended easement agreement listed the rent paid in 1993 for the existing easements, pursuant to the settlement. The parties also entered into a side letter agreement in September 1994 which underscored that exhibit E was a restatement of rental amounts actually due and paid for existing easements and thus did not, in itself, "constitute any agreement or admission by Railroad that such amounts were or are fair market rental values for the Existing Easements."

The railroad commenced the instant action for declaratory relief on August 31, 1994. The parties stipulated to the appointment of the Honorable Christian E. Markey, Jr., retired, to serve as temporary judge.

Preparing for trial, each company hired appraisal experts who issued reports using the ATF methodology. Santa Fe engaged the firm of Coopers & Lybrand L.L.P., which valued the easements at $4,930,200. The Coopers & Lybrand report describes the ATF valuation method this way: "The value of the underground real estate easements leased starts with the value of the real estate using the ATF valuation method. The ATF is a method whereby land utilized as a right-of-way is appraised assuming that its market value per square foot is equal to the value of adjacent or adjoining land. The right-of-way is divided into parcels based on adjacent land uses, and each parcel was valued separately or in groups depending on the predominant adjacent land use. The ATF method is considered a variation of the Sales Comparison Approach, which is typically employed to estimate the value of land."

Once the ATF value, representing "the sum total of the value estimates for the individual land parcels that comprise separate easements" is derived, the next step involves making possible adjustments to reflect the special value of a pipeline corridor. The third step entails determining the extent or percentage of use of the easements. The last step involves determining an appropriate rate of return.

Southern Pacific engaged expert appraiser John Donahue, who prepared a master report calculating rent payable under the ATF method at $17,982,779.

February 6, 1996, was the date scheduled to hear various motions in limine. Southern Pacific's ATF appraisals and reports were not yet before the court. However, the court captured a taste of the methodology from Southern Pacific's motion challenging the qualifications of the pipeline company's expert. The court announced that it was narrowing the valuation focus to analysis of "comparable leases or rental agreements for a perpetual corridor longitudinal easement already in place and operational." The court was convinced that "the clearest and best and most appropriate way of determining whether or not the rent being paid is fair market value, ... is look at the comparables."

Southern Pacific took the position that comparable lease data falling within the court's standard of comparability was not available; that none of the discovery or expert analysis on either side had embraced the comparables approach; and that comparability was not the appropriate analysis. Nevertheless the court demanded that proof proceed using the comparable approach, challenging the railroad to "take another look" at comparable leases "or you may not get started as a plaintiff in this case." At the same time the court indicated it was "not happy about what [the experts] have done. There are six truckloads of what they have done, and I am really not [at] all that interested.... [p] What helps me is seeing what some parties have done in negotiations of comparable leases or rental agreements--not properties, not hypothetical corporations, not residual values, not returns, not fairness of return to either the lessor or the lessee, fairness of payment by the lessee. Those seem to me to be subject to speculation, expert ratcheting beyond belief." The court emphasized that the agreements deal "with rent, and it seems to me we have fallen into a trap being [led] by experts that suggests we have to do a jillion other things. We're not talking about the value of land. We are talking about fair market value of rent paid for a longitudinal easement...."

Southern Pacific reserved the right to introduce expert evidence under the ATF methodology. Its trial brief developed the view that ATF was the superior methodology, and the methodology contemplated by the agreements. At the commencement of trial, the court announced it would circumscribe opening statements to the issue of comparable rental agreements. Southern Pacific objected and further emphasized that "the comparable leases [sic ] is not the fair way to evaluate this easement in accordance with its fair market value...."

The trial court proceeded to take evidence on the comparability of 56 leases. Southern Pacific submitted 23 leases, with the caveat...