From Kelo to Starr: Not Merely an Unlawful Taking but an Illegal Exaction

A property case even more important than Kelo v. City of New London (2005) began to wend its way toward the Supreme Court a few weeks ago. The new case is Starr International Company, Inc. v. United States, and unless the Supreme Court repudiates the lower courts, the case will lay down a strange principle: that the government can unlawfully deprive shareholders of their ownership and control as long as it does not seize their shares.

Starr International, and other shareholders of American International Group, are seeking with this suit to recover their ownership interest in AIG. The case may therefore seem just a footnote to the c. 2008 financial crisis, when the government supported many companies for the sake of the economy. The shareholders’ claim is that in the course of propping up AIG, the government, in violation of federal statute, demanded nearly 80 percent of equity in the company—ultimately depriving shareholders of their share of ownership and their voting control. Although the government did not physically take their shares—their formal indicia of ownership—it ignored federal law to seize most of their real share of ownership and their control.

Government interference in property rights is often associated narrowly with the Constitution’s Taking’s Clause, which bars government from taking private property for public use without just compensation. This was the provision that the Supreme Court notoriously misread in 2005, when it concluded in Kelo that government can take private property for transfer to a private developer.

But the Takings Clause centers on compensation for lawful takings, and it thus is not the only protection for property rights. Even more basically, government cannot exact property unlawfully. It must return any property that it acquires through an unlawful exaction.

Thus, whereas the Takings Clause requires just compensation for lawful takings, the more central constitutional point—at stake in Starr International—is that the government must return any property it gets hold of unlawfully. And here, where the government has sold the property it exacted, it ordinarily must return its ill-gotten proceeds—not as damages, but in lieu of the property itself.

If the government had acted with legal authority to take private property for public purposes, this would have been a taking, for which the shareholders would be owed just compensation. But if the government acted without legal authority, the shareholders have a right to get back their share of ownership. The distinction matters, for even when a company is illiquid and in this sense insolvent, ownership can have residual value.

In this case, the residual value was that AIG might recuperate, and the government unlawfully took advantage of this possibility. Sure enough, after the bailout the company came to be worth many billions. The government seems to assume that because the company could not have recovered without government aid, the government does not have to comply with longstanding doctrine requiring the return of the property or proceeds. The implication is that when the government provides crucial assistance, it can escape its legal limits.

The case is thus even worse than Kelo. It involves not a lawful taking, but an illegal exaction—the sort of confiscation that is familiar from other parts of the world. And as in those regions, the exaction is justified as a necessary response to an economic emergency. Both the exaction and the excuse are what one would expect in a tinpot dictatorship.

Disturbingly, the lower courts have repeatedly failed to require the government to return the unlawfully seized property. The trial judge expressly found that the government engaged in an “illegal exaction” in “plain violation[] of the Federal Reserve Act,” but he did not restore the stolen property. His explanation was that there were no damages—a puzzling argument, not least because the remedy for an illegal exaction is the restoration of the property itself or the proceeds, not damages.

On appeal, the circuit court did not deny the illegal exaction; nor did it dispute that the remedy would ordinarily be a restoration of the confiscated property or the proceeds. But like the trial court, the circuit court avoided giving a remedy—this time on a theory of prudential standing.

One might think the circuit court had a point. Rather than lose their shares, the plaintiffs suffered a dilution of their equity and voting control, and on this basis one might assume that the suit should have been a derivative action (on behalf of the corporation). But the brutal reality (undisputed by the circuit court) remains that the federal government unlawfully deprived the shareholders of their share of ownership and their voting control, and by ignoring this reality the court has announced that the government can get away with a massive illegal exaction.

Tellingly, the circuit court did not use the derivative-action point to argue that the Constitution barred standing. Instead, it avoided the substantive issues by concluding that the shareholders should be denied standing as a prudential matter. The theory that some standing questions are merely prudential rather than constitutional has long aroused fears that judges will rely upon it (even if not consciously) to evade doing their duty. This circuit court decision exacerbates such concerns.

Why have both the trial and the appellate courts so persistently avoided giving a remedy? It is difficult to know for certain, but it is also difficult to ignore that, according to the trial judge, the government went out of its way to make AIG a scapegoat for the financial crisis. The judge observed that the government  “publicly singled out AIG as the poster child for causing the September 2008 economic crisis”—even though “the evidence supports a conclusion that AIG actually was less responsible for the crisis than other major institutions.” AIG’s shareholders may therefore seem distinctly undeserving. It thus seems important to state bluntly that no one, however unpopular—or however unpopular they have been rendered by government—should be denied legal recourse on this account.

Of course, it cannot and should not be presumed that the lower courts acted in anything but a principled manner. Even the best of judges, however, can unselfconsciously veer away from conclusions that they sense will be unpopular.

Whatever underlay the decisions of the lower courts, the case leaves the disturbing impression that judges are hesitant to give a remedy. It suggests that the government can get away with an illegal exaction where it is providing crucial aid and where it singles out the target for public delegitimization.

The petition for certiorari is therefore of profound importance. The Supreme Court nowadays often uses certiorari to resolve circuit splits, but certiorari has never lost its role as a mechanism for correcting the refusal of lower courts to do justice. And the necessity of Supreme Court action is all the greater in Starr International because the case, as it stands, is so dangerous a precedent.