Untitled Texas Attorney General Opinion

ATTORNEY GENERAL OF TEXAS

GREG ABBOTT

June 5, 2008

The Honorable Kip Averitt Opinion No. GA-0634

Chair, Committee on Natural Resources

Texas State Senate Re: Valuation of real property surrounding

Post Office Box 12068 Possum Kingdom Lake that the Brazos River

Austin, Texas 78711-2068 Authority proposes to sell to the lessees ofthe

property (RQ-0639-GA)

Dear Senator Averitt:

You ask about the valuation of real property owned by the Brazos River Authority (the

"Authority") and leased to private individuals. 1 You inform us that the Authority "owns substantial

property surrounding Possum Kingdom Lake, and much of that property is subject to long-term

residential leases to private individuals." Request Letter, supra note 1, at 1. You explain that a

majority of these leases "reflect a below-market rate, and many of [them] have a number [of] years

remaining in their·terms." Id. In response to legislation proposed but not enacted during the 2007

legislative session that would have required the Authority to sell the leased property to the lessees,

the Authority is formulating procedures to offer to sell the property to the lessees. Id. You

specifically ask whether the leased property "should be valued as though unencumbered by existing

leases where the sale is to the lessee, or whether the sales price should be discounted to reflect the

remaining term ofthe existing leases." Id. at 1-2. You also ask whether using the discounted sales

price reflecting the unexpired lease term would violate article III, section 52 of the Texas

Constitution. Id. at 2.

I. Background

To provide a context for your questions and our subsequent discussion, we briefly review the

type ofreal-property interests implicated here. A title in fee is the most complete form ofownership

and establishes an interest in real property known as a fee simple interest. 34 TEX. JUR. 3d Estates

§ 3 (2002); THE APPRAISAL INSTITUTE, THE APPRAISAL OF REAL ESTATE 68-69 (12th ed. 2001).

The fee simple interest may be divided by a lease into the leased fee (the lessor or landlord's) interest

and the leasehold (the lessee's) interest. THE APPRAISAL INSTITUTE, THE APPRAISAL OF REAL

ILetter from Honorable Kip Averitt, Chair, Committee on Natural Resources, Texas State Senate, to Honorable

Greg Abbott, Attorney General of Texas, at 1-2 (Oct. 16,2007) (on file with the Opinion Committee, also available

at http://www.texasattorneygeneral.gov) [hereinafter Request Letter].

The Honorable Kip Averitt - Page 2 (GA-0634)

ESTATE 81 (12th ed. 2001). A leased fee interest generally includes the right to be paid rent for the

term of the lease and the right of repossession at the end of the lease term. Id. "[T]he value of the

leased fee interest represents the owner's interest in the property." Id. at 82. A leasehold interest

generally includes the right to possess the property for the lease period in return for the obligation

to pay rent. Id. at 83. Under the facts presented, the Authority holds a leased fee interest and a

private lessee a leasehold interest. As particularly relevant here, "[t]he value of a leased fee interest

encumbered [by] a fixed [contract] rent that is below market rates2 may be worth less than the

unencumbered fee simple interest or the leased fee interest with rent at market levels." Id.

Whether the property at issue should be valued as encumbered by the leases (as leased fee

estates) to which the property is subject or as unencumbered (as fee simple estates) is a significant

issue for the Authority and the lessees because of the particular facts. You explain that certain

lessees contend that the property should be valued as encumbered by the remaining term ofthe lease

on the property, which would result in a lower sales price in this particular instance because of the

existing below-market lease rates. Request Letter, supra note 1, at 1. 3 The Authority, however, has

been advised by its outside counsel that any sale of the leased property at a price reflecting "the

existing lease would result in a windfall to the lessee" and that such a windfall is prohibited by Texas

Constitution article III, section 52. Id. 4 This view, as we understand it, is premised in part on the

application ofthe legal doctrine ofmerger5 under which the lessee "would acquire the full fee simple

interest in the property for a price discounted by a below-market lease that would cease to exist the

moment the property is sold." Id.; see also Authority's Brief, supra note 4, at 2-3; Authority's Reply

Brief, supra note 4, at 3, 5. The lessees contend that the merger doctrine does not or would not apply

here. See Staley Brief, supra note 3, at 10-13.

2"Market rent" is "[t]he rental income that a property would probably command in the open market; indicated

by the current rents that are either paid or asked for comparable space as ofthe date ofthe appraisal." THE ApPRAISAL

INSTITUTE, THE ApPRAISAL OF REAL ESTATE 83 (12th ed. 2001). In contrast, the "contract rent" is "[t]he actual rental

income specified in a lease." Id.

3See also Letter Brief of Concerned Lessees of Possum Kingdom Lake, from James D. Shields, Rebecca C.

Lucas, Mark Lane, and Jim Handy, to Honorable Greg Abbott, Attorney General ofTexas (Dec. 14, 2007) (on file with

the Opinion Committee) [hereinafter Lessees' Brief]; Letter BriefofPossum Kingdom Lake Ass'n and Possum Kingdom

Lake Preservation Ass'n, from Law Offices ofJoe H. Staley, Jr., P.C., to Opinion Committee, Attorney General ofTexas

(Dec. 12, 2007) (on file with the Opinion Committee) [hereinafter Staley Brief].

4See also Opinion Letter Regarding Sales of Property to Lessees at Possum Kingdom Lake, from Jennifer

Knauth, Scott, Douglass & McConnico, L.L.P., to Mr. Steve Pefia, Presiding Officer, Board ofDirectors, Brazos River

Authority, at 2-3 (Aug. 16,2007), attached to Request Letter [hereinafter Authority's Brief]; Letter Brieffrom Jennifer

Knauth, Scott, Douglass & McConnico, L.L.P., to Honorable Greg Abbott, Attorney General of Texas, at 3 (Jan. 24,

2008) (on file with the Opinion Committee) [hereinafter Authority's Reply Brief].

5"Merger of estates is the absorption of a lesser estate in land into the greater; however, application of this

doctrine is disfavored in Texas." Steger v. Muenster Drilling Co., Inc., 134 S.W.3d 359, 376 (Tex. App.-Fort Worth

2003, pet. denied) (footnotes deleted). Whether a merger of two estates-such as the leased and leasehold interests

here-is intended, is a question of fact determined by looking at the estate owner's-here the lessees'-intentions and

all the related circumstances. Id. "Equity will not, however, decree a merger of estates when it would be

disadvantageous to the person acquiring both interests." Id.

The Honorable Kip Averitt - Page 3 (GA-0634)

II. Analysis

A. Statutory Authority

We begin by considering the Authority's statutory power to sell the leased property. The

Authority is a special law conservation and reclamation district established pursuant to article XVI,

section 59 of the Texas Constitution. See TEX. CaNST. art. XVI, § 59(b); TEx. SPEC. DIST. CODE

ANN. § 8502.001(a)-(b) (Vernon 2007). The Authority is governed by its special enabling

legislation and by certain general laws applicable to water districts, including chapter 49 ofthe Water

Code. See Tex. Att'y Gen. Ope No. GA-0599 (2008) at 2-3. We understand that the Authority

proposes to sell the leased properties to the lessees in private sales pursuant to section 49.226(a) of

the Texas Water Code. 6 See Authority's Brief, supra note 4, at 2-3. Section 49.226(a) generally

requires a water district to exchange real or personal property "for like fair market value":

Any personal property valued at more than $300 or any land or

interest in land owned by the district which is found by the board to

be surplus and is not needed by the district may be sold under order

of the board either by public or private sale, or the land, interest in

land, or personal property may be exchangedfor other land, interest

in land, or personal property needed by the district. Except as

provided in Subsection (b) [abandonment or release of property not

acquired with district funds], land, interest in land, or pers0l?-al

property must be exchangedfor like fair market value, which value

may be determined by the district. In connection with the sale of

surplus land, the board, at its discretion, may impose restrictions on

the development and use of the land.

TEX. WATER CODE ANN. § 49.226(a) (Vernon 2008) (emphasis added); see also Tex. Att'y Gen. Ope

Nos. GA-0371 (2005) at 3 ("Section 49.226(a) expressly authorizes a district to sell surplus land by

public or private sale."); DM-441 (1997) at 4-5 ("fair market value is generally understood to mean

a fixed, ascertainable sum").

By its terms, section 49.226(a) authorizes a district's board of directors to determine the fair

market value of land or an interest in land to be exchanged: "land [or] interest in land ... must be

exchanged for like fair market value, which value may be determined by the district." TEx. WATER

CODE ANN. § 49.226(a) (Vernon 2008). While by its literal terms this provision regarding fair

6y ou do not ask and we do not determine whether Water Code section 49.226 is in all respects consistent with

the Authority's enabling legislation. See TEX. WATER CODE ANN. § 49.002(a) (Vernon 2008) (providing that chapter

49 applies to special law districts such as the Authority to the extent that its provisions do not directly conflict with the

district's enabling legislation); see also, e.g., TEX. SPEC. DIST. CODE ANN. §§ 8502.013(b) (Vernon 2007) (authorizing

the sale ofproperty for cash "ifthe board by affirmative vote of11 ofits members determines that the property or interest

is not necessary to the business of the Authority and approves the terms of the sale") (emphasis added); 8502.009(a)

(providing that the Authority's board consists of twenty-one members).

The Honorable Kip Averitt - Page 4 (GA-0634)

market value applies to an exchange? of real property, the Authority and the lessees assume that it

also applies or would effectively apply as a matter of practice to the proposed sale of real property

here. See Authority's Brief, supra note 4, at 2-3 (suggesting that statutory fair market value

requirement applies to sale ofproperty); Authority's Reply Brief, supra note 4, at 4 (stating that the

statute requires the Authority to receive fair market value for property sold); Lessees' Brief, supra

note 3, at 2 (suggesting that appraisal practices require valuing the property to be sold at its fair

market value); Staley Brief, supra note 3, at 3 ("It is not disputed that the Texas Water Code ...

requires the [Authority to] receive fair market value ... for any 'interest in land' that it sells.")

(footnote omitted). But see TEX. SPEC. DIST. CODE ANN. §§ 8502.012(f) (Vernon 2007) (permitting

the Authority to sell property "on terms and conditions . . . or sale prices, on which the parties

agree"), 8502.013(b) (permitting the Authority to "sell for cash any property or interest ifthe board

by affirmative vote of 11 of its members determines that the property or interest is not necessary to

the business ofthe Authority and approves the terms ofthe sale"). Assuming for the purposes ofthis

opinion that the fair market value requirement also applies or would effectively apply to the sale of

property, the statute does not directly state that a water district board must or must not, in arriving

at the fair market value of the land or interest in land, consider any leases on the land. See TEX.

WATER CODE ANN. § 49.226(a) (Vernon 2008).

In the absence of such a direct expression in section 49.226 regarding a lease, we consider

whether the definition of fair market value itself, as a matter oflaw,8 imposes any constraints on a

district board's discretion to make that determination. Section 49.226 does not define or otherwise

elaborate on the phrase "fair market value." Nor has a court construed the phrase as used in this

statute. However, Texas courts have generally defined "market value" as the "'price the property

will bring when offered for sale by one who desires to sell, but is not obligated to sell, and is bought

by one who desires to buy, but is under no necessity of buying.'" City ofHarlingen v. Estate of

Sharboneau, 48 S.W.3d 177,182 (Tex. 2001) (quoting State v. Carpenter, 89 S.W.2d 979,980 (Tex.

1936)); accord State v. Windham, 837 S.W.2d 73, 77 (Tex. 1992); see also Tex. Att'y Gen. LO-98-

082, at 2; Tex. Att'y Gen. Ope No. DM-441 (1997) at 4.

No decision that we find addresses whether fair market value as used in Water Code section

49.226(a) or in a similar context requires valuing leased public property as encumbered or

7While a court has construed the term "sale" to include an "exchange" of property, we fmd no Texas case that

has construed the term "exchange" to include a sale. Cf Bowling v. City ofEl Paso, 525 S.W.2d 539, 541 (Tex. Civ.

App.-EI Paso 1975, writ refd n.r.e.) (acknowledging "that there is a technical distinction between a sale and an

exchange ofproperty," and construing the term "sale" in the statute at issue to encompass an "exchange" because ofthe

purpose of the statute); see also THE NEW OXFORD AMERICAN DICTIONARY 592 (2001) (defming the term "exchange"

when used as a verb as to "give something and receive something of the same kind in return"); BLACK'S LAW

DICTIONARY 585 (7th ed. 1999) (defming "exchange" when used as a noun as "[t]he act of transferring interests, each

in consideration for the other").

8See Tex. Att'y Gen. LO-98-082, at 3 ("The method used to calculate the fair market value of a particular

property and the factors that must be considered in arriving at the fair market value of a particular piece of property are

for a qualified appraiser to determine in accordance with accepted standards of appraisal; they are not questions of law

that are susceptible to the opinion process.") (footnote deleted).

The Honorable Kip Averitt - Page 5 (GA-0634)

unencumbered by the lease. And no statutory definition ofgeneral application aids us in making that

determination. The only Texas decision we find addressing this issue is in the context of a private

equipment lease containing an option to purchase.

In a 2007 unpublished memorandum opinion, the Amarillo Court ofAppeals considered the

fair market valuation of equipment leased under an operating agreement and sold to the lessee. See

Brogan, Ltd. v. Brogan, No. 07-05-0290-CV, 2007 WL 2962996, *6 (Tex. App.-Amarillo Oct. 11,

2007, pet. denied) (mem. op.). Under the operating agreement, the value ofthe equipment included

the equipment's value at the end of the lease term plus the lease payments representing payment of

principal and interest. Id. Because the sale had occurred before the end of the lease term, the

equipment was valued, in accordance with the operating agreement, by adding the "remaining lease

payments discounted by the interest remaining to be paid, and the fair market value ofthe equipment

at the end of the lease period." Id. The court determined that the valuation was consistent with

Texas law, as well as the governing partnership agreement, because the valuation comported with

the broad definition Texas courts give to the phrase "fair market value," namely, "the price a piece

of property would bring on the open market if the seller and buyer were not compelled to enter into

the transaction." Id. (citing City ofHarlingen, 48 S.W.3d at 187). More significantly, as relevant

here, the Brogan court, citing the Fifth Circuit Court ofAppeals's 2001 decision in Petula Associates

v. Dolco Packaging Corp., stated: "Moreover, the value of a lease is considered under Texas law

in a determination offair market value when the property is sold from lessor to lessee." Id.; see also

Petula Assocs. v. DolcoPackaging Corp., 240 F.3d 499, 503-04 (5th Cir. 2001). Even though no

Texas court had considered this precise issue, the Brogan court did not provide further analysis.

In Petula, the Fifth Circuit Court of Appeals considered a commercial building lease giving

the lessee the option to purchase the premises. at fair market value. Petula, 240 F.3d at 501 (reciting

factual background). The lessee's appraiser valued the property as ifit were not subject to the lease

and arrived at the figure of $2.75 million; the lessor's appraiser valued it subject to the lease and

arrived at a $5.15 million value. Id. (The leased fee was more valuable than the unleased fee

because the lease provided for increasing the rents over the life of the lease. See id at 503.) The

district court, among other things, had ordered another appraiser to be appointed to value the

property as unleased. Id at 501-02. The lessor appealed to the Fifth Circuit Court of Appeals.

The Petula court concluded that the leased property must be valued subject to the lease. Id.

at 503-04. The court noted that the Texas courts had consistently defined "fair market value"

broadly as the price a piece ofproperty would receive on the open market ifthe seller and buyer were

not required to enter into the transaction. Id. at 503 (citing Windham, 837 S.W.2d at 77).

Consequently, the Petula court stated that when the phrase is used in a contract governed by Texas

law, "it may be presumed that the parties intended the term to be understood according to this

meaning, absent a clear indication to the contrary." Id. (citing RESTATEMENT (SECOND) OF

CONTRACTS § 202(3)(a) (1981)). The court then concluded that "[i]f Texas's definition of 'fair

market value' is applied, the value ofthe lease should be considered." Id The Petulacourt offered

as an example an Arizona case-TCC Enterprises v. Estate ofErny-that applied the definition of

fair market value, characterized by the Petula court as identical to the Texas definition, to conclude

that the lease must be considered because a buyer in the open market would purchase the property

The Honorable Kip Averitt - Page 6 (GA-0634)

only as a leased fee estate. Id.;9 see Tee Enters. v. Estate ofErny, 717 P.2d 936 (Ariz. Ct. App.

1986). The Petula court explained that, here, what the lessor had to sell was an "estate subject to

a lease"lo and "fair market value must reflect the value of that which can be sold." Id. Finally, the

court concluded:

Absent explicit language indicating that the lease should or should

not be included in determining fair market value, the district court

erred in deviating from the definite and fixed meaning given to the

term "fair market value" in Texas contract law, which would include

the value of the lease.

Petula, 240 F.3d at 503-04. In short, the Petula court held that, under Texas law, fair market value

includes the value of a lease unless the governing contract clearly provides otherwise.

We make the following observations about the Brogan and Petula decisions. First, they are

factually distinguishable from the facts with which we are presented. Both cases construed private

lease transactions that contained express and negotiated options to purchase the leased property. See

Petula, 240 F.3d at 501-02; Brogan, 2007 WL 2962996 at *6. In contrast, at issue here is a statute

governing the sale of surplus public property that does not, on its face, even contemplate the

existence of a lease on such property. Moreover, the property leases here, we are informed, do not

provide an option to purchase. See Authority's Reply Brief, supra note 4, at 3. Second, a Texas

court construing Water Code section 49.226 or a similar statute may not necessarily follow the two

cases' view of the law. The Arizona case that the Fifth Circuit Court ·of Appeals relied on is not

representative ofthe case law in other jurisdictions as to the valuation ofland encumbered by a lease

when sold to the lessee. See, e.g., Napleton v. Ray Buick, Inc., 704 N.E.2d 864, 870-71 (Ill. App.

1999) (relying on affirmative lease terms "clearly indicat[ing] that the parties did not intend for the

9The Arizona court stated:

Emy's estate is not now in a position to sell unencumbered fee simple to

the subject property, for it does not own such fee. The estate they now hold and

could sell is a "leased-fee" estate. Market value is determined by hypothesizing a

sale; it is that price a desirous but unobligated purchaser would pay a desirous but

unobligated seller after consideration of all uses to which the property is adapted

and for which it is capable ofbeing used. Until 2002 the subject property is capable

of use only in accord with the lease terms; the hypothetical sale price must be

adjusted accordingly. We hold that the current market value ofthe lessor's interest

in leased property is the value a purchaser would pay for what the owner-lessor has

to sell, the fee subject to the lease.

Tee Enters. v. Estate ofErny, 717 P.2d 936,937 (Ariz. Ct. App. 1986) (citation and footnote omitted).

laThe Petula court noted in a footnote the following with respect to what the lessor had to sell, i.e., an estate

subject to a lease: "Because Texas law defines 'fair market value' with reference to an unobligated seller and an

unobligated buyer, we must disregard the obligations placed on Petula [the lessor] and Dolco [the lessee] by the purchase

option contained in the lease." Petula, 240 F.3d at 503 n.4.

The Honorable Kip Averitt - Page 7 (GA-0634)

leasehold to merge with the fee when the lessee exercised the option to purchase" and lease language

stating "that the lease and the options to purchase should be included in the calculation of the

purchase price" for its conclusion that the lease would be considered in determining purchase price);

Taylor v. Fusco Mgmt. Co., 593 So.2d 1045, 1047 (Fla. 1992) (stating that absent specific language

to the contrary, the market value of leased property at the time a lessee exercises an option to

purchase should be calculated as if the property were unencumbered by the lease; "[a]ny intent to

value the property otherwise should be clearly stated in the lease"). Third, because Water Code

section 49.226 predates the Petula and Brogan decisions, a court might not necessarily find them

persuasive in construing the statute. See Act of May 25, 1995, 74th Leg., R.S., ch. 715, § 2, 1995

Tex. Gen. Laws 3755, 3775. It cannot be presumed that the Texas Legislature intended in section

49.226(a) to adopt the construction placed on the phrase "fair market value" by these courts. See

Morris v. JTM Materials, Inc., 78 S.W.3d 28,46 (Tex. App.-Fort·Worth 2002, no pet.) ("Because

the provisions in the Texas statute predate their federal counterpart, we cannot presume that the

Texas Legislature intended to adopt the construction placed on the wording by federal courts.").

And, of course, a Texas court is not bound by federal interpretations of Texas statutes. See Jeffery

v. State, 169 S.W.3d 439,443 n.1 (Tex. App.-Texarkana2005, pet. refd) ("Although Fifth Circuit

opinions ... may be relied on as persuasive authority, we are obligated to follow only higher Texas

courts and the United States Supreme Court.").

But, while recognizing the distinctions and the absence of fully developed Texas

jurisprudence supporting the Brogan and Petula decisions, we cannot disregard these two decisions.

See, e.g., Tex. Att'y Gen. Ope Nos.GA-0563 (2007) at 6 ("[T]his office cannot ignore or overrule

judicial decisions ...."), GA-0279 (2004) at 5 (stating that the attorney general cannot legislate or

establish binding judicial precedent, but "may advise only about the current status of the law"),

JC-0507 (2002) at 8 ("[T]he Office of the Attorney General cannot overrule ajudicial decision.").

The two cases' statement of the law-that application ofthe Texas courts' definition of fair market

value includes the value of the lease-is not limited to their particular facts. We can see no

reasonable basis for not applying this judicially established definition of the phrase "fair market

value" to that phrase as it is used in Water Code section 49.226(a). Moreover, the Brogan and

Petula statement ofthe law is consistent with appraisal industry standards that require the effects of

a lease be considered when appraising property. See APPRAISAL STANDARDS BOARD, UNIFORM

STANDARDS OF PROFESSIONAL PRACTICE, S.R. 1-2(e) (2008-2009); see also Petula, 240 F.3d at 503

n.6 ("Indeed, appraisal industry standards indicate that the effects of a lease must be considered.").

Texas law requires persons licensed or authorized to appraise property to comply with these industry

standards or other standards provided by rule that are at least as stringent. TEX. OCC. CODE ANN.

§ 1103.405 (Vernon Supp. 2007) (Real Estate Appraisals). Finally, we have not found any direct

Texas judicial authority to the contrary.

Thus, we presume that when the Legislature used the phrase "fair market value" in section

49.226(a), it intended the phrase to have its established meaning under Texas law. Petula, 240 F.3d

at 503-04; Brogan, 2007 WL 2962996 at *6; see also Acker v. Tex. Water Comm 'n, 790 S.W.2d

299, 301 (Tex. 1990) (stating that a court must presume that the Legislature adopted an enactment

"with complete knowledge of the existing law and with reference to it" (citing McBride v. Clayton,

166 S.W.2d 125, 128 (Tex. 1942))). Because section 49.226(a) does not contain explicit statutory

The Honorable Kip Averitt - Page 8 (GA-0634)

language to the contrary, "fair market value" as used in the statute includes the value of a lease to

which the property is subject. Accordingly, we conclude that the established definition of "fair

market value" requires the Authority's board to value the real property leased to the private lessees

as encumbered by the existing leases on the property. Given our conclusion, we do not consider

application of the equitable doctrine of merger. 11 See also infra p. 9 (discussing Tex. Att'y Gen.

LO-98-082).

B. Constitutional Constraints

You also ask whether using the discounted sales price reflecting the unexpired lease

term-which we understand to mean the lower sales price resulting in this particular instance from

valuing the property as encumbered by the existing leases-would violate article III, section 52 of

the Texas Constitution. Request Letter, supra note 1, at 2. We do not-and cannot-determine the

actual value or sale price of any property. Nor do we determine here that valuing the Authority's

property as encumbered by the leases results in a lower sale price. You indicate that valuing the

Authority's property as encumbered by the leases results in a lower sale price because ofthe below-

market rates charged under those leases. See id at 1; cf Petula, 240 F.3d at 503 (noting that in an

Arizona case, the effect of including the value of the lease was to decrease the fair market value,

whereas in the Texas case, because of the graduated rent schedule, the effect of including the lease

is to increase the fair market value); THE APPRAISAL INSTITUTE, THE APPRAISAL OF REAL ESTATE

82, 83 (12th ed. 2001) (explaining that the value of a leased fee or fee simple may be less when the

lease rent is below market and suggesting that if the rent is at the market rate, consideration of the

lease generally has a neutral effect). We assume that to be the case for the purposes of addressing

your concern regarding article III, .section 52.

Article III, section 52(a) generally forbids the Legislature from authorizing a political

corporation or political subdivision "to grant public money or thing of value in aid of, or to any

individual, association or corporation." TEX. CaNST. art. III, § 52(a); see also TEX. SPEC. DIST.

CODE ANN. § 8502.001(a) (Vernon 2007) ("The [A]uthority is a river authority, a governmental

agency, a municipality, and a body politic and corporate.").

The suggestion that a valuation of public property as encumbered by unexpired lease terms

may violate article III, section 52(a) is largely premised on this office's conclusion in Attorney

General Letter Opinion 98-082. See Authority's Brief, supra note 4, at 7; Authority's Reply Brief,

supra note 4, at 3. In that opinion, this office addressed the sale of city land to the private lessees

llWe also note that Texas courts disfavor application ofthe merger doctrine and do not apply it when it would

be "disadvantageous" to the person acquiring the two different property estates. See Steger, 134 S.W.3d at 376 (stating

that "application of this doctrine is disfavored in Texas" (citing Ferguson v. Ragland, 243 S.W. 721,724 (Tex. Civ.

App.-San Antonio 1922, writ ref d), Montgomery v. Browder, 930 S.W.2d 772, 781 (Tex. App.-Amarillo 1996, writ

denied), Smithv. U.S. Nat'l Bank, 767 S.W.2d 820,823 (Tex. App.-Texarkana 1989, writ denied), Westv. Seigler, 265

S. W.2d 618, 620-21 (Tex. Civ. App.-Fort Worth 1954, writ ref d n.r.e.), Huselby v. Allison, 25 S.W.2d 1108, 1112-13

(Tex. Civ. App.-Amarillo 1930, writ dism'd w.o.j.»). The lessees argue that application ofthe merger doctrine would

be disadvantageous to them. See Lessees' Brief, supra note 3, at 11. We do not determine whether application of the

merger doctrine would or would not be disadvantageous to the lessees.

The Honorable Kip Averitt - Page 9 (GA-0634)

of the land at a price equal to the land's fair market value pursuant to Local Government Code

section 272.001 (h). See Tex. Att'y Gen. LO-98-082, at 1. The city had appraised the land based on

its "underlying fee and reversionary interest," but the lessees asserted that the appraisal should

consider "the fact that the land is burdened for some period of time by the lease." Id. The opinion

first concluded that because the sale would be to the lessees of the property, the merger doctrine 12

would apply to extinguish the leases, the lessees would acquire the whole of the city's estate, and

thus, the land must be valued as unencumbered by the leases. Id. at 3-4. Accordingly, the opinion

advised, the lessees in these circumstances must pay for the whole fee estate-which included the

right to receive rents for the remaining lease term and the city's reversionary interest-because

section 272.001(h) did not authorize the city to give the lessees the value of future rental payments

as the lessees contended. Additionally, the opinion suggested, discounting the purchase price by

subtracting the value of future rents could violate the article III, section 52's prohibition against

granting a "thing of value ... to any individual." Id. at 4.

Texas Attorney General Letter Opinion 98-082 did not construe "fair market value,,13 in

relation to a lease and preceded the Brogan and Petula decisions. Our conclusion here is based on

this case law that provides that the established definition of fair market value includes the value of

a lease. By definition, the sale of property at its fair market value cannot violate article III, section

52(a). "It has been uniformly held that the resale of [] property at its fair [market] value is not a

gratuity or an extension of public credit." Davis v. City ofLubbock, 326 S.W.2d 699,709 (Tex.

1959) (rejecting the contention that property purchased by a city for urban renewal "may not be

resold at its' fair value' which might be less than the [city's] cost ofacquisition and clearance ofsuch

land"); see also Tex. Att'y Gen. Ope No. GA-0371 (2005) at 3 n.4 ("Certainly a land sale for fair

market value could not be challenged as a gratuitous transaction." (citing Walker v. City of

Georgetown, 86 S.W.3d 249, 260 (Tex. App.-Austin 2002, pet. denied))). Moreover, in this

instance, the "windfall" or "discount" the Authority's lessees may receive is not the direct result of

valuing the property as encumbered by the lease, but the result ofthe previously granted discounted

or below-market lease rates. Cf Petula, 240 F.3d at 503 (noting that in the Arizona case, the effect

of including the value of the lease was to decrease the fair market value, whereas in the Texas case,

because ofthe graduated rent schedule, the effect ofincluding the lease is to increase the fair market

value); THE ApPRAISAL INSTITUTE, THE APPRAISAL OF REAL ESTATE 82-3 (12th ed. 2001)

(explaining that the value of a leased fee or fee simple may be less when the lease rent is below

market). The question ofthe validity ofthe discounted or below-market lease rates is not before us.

Texas Attorney General Letter Opinion 98-082 has been superseded by recent court decisions

and is modified to the extent inconsistent with our conclusion here.

12See supra notes 5 & 11.

13 See supra note 8.

The Honorable Kip Averitt - Page 10 (GA-0634)

SUMMARY

The Brazos River Authority (the "Authority"), a special law

conservation and reclamation district under Texas Constitution article

XVI, section 59., owns real property surrounding Possum Kingdom

Lake that is leased to private parties at below-market lease rates. The

Authority is formulating procedures to offer to sell the property to the

lessees of the property.

The first question presented is whether the leased property

must be valued as unencumbered by the leases or encumbered by the

unexpired terms ofthe existing leases for the purposes ofdetermining

the sales price if the property is offered for sale to the lessees. If the

property is offered for sale to the lessees, the Authority would sell the

property pursuant to Water Code section 49.226. Section 49.226(a)

generally provides that surplus real or personal property owned by a

water district may be sold in a private or public sale or be exchanged.

Section 49.226(a) requires that the surplus property be exchanged for

"like fair market value." The Authority and the lessees assume that

this fair market provision applies to the sale of the Authority's

property. The lessees contend that the fair market value provision

in section 49.226 requires the Authority to value the property as

encumbered by the leases. Because section 49.226(a) does not

explicitly state that a lease may not be considered, fair market value

as used in the statute has the meaning established by the Texas courts,

which meaning includes the value ofa lease. Thus, application ofthe

established judicial definition of fair market value requires the

Authority to value the property as encumbered by the leases.

The second question presented is whether using the

discounted sales price resulting from valuing the Authority's property

as encumbered by the leases would violate Texas Constitution article

III, section 52(a), which prohibits gratuitous transfers of public

funds to individuals or private parties. Using a discounted sales

price-resulting in this particular instance from valuing the property

as encumbered by the existing leases-would not violate article III,

section 52(a).

The Honorable Kip Averitt - Page 11 (GA-0634)

KENT C. SULLIVAN

First Assistant Attorney General

ANDREW WEBER

Deputy Attorney General for Legal Counsel

NANCY S. FULLER

Chair, Opinion Committee

Sheela Rai

Assistant Attorney General, Opinion Committee