Pat Murphy, The Daily Record Newswire
An Arizona court has decided that the valuation of a lawyer’s professional goodwill is not limited to his stock redemption value in his law firm.
The Arizona Court of Appeals reached that conclusion last week in the divorce of E. Jeffrey and Cheryl Walsh. Both are attorneys. Jeffrey is a shareholder at the Phoenix branch of a “national law firm,” which the court politely declined to identify by name (this corner will only note that GreenbergTraurig has an office in Phoenix).
Jeffrey and Cheryl were married in 1986. By 2010, Cheryl had had enough and filed for divorce. The primary issue regarding property division was over the community’s interest in Jeffrey’s intangible professional goodwill.
In the family court, Jeffrey’s position was that his interest in the firm should be $140,000 — his stock redemption value pursuant the terms of his shareholder agreement.
That number was chicken feed, according to Cheryl. Her expert valued Jeffrey’s professional practice at $1,269,000, taking into account the husband’s tax returns, historical income performance, earning sustainability, reputation and client loyalty.
The family court decided Jeffrey had the better argument. Applying a “realizable benefits” standard, the lower court concluded that Jeffrey’s goodwill was limited to $140,000.
The Arizona Court of Appeals reversed the family court last week:
Here, the family court should not have restricted its analysis of the community interest in Husband’s goodwill to “realizable benefits.” Those realizable benefits apply to Husband’s interest in the firm’s net assets, not his goodwill based on his reputation and experience.
That said, how should professional goodwill be valued?
First, the court made clear that goodwill does not equate to a lawyer’s future earning capacity.
“While future earning capacity may be evidence of goodwill, the earning capacity is not itself a divisible community asset,” the court said.
Apart from that, the court provided little guidance. The court did explain that “goodwill is when ‘future earning capacity has been enhanced because reputation leads to probable future patronage from existing and potential clients.’” The court also went so far as to analogize goodwill to pension rights:
In the case of a pension, value is generated (at least in part) during the marriage. That value will be realized later, without further effort by the professional. In the case of goodwill, when the professional continues to practice after the divorce, the professional may realize value as a direct result of his or her future efforts. That value is nothing more than future income, and cannot be divided.
After offering these rather meager guideposts, the court punted on the issue, concluding “[w]e recognize that the myriad differences between professional practices make it impractical to adopt a one-size-fits-all approach to valuation of a professional’s personal goodwill.” (Walsh v. Walsh)
So on remand the family court will have its work cut out for it, with this parting shot by the appeals court to help muddy the waters:
[T]he fact that our law allows great flexibility on a case-by-case basis in the choice among valuation methodologies should not be confused with an endorsement of an ad hoc approach untethered to legal limits.
