ValueLinks Newsletter

October, 2004

Recent family court opinions outside New Jersey exclude goodwill from the marital estate.  Some opinions make clear distinction between personal and entity goodwill while others do not make such a distinction.  This is contrary to the basic premise of Dugan v. Dugan and Piscopo v. Piscopo in New Jersey, where goodwill associated with these individuals are included in the marital estate for purposes of equitable distribution.

There are many definitions of goodwill.  Justice Benjamin Cardozo, In re Marriage of Brown, stated it simply when he viewed goodwill as the tendency for customers to return to the same location or business because of its name or other attributes, regardless of its location.  A separate asset, personal/professional goodwill, may arise when an entity relies on an individual’s presence as a result of that individual’s personal skill, training or reputation.

That goodwill attaches to a business is clear in a commercial enterprise such as a retailer or manufacturer where the company business and name are the driving force in the customer’s decision to transact business with the entity.

In a professional entity (practice), the question of to whom does the goodwill attach is not as clear-cut.  Are we dealing with entity goodwill or personal (professional) goodwill? Personal goodwill attaches to the individual and it can be argued that such personal goodwill is not subject to equitable distribution.  In New Jersey, Stern v. Stern, Levy v. Levy and Dugan v. Dugan make it clear that goodwill associated with a professional entity should be measured and considered in the marital estate for purposes of equitable distribution. No distinction was made as to entity or personal goodwill in these cases.

Once it is established that goodwill is associated with the entity being valued, what factors might lead to a consideration by the court that some if not all of this goodwill is professional/personal goodwill?  What elements of goodwill attach to the professional as opposed to the entity?  Factors[1] the courts have considered in considering professional goodwill are:

• The age and health of the professional. If the practitioner were going to retire and close the practice two years after the valuation date, any multiple of his earnings (or excess earnings) over two would normally overvalue the professional goodwill.  On the other hand, a fairly young practitioner who had only recently started practice would necessarily have a lower earning potential than the “average” practitioner.

Health is another factor.  A doctor recently diagnosed with heart problems may soon have to curtail his practice.  Knowing this fact will limit the quantifiable amount of professional goodwill associated with the doctor.

• The professional’s demonstrated past earnings power  -  If the professional has shown a consistent ability to earn in his/her professional career, professional goodwill is enhanced.

• The professional’s reputation in the community for judgement, skill and knowledge  -  This can be one of the most abstract factors in the measurement of goodwill.  A review of the practitioner’s curriculum vitae and inquiry if the practitioner has received any special certifications, professional awards, written any articles or taught classes may help quantify the elements of professional reputation.

• The professional’s comparative professional success  -  Comparative professional success is a crucial factor  in establishing professional goodwill.  Success is usually measured by the amount of income generated.  However, other factors, such as the number of patients seen, hours spent working and so forth, must also be reviewed.

• The nature and duration of the professional’s practice  -  Goodwill is built over time.  Accordingly, the length of time the practice has been in existence will have a bearing on goodwill.  Separating the personal versus practice goodwill aspect of longevity can be difficult, but it is a factor to be reviewed.

The list of above factors is relatively clear, but the dividing line between Entity and Personal goodwill requires detailed inquiry and analysis to determine if the two can be separated. 

The trend to separate goodwill appears to have started in 1999 when two states, Indiana and Ohio, that had previously concluded that professional goodwill is a business asset with a determinable value subject to equitable distribution, reached decisions that disallowed the distribution of personal goodwill.

In Jay Myoung Yoon v. Sunsook Yoon, No. 49S02-9906-CV-353 (June 21, 1999), the Indiana Supreme Court determined that there were two types of goodwill: enterprise goodwill, which represents the prospect of repeat business generated by business name, location, etc., and personal goodwill, which represents the future earnings capacity of an individual.  It noted that enterprise goodwill is a marital asset, but personal goodwill is not.

In Young v. Young, No. 98CA56, 98CA79,1999 WL 254426 (April 19, 1999), the Ohio Appellate Court ruled that personal goodwill associated with the owner of a small newspaper business (not a professional practice) shouldn’t be considered as part of the marital estate for distribution purposes.

The Trend Picks Up in 2002 and 2003
A number of opinions have come down recently that continue the segregation of goodwill and exclude it from the marital estate:

In In re the Marriage of Boyd, No. C3-02-1751 (Minn. App. October 15, 2003), unpublished, the trial court determined that the husband’s business had a Fair Market Value of $37,800, inclusive of $10,000 for goodwill and other intangibles.  Trial court later amended its valuation to $27,800, to exclude goodwill value from the valuation of the business and the wife appealed.  The appellate court ruled that “…the reduction of the business’s value for the intangibles is consistent with case law”.

In Alonzo D. Williams, Sr. v. Henrietta E. Williams, No. CA02-453 (Ark. App. May 28, 2003), the Arkansas Court of Appeals considered whether two medical practices had entity goodwill to be included in the marital estate.  Dr. Alonzo Williams was an Arkansas gastroenterologist.  He ran two businesses. Dr. Williams’ expert was successful in convincing the trial court that personal goodwill should not be included in the enterprise fair market value and therefore not subject to equitable distribution.  Wife appealed, arguing that the business had substantial entity goodwill.

The Arkansas appellate court ruled based on a fair market value standard and found that for goodwill to be included in valuation of a business a party must establish salability of that goodwill as an asset of the business.  The appellate court affirmed the trial court.  It found the success of the business was dependant upon Dr. Williams’ continued association with the business.  Dr. Williams presented evidence indicating:

• most of his practice is dependant upon referrals from other physicians, not repeat business;
• he works hard and efficiently;
• his reputation in the Little Rock area, where he grew up is excellent;
• he is very involved in community affairs;
• at time of trial he was secretary of Arkansas Medical Board.

In summary, the court relied on Dr. Williams’ evidence demonstrating his professional reputation in the community, professional attainments and success in addition to the nature and duration of his practice.  All these contribute to personal goodwill.  While the court appears to have recognized the difference between personal and entity goodwill, there is no indication that the court requested that either or both be quantified.

In Hillman H. May v. Carol S. May, No. 31134 (November 10, 2003), a West Virginia trial court adopted the wife’s expert opinion of value of husband’s dental practice of $120,000, which included personal goodwill.  Husband appealed, objecting to the inclusion of goodwill in the appraisal. The Supreme Court noted a “split of authority” regarding the inclusion of personal Goodwill in the marital estate.  It looked to other jurisdictions to determine if the inclusion of goodwill is appropriate.  The Supreme Court found that the majority of courts deemed enterprise goodwill to be marital property, but personal goodwill was not.  In its ruling the Supreme Court provided definitions of entity and personal goodwill:

Enterprise goodwill – an asset of the business and may be attributed to a business
by virtue of its existing arrangements with suppliers, customer or others, and its
anticipated future customer base due to factors attributable to the business.

Personal goodwill – an asset that depends on the continued presence of a
particular individual and may be attributed to the individual owner’s personal
skill, training or reputation.

The West Virginia Supreme Court ruled personal goodwill is not subject to equitable distribution, but that enterprise goodwill is subject to equitable distribution.  The case was remanded to the trial court.

Finally, in Barbara G. Wright v. Steven E. Wright, No. A-01-1179 (Neb. App. September 30, 2003), the trial court included “practice” goodwill in the husband’s veterinary clinic as part of equitable distribution.  Wife appealed the decision, dissatisfied with the amount of “practice goodwill”. The appellate court upheld the trial court, and noted, “goodwill must be a business asset with value independent of the presence or reputation of a particular individual, an asset which must may be sold, transferred, conveyed or pledged”. 

From the above cases we see a trend to exclude personal goodwill from the marital estate.  In one case discussed above, Boyd, goodwill was excluded without any apparent attempt to segregate personal versus entity goodwill.

Quantification
Quantification of the amount of personal or entity goodwill remains difficult.  The five factors presented above are valid considerations, but quantification is a separate issue. Differences in the courts as to how they are measured remain.  As more positions are taken to exclude “personal” goodwill from equitable distribution, we will see standards develop in this debate as we saw in the acceptance of entity goodwill as a marital asset associated with the licensed professional.

One possible method to determine an amount of “excludable” personal goodwill, after recognition of the five factors above, might be to question the need for the selling professional to remain in the business to effectuate a smooth transition to a new owner if the professional entity was actually sold.  This would provide a measure of the professional’s personal goodwill with clients and their reliance on him or her apart from the entity itself.  A present value factor of the selling professional’s salary covering the period of transition would be a good starting point.

Where Are We Going?
The recent trends in the nation seem contrary to New Jersey, where the State appears headed to a “fair value” or “value to holder” type of standard.  The spirit of Brown v. Brown, (348 N.J. Super. 466, 7922 A.2d 463) tells us that there should be no academic reductions in the value of a titled spouse’s interest if there is no intended sale of the business.  This seems at direct odds with the exclusion of goodwill from the marital estate, whether segregated between personal goodwill and entity goodwill or not.

In Piscopo v. Piscopo, 231 N.J. Super. At 576, the court acknowledged the celebrity’s right to protect against unpermitted use of the celebrity’s name, likeness, photograph or voice.  With that concept in place, the family court would not deprive “a spouse from sharing in that very same protectible interest.”  This became known as “celebrity goodwill”.  It is apparent that celebrity goodwill is personal goodwill, only for celebrities.  Will New Jersey family courts now be asked to segregate personal goodwill out and exclude the same from equitable distribution?

The trends of the last few years raise a few interesting questions for family law practitioners in New Jersey and elsewhere:

• If goodwill is established in relation to a professional entity, is it equitable to segregate such goodwill between entity and personal goodwill?
• If goodwill arises during a marriage, isn’t it the result of the marriage partnership, whether personal or entity goodwill?
• Should the non-titled spouse not share in this asset, whether personal or entity goodwill?
• In light of Piscopo, does it matter?
• In a marriage of two working professionals and one is a business owner; is such segregation and exclusion valid?

We’ve all sat across the table from a chest-thumping business owner who tells us, “the business is nothing without me, there’s no value here”.  Please don’t tell me I might have to say, “Yes”.