Article: To Have and to Hold: Considering Goodwill in Professional Practice Valuations for Marital Dissolutions

by Shannon Farr

The fair market value standard contemplates both a hypothetical willing and able buyer and seller, neither under compulsion to buy or sell. However, in marital dissolution, many courts have recognized that a spouse with a successful professional practice is not a “willing seller.”

Two of the most important duties of divorce courts are the determination of alimony and child support provisions, as well as the distribution of assets and liabilities between the two spouses. The first is based on the parties’ income on an ongoing basis, while the second is based on assets held at a specified date. The assumption is often made that a professional practitioner’s current income will be ongoing for purposes of the determination of alimony and child support. It is incongruent in this setting to then assume, for purposes of the property settlement, that the professional practitioner is willing and able to sell his/her source of income–the practice.

Furthermore, the most significant effect the standard of value has on the valuation is the treatment of goodwill. Fair market value is designed to capture the value of all of an entity’s assets, whether tangible or intangible, including goodwill. As the treatment of goodwill for marital dissolution purposes has evolved, the concepts of two distinct goodwill types, personal and enterprise, have developed. These concepts are aptly described in a 2003 case decided by the Supreme Court of Appeals of West Virginia, May v. May, (No. 31123), which involved a solo dental practice. In May, the court provided the following definitions in its ruling:

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

“Personal goodwill is a personal 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.”

In the May case, the Court ruled that personal goodwill, being intrinsically tied to the attributes and skills of an individual, is not marital property. On the other hand, enterprise goodwill, which is attributable to the business itself, is marital and therefore subject to equitable distribution.

Business Valuation Resources, LLC, maintains a state-by-state summary of the legal cases establishing a precedent for treatment of goodwill in marital dissolution, entitled “Goodwill Hunting in Divorce,” which is available at its website, www.bvresources.com. The latest edition of that publication, accessed March 24, 2009, is the source for the following summary of how various states presently treat this issue.

Currently, Georgia and Alabama are the only two states that have yet to decide whether the goodwill of a professional practice constitutes marital property. It is also unclear whether there should be a further distinction between enterprise goodwill (marital) and personal or professional goodwill (non-marital).

Tennessee is one of four states which preclude characterizing goodwill in a professional practice–whether personal or enterprise–as marital property. In other words, only the net tangible assets of a professional practice are considered marital property in Tennessee. However, a distinction has been made by Tennessee courts in cases involving larger-scale medical operations, which run more like business enterprises than sole professional practices.

Fourteen states currently make no distinction, considering both personal and enterprise goodwill as marital. Twenty-eight states, along with the District of Columbia, have established case law that differentiates between enterprise and personal goodwill; e.g., the majority of states have adopted the view that enterprise goodwill continuing with the business, absent the presence of the professional practitioner, be considered marital property, whereas personal goodwill would not.

A recent Kentucky decision departed from previous case law established in that state. In her February 19, 2009, opinion in Gaskill v. Robbins, Kentucky Supreme Court Justice Mary Noble summarized some of the issues with which courts have wrestled in determining the value of professional practices for purposes of property distribution:

“The valuation of a business is complicated, often speculative or assumptive, and at best subjective. This is particularly true in a divorce case where the business is a professional practice with only one practitioner, clients or patients come to the business to receive that particular person’s direct services, the business is not actually being sold, and the success of the business depends upon the personal skill, work ethic, reputation, and habits of the practitioner.”

Prior to the Gaskill case, no distinction was made between personal and enterprise goodwill in Kentucky; both were considered marital assets, a precedent established in that state in Heller v. Heller, 672 S.W. 2d at 947-48. Since the Heller case was decided in 1984, trial courts throughout the nation have considered this issue, leading to the development of the concepts of the two goodwill types. In its Gaskill decision, the Kentucky Court looked to other states, citing West Virginia’s May as an example, concerning how this distinction is applied. The Court also noted that considering personal goodwill as marital effectively attaches the professional spouse’s future earnings, to which the former spouse generally has no claim.

A professional practice may have elements of both personal and enterprise goodwill. The operation itself may possess intangible elements, such as location, a recognized telephone number, computer systems, operating procedures, a trained and assembled staff, and patient or client files, which comprise the enterprise goodwill. Additionally, the patient or client relationships, which result from the trust and respect of the professional, represent personal goodwill. The concept of transferability is closely linked to distinguishing between these two types of goodwill. A professional typically cannot easily sell or transfer his or her reputation, skills, or knowledge, while enterprise goodwill elements are more readily transferred to a new owner.

Decosimo professionals have worked on a number of professional practice valuation cases. As a result, we endeavor to ensure our findings are in concert with judicial opinions. If you or your client needs to discuss a potential case in confidence, please call 800.782.8382.