Should salable personal goodwill remain in the marital estate in a divorce? That was the question presented in a Wisconsin case, which could have a far-reaching impact on divorce valuation.
In the case, the Supreme Court of Wisconsin upheld both its lower and appellate courts. The case allowed salable personal goodwill to remain in the marital estate. Prior to that case, Wisconsin had been one of many states that excluded personal goodwill from the marital estate. This case has now refined that process to distinguish between salable (or transferrable) personal goodwill and “pure” personal goodwill.
Case in Point
Tim McReath was a successful orthodontist in Wisconsin. He had purchased his practice from another retiring orthodontist several years prior to his divorce. The lower court affirmed the value assigned to the practice by the wife’s valuation expert. It clearly included both entity (enterprise) goodwill and personal goodwill.
Personal goodwill is the goodwill which attaches to an individual due to his/her specialized skills, knowledge, reputation, contacts, etc. Then the Supreme Court affirmed the lower courts’ decisions, including the salable personal goodwill in the marital estate. It commented as follows:
The court of appeals affirmed on the basis that the personal goodwill was salable, as evidenced by the fact that Tim himself had paid for the personal goodwill of Dr. Grady when he bought the orthodontic practice and the reality that any hypothetical buyer would demand a noncompete agreement. Because there is no rule excluding salable goodwill from divisible property, the court of appeals concluded that the circuit court did not err when it included personal goodwill in the marital estate.
The Supreme Court of Wisconsin also found that it wasn’t “double counting” to allow all of Tim’s earnings to be used when determining a maintenance (alimony) award for his wife Tracy. Once again, the Supreme Court found no prohibition against doing so and didn’t adjust Tim’s earnings for maintenance to account for the fact that the salable personal goodwill is included in the marital estate (McReath v. McReath, 2011 WI 66, 2009AP639.)
Beyond Wisconsin State Lines
The inclusion of salable personal goodwill has been implied in a number of cases in other states, but it had not been clearly delineated until the McReath case. Although this case doesn’t serve as a precedent in other states or jurisdictions, it may be used in arguments on whether transferrable (salable) personal goodwill should be included in the marital estate in a divorce. This is relatively new territory for most states or jurisdictions, but one that bears watching.
It’s important to note, however, that the orthodontic practice in McReath had been purchased several years prior to the divorce. This arm’s length transaction could have made it easier for the wife to substantiate the value of salable goodwill.
Currently, many states specifically exclude personal goodwill from the marital estate if an owner’s earnings are used to determine maintenance. The potential bifurcation of personal goodwill into its salable and non-salable (“pure”) elements is sure to complicate the valuation process in a divorce setting even more. It’s already difficult enough for a valuation analyst to determine the relative values of enterprise and personal goodwill in a total value of goodwill for a company.
Adding the third component may require a valuation analyst to divide total goodwill of the company into three pieces. There are accepted methods to determining this breakdown, but they are generally subjective. It is important that the methods be clearly explained and supported by the valuation analyst.
Divorce valuation has traditionally been a battle of the experts. The stakes were raised again in the wake of the McReath case.