How to Divide the Assets of Professional Goodwill in Divorce

Laura Monroe

American courts have long been divided over how to fairly assess and distribute business and professional goodwill in divorce cases. While some courts feel that goodwill is nothing more than future earnings, others feel it’s an asset of real economic value and must be fairly divided. Essentially, all agree that businesses and professional practices constitute marital property, with the divisible asset being the owning spouse’s interest in the business (or tangible assets). However, the question remains as to whether this can be valued at an amount over and above those measurable asset values in order to address the intangible business asset known as goodwill, which can involve a substantial amount of money.

Defining Professional Goodwill in Business

So what exactly is professional goodwill? When businesses are bought and sold on the open market, the negotiated sale price is often greater than the total net value of the tangible assets of the business in question. This can be for several reasons: a convenient business location, customer loyalty, and/or potential future income. Thus, this becomes a valuation of the business in theory, based on how the commercial world would assess it.

The court is left to determine whether this goodwill is relevant to the overall valuation of the business asset. Most often, the critical factor in this is the degree to which the business can be sold on the open market—for instance, if it’s the type of business that can be transferred to another party and is not necessary tied in with the personal identity and reputation of the owner, or if it’s a corporation with a distinct identity. If this latter example is the case, then the goodwill can be considered an asset with real, immediate, tangible cash value. But if it cannot be separated from its owner, then that goodwill becomes much less tangible and not necessary applicable to a divorce settlement.

Realizable (Enterprise) Goodwill vs. Unrealizable (Individual) Goodwill

By far the easiest type of professional goodwill to classify is realizable goodwill (consisting of a tangible asset), which the owner can convert into cash at any time by selling the business on the open market. Basically, any time goodwill is readily convertible into a cash equivalent, it is found to constitute marital property, as it cannot plausibly be argued that it represents nothing more than speculative future earnings. Even those states who generally hold that goodwill is never marital property consider realizable goodwill an obvious exception, even if the business at issue is a professional practice. However, two states still hold that realizable enterprise goodwill is not marital property: Mississippi and South Carolina. Instead, they insist that a business must be limited to its net asset value even if it could be immediately sold on the open market for a much greater sum.

On the contrary, the issue of division of unrealizable goodwill (when the business in question cannot be sold on the open market) is considered a trickier issue. This situation applies most frequently to law and other professional practices, but it can be relevant to other businesses that essentially market the personal skills of the owner. Case law on the division of unrealizable goodwill has traditionally been divided, with the states that refuse to divide such goodwill clearly in the majority. Arguments against the equity of such a division include the assertion that dividing goodwill would divide the owner’s future earnings, that the spouse who owns the unrealizable goodwill can never actually recover the value of that goodwill on the open market, and finally, that the goodwill is indistinguishable from the owning spouse’s personal reputation. While many of these courts do recognize that such goodwill is to some extent a product of the non-owning spouse’s efforts, they still hold that this goodwill is indivisible and instead consider these contributions in the division of other marital property and in the setting of the alimony award.

However, a minority of courts do continue to treat unrealizable goodwill as marital property, recognizing that many assets with no immediate cash value are treated as marital property (such as unvested retirement benefits). The reasoning here is that goodwill provides a sufficiently high probability of future earnings that it constitutes presently existing divisible property. States that support this minority view include: California, Colorado, District of Colombia, Montana, New Jersey, North Carolina, Ohio, Oregon, Utah, and Washington State.

How Realizability Is Determined

When it comes to division of property, the distinction between realizable and unrealizable goodwill has become a critical issue, as it ultimately helps determine whether that goodwill is marital or separate property. However, this isn’t simply a black or white issue, but rather depends fundamentally on the question of why a business is patronized by its customers and whether that customer loyalty hinges on the individual reputation of the owner that cannot be transferred. Clearly, this can get tricky, as it’s not always so cut and dry. For instance, one customer might be attracted by factors specific to the owner, whereas others might simply like the convenience of the business’s location.

However, there are a number of specific factors considered in determining the extent to which the goodwill of a business is enterprise or individual. Here are some of the most prominent:

Actual past sales: The best way to prove that a business has realizable goodwill is to show that the business has actually been sold on a past occasion for a price that included that goodwill. This can also be applied conversely, in that if comparable sales haven’t included any value for goodwill, then this makes a good case that the goodwill is indeed unrealizable.
Covenant not to compete: This type of clause can be an important component to look at when examining comparable sales, as payment for a future covenant not to compete is compensation for post-marital services and thus not marital property. Some states even hold that if the business at issue cannot be sold without a covenant not to compete, then it has no enterprise goodwill.
Trade name: It’s generally accepted that a business is more likely to have enterprise goodwill when it practices under a trade name that could be sold to another owner. However, it should be stressed that the presence of a trade name does not necessarily guarantee that no individual goodwill is present. The key issue will always be what specifically attracts customers.
Reputation of the owner: Individual, or unrealizable, goodwill is most likely to exist where the owner has a favorable reputation that inspires customer loyalty. An owner with such a reputation potentially draws significant financial benefit from it, resulting in substantial individual goodwill. However, if many competing businesses exist and all the owners have similar reputations, then the goodwill is much more likely to be realizable.
Marketing: A useful way to determine customer attraction to a business is to examine the way in which the business markets itself. If the marketing is focused on the reputation and abilities of the owner and the customers respond to that marketing, then the resulting goodwill is most likely individual/unrealizable. But if the marketing was done under a trade name, then it would be realizable.
Nature of the business: Insight into the realizability of goodwill can be obtained by looking at the nature of the business itself. Does the business structure critically depend on the skill of a single individual person? If the answer is yes, then it probably involves unrealizable goodwill.
Expert testimony: Some cases have relied upon expert testimony stating that the goodwill of a particular business is enterprise or individual. Although this is inevitably less persuasive than actual evidence (such as a past sale), it can be helpful, particularly for those businesses where these other factors aren’t very prominent or even present.

When it comes to dividing professional goodwill in a divorce settlement, opinions trend toward the marital estate not including the type of goodwill that is, in essence, derived from the personal reputation of the owner and cannot be sold for value on the open market. Thus, any evidence supporting the fact that the goodwill is convertible into a tangible asset becomes extremely important when it comes to case law, as this can prove that it should indeed be considered marital property and divided accordingly.

HOW STATES APPROACH REALIZABILITY IN DIFFERENT BUSINESSES

Business Type	Realizable (Applicable to states where only realizable goodwill can be divided)	Unrealizable/Separate (Applicable to states where only realizable goodwill can be divided)	Always Marital (Applicable to states where all goodwill is divisible, regardless of realizability)	Other
Accounting	N/A	Florida Pennsylvania	Arizona Kentucky North Carolina	N/A
Architecture	Florida Pennsylvania	N/A	N/A	N/A
Arts and Entertainment	N/A	California Florida	New Jersey New York	N/A
Automotive	Indiana North Dakota Pennsylvania Texas	Utah	N/A	Illinois (remanded for factual determination of marketability)
Chiropractic	N/A	Hawaii West Virginia	N/A	N/A
Consulting	Alaska Idaho Missouri	Louisiana	N/A	N/A
Cosmetics	N/A	Arizona South Carolina	N/A	N/A
Dentistry	Maryland Pennsylvania Wisconsin	Arkansas Illinois Iowa Kentucky Maine South Carolina Utah West Virginia	Colorado North Carolina Oregon	N/A
Energy	N/A	Louisiana	N/A	N/A
Insurance	N/A	Florida	Montana	N/A
Law	Pennsylvania Virginia	Hawaii Illinois Ohio Oklahoma Pennsylvania Rhode Island Tennessee Texas Wisconsin	California Colorado District of Columbia Montana New Jersey North Carolina Washington	N/A
Law Enforcement	N/A	Indiana	N/A	N/A
Literature	N/A	Oregon	N/A	N/A
Manufacturing	Oklahoma	Florida	N/A	N/A
Medicine	Idaho Oklahoma Virginia Texas	Alaska Arkansas Connecticut Illinois Indiana Iowa Kansas Louisiana Missouri Nebraska Oklahoma Pennsylvania Tennessee Texas	Colorado Kentucky Nevada Ohio Utah Virginia Washington	N/A
Real Estate (Construction)	Illinois Mississippi Missouri South Dakota	Oklahoma Oregon Tennessee	N/A	Alaska Rhode Island (both cases remanded for factual determination of whether goodwill was realizable)
Real Estate (Other)	North Dakota Oregon	N/A	N/A	N/A
Restaurant	Alabama Arkansas Idaho	N/A	N/A	N/A
Sales	Indiana	Utah	N/A	N/A
Services	N/A	Florida	N/A	N/A
Technology	Alaska	N/A	N/A	N/A
Transportation	Alaska Pennsylvania	N/A	N/A	N/A
Veterinary	Idaho Wisconsin	Pennsylvania	Virginia	N/A