The majority of states now recognize that the commercial or enterprise goodwill of a private professional practice constitutes marital property in divorce cases, while goodwill pertaining to the individual professionals does not. However, few cases give concrete guidance how to characterize the components of commercial versus professional goodwill. And when, as in this Texas divorce, a law practice depends primarily on large, contingency fee cases, it can be difficult to distinguish between future income of the firm and the future earnings of its professionals. Von Hohn v. Von Hohn, 2008 Tex. App. LEXIS 5416 (Tex. App. Tyler July 23, 2008).
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The husband was partner at a prominent plaintiffs’ firm working on contingency in cases against such defendants as cigarette companies and financial institutions. The firm’s partnership agreement stated that upon leaving the firm he would be entitled to his capital account and undivided profit accounts along with any unpaid draw. The agreement did not provide a buy-out formula in the event of divorce. The husband said the wife’s valuation expert should have relied exclusively on the partnership agreement. The expert rejected the asset approach, finding the income approach was the best indicator of value. He was permitted to testify and rely on valuation methods other than those in the partnership agreement but was not allowed to use more than two years of future earnings under the income approach, decisions that were affirmed. The husband raised the argument at trial again, but said he didn’t plan to leave the firm. The trial court found, and was affirmed, that the valuation of the law firm could include methods beyond simple withdrawal and reimbursement of partnership accounts.
Time, Toil & Labor
In his application of the income approach, the wife’s expert said he specifically included the firm’s commercial goodwill but not any of the husband’s personal goodwill—his “future time, toil, and labor.” He considered the firm’s historical operations and any income it could reasonably realize within two years, adjusted for any nonrecurring events, including the settlement of a large patent infringement case. The husband’s interest in the general law practice was worth $1.5 million, the expert said. His interest in the settled cases was worth an additional $400,000, based on the payment history of the opposing parties and projected payments over the next two years, bringing his total interest to $1.9 million.
But then the expert valued pending cases, using a royalty rate calculation. If the four largest clients settled in the next two years, the husband’s interest would be worth $4.1 million, he said. If all defendants settled within this time frame, the husband’s interest would increase by another $2.2 million.
Ultimately, the jury valued the husband’s interest in the firm at $4.5 million, but on this appeal, the higher court found problems. The valuation of the husband’s interest in the general law firm and the “settled” cases ($1.9 million total) was proper, because the amounts were fixed by settlement contracts and the husband would not have to expend more effort to receive them. However, the proceeds from the unsettled cases were an expectancy interest, the court said, derived from the husband’s future earnings. The jury must have included this amount in its $4.5 million valuation, and the court remanded the case for findings that did not include future earnings or expectancy interests in the calculation of law firm value and commercial goodwill.