By: Joy M. Feinberg for Feinberg Sharma / October 23, 2019
Joy Feinberg recently wrote an article for Family Lawyer Magazine on the Good, the Bad, and the Ugly of expert witness selection. Download her article below.
By: Joy M. Feinberg
In every divorce case involving a business, the question arises: Is there a ” goodwill” component, and if so, will it be valued and divided? The first step in understanding the law of divisibility of goodwill is to define goodwill accurately. When businesses are bought and sold on the open market under conditions far removed from any divorce case, the negotiated sale price is often greater than the total value of the tangible assets of the business involved. “Goodwill” is the economic advantage that exists when the total value of a business is more than the value of its identifiable assets. Welsch, Zlatovich & Harrison, Intermediate Accounting 438 (6th ed. 1982). The American Society of Appraisers Business Valuation Standards defines “goodwill” as:
“That intangible asset that arises as a result of name, reputation, customer patronage, location, products, and similar factors that have not been separately identified and/or valued, but which generate economic benefits.”
Shannon Pratt, in “The Lawyer’s Business Valuation Handbook”, American Bar Association, 2000 notes that:
“…the classic concept of goodwill is the propensity of customers to return. If this propensity is due to the practitioner, it is often called personal goodwill. If it is due to other factors (such as location) not dependent on the individual practitioners, it is often called practice goodwill or enterprise goodwill.” p. 332.
If the goodwill can actually be bought and sold, then the goodwill is realizable and can be valued. This type of “goodwill” is called “enterprise goodwill”. If the goodwill cannot be bought and sold, the goodwill is not realizable, cannot be valued and is referred to as “personal goodwill”.
Because the divisibility of goodwill is such a hotly litigated issue, see Brett R. Turner, Equitable Distribution of Property §6.22 (2d ed., 1994); Grace Ganz Blumberg, “Professional and Business Goodwill” in Valuation and Distribution of Marital Property ch. 25 (1992 & Supp. 2001); Alan Parkman, The Treatment of Professional Goodwill in Divorce Proceedings, 13 Fam. L.Q. 213 (Summer 1984); some courts considering the divisibility of unrealizable goodwill have sometimes acted as if all goodwill is unrealizable. Courts making this assumption will frequently hold in an unrealizable goodwill case that goodwill is never marital property. Almost inevitably, however, a case then arises in which the goodwill is realizable on the open market. When these cases arise, courts have shown a strong tendency to limit their previous decision to unrealizable goodwill, thus holding that realizable goodwill can be divided. This is exactly what happened in Illinois.
Professional practices have been intriguing when scrutinized and were the first cases reviewed. In these early cases, In re Zells, (a lawyer in a solo practice) 143 Ill. 2d 251, 572 N.E.2d 944 (1991); Head v. Head, 168 Ill. App. 3d 697, 523 N.E.2d 17, 119 Ill.Dec. 549 (1 st Dist., 1988); Courtright v. Courtright, (doctor) 155 Ill. App. 3d 55, 507 N.E.2d 891, 107 Ill.Dec. 738 (3 rdDist., 1986); In re Marriage of White, (dentist), 151 Ill.App. 3d 778, 104 Ill.Dec. 424, 502 N.E.2d 1084, appeal denied 144 Ill. 2d 546, 108 Ill.Dec. 426, 508 N.E.2d 737 (1986) and In re Marriage of Wilder, (optometrist) 122 Ill.App.3d 338, 77 Ill.Dec. 824, 461 N.E.2d 447 (1 st Dist., 1983) the courts seemed to hold that all goodwill, whether personal or enterprise, can never be divided. These cases, however, were limited on their facts to unrealizable goodwill in professional practices.
These cases that refused to divide unrealizable goodwill also recognized that such goodwill is to some extent a product of the non owning spouse’s efforts. But, the courts continued, the non owning spouse is already sufficiently compensated for those contributions by the owning spouse’s increase in earning capacity. As stated in Courtright v. Courtright, 155 Ill. App. 3d 55, 107 Ill.Dec. 738 507 N.E.2d 891, 894 (3 rd Dist.,1987):
Although many businesses possess this intangible asset known as good will, the concept is unique in a professional business. The concept of professional good will is the sole asset of the professional. If good will is that aspect of a business which maintains the clientele, then the good will in a professional business is the skill, the expertise, and the reputation of the professional. It is these qualities which would keep patients returning to a doctor and which would make those patients refer others to him. The bottom line is that this is reflected in the doctor’s income gathering ability.
Since a doctor’s income-gathering ability is already considered once by the court when it determines how much of the marital property to award to each spouse and how much alimony to award, the Courtright court held that goodwill need not be considered as a separate item of marital property. 507 N.E.2d at 894. The Supreme Court in In re Zells, 143 Ill. 2d 251, 572 N.E.2d 944, 157 Ill.Dec. 480 (1991), likewise held that personal goodwill is not marital property because it is not realizable, and because to divide personal goodwill would be to “double dip” when also awarding alimony.
Then, along came In re Marriage of Head, 652 N.E.2d 1246, 273 Ill.App.3d 404, 210 Ill.Dec. 270 (1 st Dist., 1995) where the examination of a medical practice occurred. The medical practice was distinguished from the personal goodwill attributable to the individual doctor; however, the record on appeal contained no factual basis upon which a value of enterprise goodwill could be set. Thus, the court held out the notion that there was a distinction to be made: only unrealizable goodwill (i.e., personal goodwill) could not be valued and divided. The court embraced the concept that realizable goodwill (i.e., enterprise goodwill) could be valued and divided, so long as sufficient proof of the existence of same existed and could be valued. In re Talty, 623 N.E.2d 1041, 252 Ill.App.3d 80 (2 nd Dist, 1993) rev’d, 166 Ill. 2d 232, 652 N.E.2d 330, 191 Ill.Dec. 451 (1995), the court addressed a nonprofessional practice and held that not all of the goodwill associated with the husband’s automobile dealership was personal to him. Rather, some of the goodwill could be transferred, was likely valuable and was to be valued as enterprise goodwill. The court remanded the case back to the trial court for a determination as to what part of the goodwill was wholly personal, and thus not realizable, and what part was not wholly personal, and was thus realizable. This same distinction was reiterated in In re Marriage of Blackstone, 288 Ill. App. 3d 905, 681 N.E.2d 72, 224 Ill.Dec. 90 (1 st Dist., 1997).
In In re Schneider, 343 Ill. App.3d 628, 798 N.E.2d 1242, 278 Ill.Dec. 485 (2 nd Dist. 2003), the appellate court distinguished Zells, holding that Zells prevents the division of professional goodwill only where the court also awards spousal support. If the wife waived alimony, then the goodwill would be subject to division. The appellate court thus focused on the second prong of the Zells analysis, ignoring whether the goodwill was realizable “enterprise” goodwill and focusing solely on whether or not maintenance (alimony) was to be paid to the nonowner spouse. Had this holding been affirmed by the Supreme Court, attorneys in Illinois would have faced the difficult issue of whether to seek professional goodwill or spousal support. The Supreme Court eradicated this Hobson’s choice.
The Supreme Court decision in In re Schneider, 2005 WL 120356 (Illinois Sup. Ct. Jan. 21, 2005), however, reiterates the concepts contained in Zell and Talty: (1) personal goodwill cannot be marital property because it is not realizable; and (2) dividing personal goodwill would constitute double dipping with alimony. This is in keeping with the majority trend. B. Turner, Equitable Distribution of Property § 6.22 (2d ed. 1994).
The Supreme Court in Schneider made it clear that personal goodwill is never marital property by contrasting it with the accounts receivable. The accounts receivable, money to be received in the future, was realizable in the present, was marital property and thus, was subject to division. The personal goodwill, on the other hand, could not be transferred and thus had no value. Because it had no value, it could not be considered property, let alone marital property. One is left to wonder if this is not a classic “double dipping” by dividing accounts receivable as an asset and then with those same funds, paying out maintenance (alimony) and child support to the nonowner spouse.
A significant minority of jurisdictions disagree with the idea that personal goodwill can never be marital property. The effect of Zells and Schneider is that if a wife contributes to the corporate reputation of Widgets, Inc., wholly owned by the husband, then the wife is entitled to share in the enterprise goodwill. On the other hand, if a wife contributes to the reputation of John Q. Lawyer or John Q. Doctor, the goodwill is not marital. The court may seek to differentiate the two situations by stating that Widgets, Inc., can be sold, but in 999 out of 1,000 cases, Widgets, Inc., will not be sold. Mr. Widgets will realize his goodwill the same way Mr. Lawyer or Dr. Doctor will: through increased future earnings.
The problem of double dipping discussed in Zells and Schneider can be solved by reducing alimony to account for the increased earnings. New York has adopted this approach with regard to professional degrees and professional practices. For now, however, Illinois law is clear: professional goodwill that is personal is never marital property. Only enterprise and freely realizable goodwill can be considered marital property.
By: Joy M. Feinberg / March 21, 2001
On March 21, 2001, the United States Supreme Court addressed a nagging issue that all too frequently faced recently divorced couples: IF YOU DIE AFTER DIVORCE, WITHOUT CHANGING YOUR BENEFICIARY DESIGNATION FORMS ON ERISA-GOVERNED RETIREMENT PLANS, WHO WILL GET YOUR BENEFITS?
And, of even greater importance: WHAT NEW BURDENS DOES EGELHOFF PLACE ON MATRIMONIAL PRACTITIONERS IN ORDER TO AVOID CLAIMS OF MALPRACTICE?
THE FACTS OF EGELHOFF
David and Donna Egelhoff were divorced in April, 1994. This was a second divorce for David, who had children from a prior marriage. There were no children born to David and Donna. David was a Boeing executive and the parties resided in the state of Washington. Donna had been his designated beneficiary on his company-provided life insurance and retirement benefits. Less than three months after the divorce was finalized, David died, never having changed his beneficiary designations on his life insurance or retirement benefits. In the divorce settlement, David had received 100 percent of his pension benefits. Donna had received other assets. It is presumed that there was some waiver of rights language in the Divorce Judgment. Washington state had a law that provided that beneficiary designations for retirement plans or life insurance made prior to divorce were not valid if death occurred prior to reaffirmation of the designated beneficiary. Such laws are often referred to as “Divorce Redesignation Laws.”
David’s children from his first marriage assumed that they would be the beneficiaries of his life insurance and retirement benefits that were not assigned to Donna in the divorce proceedings between Donna and their father. They filed their claim for benefits after David’s death. After all, they had a state statute supporting this claim and a reasonable expectation of receipt, given that in the divorce judgment, Donna waived all of her rights to the ENTIRE proceeds of the retirement plan and the insurance policy. Much to the children’s surprise, at the time of David’s death, Donna was still named as beneficiary. Donna, too, filed a claim for proceeds from the life insurance policy as well as the retirement benefits.
The Washington Supreme Court ruled that David’s CHILDREN — not his pre-divorce designated beneficiary and former spouse, DONNA — were entitled to the benefits, relying on the state statute and providing that this state law was not PREEMPTED by federal law, ERISA, for these reasons:
The United States Supreme Court REVERSED and REJECTED each of the arguments put forth by the Washington Supreme Court. The U.S. Supreme Court was very clear in its ruling that this state statute would be preempted by ERISA for it stated that DETERMINING BENEFICIARY STATUS WAS A CORE ERISA CONCERN. The Supreme Court noted that this state statute would interfere with the UNIFORM NATIONAL ADMINISTRATION of plans. It went on to state that the presumption against preemption in the arena of family law was OVERCOME when family law “…conflicts with ERISA or related to ERISA plans.” The issue of the remaining validity of “slayer” statutes was not decided by Egelhoff; however, the ruling appears to suggest that such statutes would not be preempted by ERISA as these statutes have a history pre-dating ERISA and are relatively uniform throughout the country, which would allow for consistent plan administration nationally. The Supreme Court suggested that “slayer statutes” were a form of Federal Common Law, which could be looked to in certain instances. {However, see Justice Beyer’s dissent for an excellent analysis of this issue and his disagreement with following the clear intent of the parties.}
Thus, David’s former spouse, DONNA — not David’s children — received David’s life insurance proceeds and retirement benefits.
After Egelhoff, will state law ever be able to protect the family law practitioner against claims for failure to warn the participant to change his/her beneficiary designation? This is doubtful. However, most divorce decrees or judgments provide for the division of assets, including retirement benefits. Most instruments provide standardized language “waiving” all other rights in or to the former spouses’ property and any right to inheritance. Will these clauses protect family law practitioners against claims for failure to warn the participant to change his/her beneficiary designation? Perhaps. There is an Eighth Circuit case which ALLUDES to such a result, IF THE LANGUAGE IN THE SETTLEMENT AGREEMENT IS “… SUFFICIENTLY SPECIFIC TO CONVEY THE INTENT OF THE PARTIES TO DIVEST ONE OR THE OTHER, OR BOTH, OF A BENEFICIARY INTEREST”. Hill v. AT&T Corp., 125 F.3d 646 (8 th Cir. 1997). Again, the validity of a pre-Egelhoff case is unclear.
It is this author’s belief that the most fertile area of malpractice litigation in the family law arena lies in the retirement plan portion of each case. Failure to enter a Qualified Domestic Relations Order can be devastating — especially if the participant dies prior to the entry of a Domestic Relations Order at time of Judgment entry. Even entry of a “nunc pro tunc” order will not revive the benefits provided pursuant to the Judgment for Dissolution of Marriage, unless the Judgment has all of the elements of a Domestic Relations Order and thus, can be qualified by the plan when the participant dies. Guzman v. Commonwealth Edison, 2000 W.L. 1898846 (N.D. Ill., December 28, 2000); Samaroo v. Samaroo, 193 F.3d 185 (3d Cir. 1999).
NEW OBLIGATION FOR FAMILY LAW PRACTITIONERS PER EGELHOFF
It is this author’s suggestion that family law practitioners may now have a new obligation — we had better tell our clients to change their beneficiary designation forms upon Judgment entry, lest we subject ourselves to potential claims of malpractice.
Need we go so far as obtaining the change of beneficiary forms ourselves and present them to our clients to sign in our presence and return to the plan administrator? I think not. But we had better have WRITTEN INSTRUCTIONS in our files advising our PARTICIPANT clients to act on this matter as soon as the divorce is final. Without this, will we be believed that we “told” our client to act deliberately to change his/her beneficiary designations? There are some questions we need not face — this being one. I have attached a suggested form that you should copy and include in your usual procedure for every divorce case you handle.
One further note: Due to the Egelhoff case, ERISA counsel are suggesting to their employer clients that they amend their plan documents and include a provision which would automatically revoke pre-divorce spousal beneficiary designations. Keep a watchful eye open for such changes so that in the unusual case where you negotiate to retain the about-to-be-former spouse as the beneficiary on such benefits, that there is an affirmative action taken after judgment entry to retain or reaffirm that spouse as beneficiary designate.
SUGGESTED LANGUAGE TO PROVIDE TO CLIENTS
As an employee of _______________ Corporation, you are entitled to various benefits including:
Possible other benefits which your human resources department can advise you about and supply you with beneficiary change forms.
You also have other assets which have beneficiary designations, such as IRAs, annuity contracts and the like.
We are now getting close to finalizing your divorce. Contact these administrators and/or the Human Resources Department of your company to obtain the forms necessary to CHANGE THE BENEFICIARY DESIGNATION on EACH of these benefits. Have the designation changes completed and delivered to the appropriate locations the DAY BEFORE your divorce is to be finalized and advise the plan administrators that your divorce will be final on the next day. Then, provide a certified copy of your Judgment to each of these Plan Administrators or appropriate persons for their files to make your beneficiary change designation(s) become effective.
NOTE: FAILURE TO CHANGE YOUR BENEFICIARY DESIGNATION PRIOR TO YOUR DEATH MAY VERY WELL CAUSE YOUR FORMER SPOUSE TO RECEIVE THESE BENEFITS INSTEAD OF THE PERSON(S) YOU INTEND TO BENEFIT.
You should also consider sending this notice as part of your closing procedure.