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Goodwill and Spousal Support
2005 National Legal Research Group, Inc.

Background

The court's power to divide assets upon divorce applies only to interests which constitute property. An interest which does not constitute property to begin with cannot be classified as marital property, and it cannot be divided upon divorce. The classic examples are educational degrees and the right to receive a future inheritance. E.g., In re Marriage of Graham, 194 Colo. 429, 574 P.2d 75 (1978); Rubin v. Rubin, 204 Conn. 224, 527 A.2d 1184 (1987). See generally Brett R. Turner, Equitable Distribution of Property 6.20, 6.27 (2d ed. 1994 & Supp. 2004).

One of the greatest splits in authority in the law of equitable distribution involves the classification of businesses. There is general agreement that a business is property to the extent of its net asset value the fair market value of its tangible assets, minus the value of its liabilities. E.g., Mace v. Mace, 818 So. 2d 1130 (Miss. 2002); Turner, supra, 6.22. There is also general agreement that a business is property to the extent of its transferable enterprise goodwill that portion of the goodwill of the business which resides in the entity itself, and which can be transferred to another owner. E.g., In re Marriage of Talty, 166 Ill. 2d 232, 652 N.E.2d 330 (1995). Some decisions combine net asset value and enterprise goodwill into going concern value the value which the business would command if sold on the open market by a willing seller to a willing buyer, with neither party under any time pressure to complete the transaction. E.g., Bowers v. Bowers, 349 S.C. 85, 561 S.E.2d 610 (Ct. App. 2002). The going concern value of a business is always property, and it is marital property to the extent acquired during the marriage.

The difficult issue involves the classification of individual goodwill goodwill which resides in the personal reputation and earning capacity of the owner of a business. The classic example is the goodwill of a doctor or attorney who practices alone or in a small firm. This sort of business can have enterprise goodwill if it can be sold to another professional for an amount greater than its net asset value. E.g., Traczyk v. Traczyk, 891 P.2d 1277, 1279 (Okla. 1995) (podiatry practice operating under trade name as "Bethany Foot Clinic"). In most situations, however, the goodwill of a professional practice will be nontransferable, because it will reside exclusively in the individual reputation of the professional.

A majority of states hold that individual goodwill is not property, and therefore that it cannot be considered in valuing the practice for purposes of property division. See In re Marriage of Zells, 143 Ill. 2d 251, 572 N.E.2d 944 (1991); Jay Myoung Yoon v. Sunsook Yoon, 711 N.E.2d 1265 (Ind. 1999); May v. May, 214 W. Va. 394, 589 S.E.2d 536 (2003); Holbrook v. Holbrook, 103 Wis. 2d 327, 309 N.W.2d 343 (Ct. App. 1981). A respectable minority of states hold that individual goodwill is property. Such goodwill may not have value on the open market, but it has value in the hands of the owner. As long as the practice is not being sold at the time of divorce, these states hold that individual goodwill is a real asset which will benefit the owner in the future, and which must therefore be included when the practice is valued for purposes of divorce. See In re Marriage of Nichols, 43 Colo. App. 383, 606 P.2d 1314 (1979); Drake v. Drake, 809 S.W.2d 710 (Ky. Ct. App. 1991); McLean v. McLean, 323 N.C. 543, 374 S.E.2d 376 (1988); Goswami v. Goswami, 152 Ohio App. 3d 151, 787 N.E.2d 26 (2003).

The classification of individual goodwill is very closely linked with the issue of spousal support. Opinions which do not treat individual goodwill as marital property are often based upon the principle that such goodwill is already fully considered in setting support. "Personal goodwill, which is intrinsically tied to the attributes and/or skills of an individual, is not subject to equitable distribution. It is not a divisible asset. It is more properly considered as the individual's earning capacity that may affect property division and alimony." May, 214 W. Va. at 394, 405, 589 S.E.2d at 547.

States which do divide individual goodwill have traditionally not addressed clearly the overlap between individual goodwill and spousal support. The clearest law on the subject is from New York, which defines as property not only individual goodwill, but also educational degrees. O'Brien v. O'Brien, 66 N.Y.2d 576, 498 N.Y.S.2d 743, 489 N.E.2d 712 (1985). New York clearly holds that any earnings considered in valuing a professional's practice or degree cannot be considered as a source for support. See McSparron v. McSparron, 87 N.Y.2d 275, 639 N.Y.S.2d 265, 662 N.E.2d 745 (1995); Grunfeld v. Grunfeld, 94 N.Y.2d 696, 709 N.Y.S.2d 486, 731 N.E.2d 142 (2000).

In minority rule jurisdictions outside of New York, the law is much less clear. Courts have to some extent avoided the issue by moving toward the majority rule that individual goodwill is not property at all. For instance, Virginia divided the individual goodwill of a psychologist in solo practice in Russell v. Russell, 11 Va. App. 411, 399 S.E.2d 166 (1990), but the most recent decisions recede from Russell and refuse to treat individual goodwill as a marital asset. See Hoebelheinrich v. Hoebelheinrich, 43 Va. App. 543, 600 S.E.2d 152 (2004); Howell v. Howell, 31 Va. App. 332, 523 S.E.2d 514 (2000).

Steneken v. Steneken: Facts

The relationship between goodwill and spousal support recently reached the Supreme Court of New Jersey. Steneken v. Steneken, 2005 WL 1159427 (N.J. 2005). New Jersey is the leading state treating all forms of goodwill as marital property; its case law on the issue predates even O'Brien. See Dugan v. Dugan, 92 N.J. 423, 457 A.2d 1 (1983); Stern v. Stern, 66 N.J. 340, 331 A.2d 257 (1975). The New Jersey court therefore had an excellent opportunity to clarify the issue. Unfortunately, the court's opinion not only confuses the issue, but also confuses another issue which previously seemed settled. The practical effect may be to encourage more states to avoid the issue by refusing to treat individual goodwill as marital property.

The husband in Steneken earned a very substantial income as the CEO of a corporation called Esco. Both parties' experts valued Esco using the capitalization of earning method, which computes value as a function of the adjusted income of the business. The adjustments are mainly a matter of valuation practice, but they include treating a fair salary for the owner as an expense, so that the valuation is not based upon the improper assumption that the owner is working for free. The amount so treated is an objectively reasonable salary for the actual contributions made by the owner. Since owners of businesses are under no duty to pay themselves an amount equal to the exact value of their contributions, the court not infrequently finds that a reasonable salary is different from the owner's actual salary.

In Steneken, the court relied upon the testimony of the husband's own expert. The expert testified that the husband had paid himself a salary significantly greater than the value of his contributions. The expert therefore used a "normalized" figure for the husband's salary that is, an objectively reasonable salary for his actual contributions. The result was a smaller salary deduction, and therefore a greater value.

The difficult issue arose when the husband argued that the court must also base its spousal support award upon his normalized salary, which was again materially less than his actual salary. To do otherwise, he argued, would constitute improper double-dipping, making improper duplicative awards of both equitable distribution and spousal support from the same future earnings. The trial court refused to base its award upon normalized earnings, the Appellate Division affirmed, and the husband appealed to the New Jersey Supreme Court.

Steneken v. Steneken: Holding

Double-dipping arguments have flown poorly or not at all in some states, but they have always done well in New Jersey. New Jersey was the first major case to hold that retirement benefits cannot be treated as both marital property and a source for spousal support. This result was originally reached by case law, see Innes v. Innes, 117 N.J. 496, 569 A.2d 770 (1990); D'Oro v. D'Oro, 187 N.J. Super. 377, 454 A.2d 915 (Ch. Div. 1982), aff'd, 193 N.J. Super. 385, 474 A.2d 1070 (App. Div. 1984), and was then written into the New Jersey statute. "When a share of a retirement benefit is treated as an asset for purposes of equitable distribution, the court shall not consider income generated thereafter by that share for purposes of determining alimony." N.J. Stat. Ann. 2A:34-23(b) (Westlaw 2005).

In a sharp departure from the state's prior willingness to accept double-dipping arguments, a narrow majority of the New Jersey Supreme Court rejected the husband's argument in Steneken. Indeed, the opening passage of the court's discussion of the support issue seems to reject the very concept of double-dipping:

Much of the controversy inherent in this appeal stems from the unspoken premise that because alimony and equitable distribution are interrelated, a credit on one side of the ledger must perforce require a debit on the other side; otherwise, defendant claims, the interplay between alimony and equitable distribution results in "double counting." We disagree.

2005 WL 1159427, at *4. It may indeed be poor policy to insist that "a credit on one side of the ledger must perforce require a debt on the other side," but that notion is the entire policy basis for both the New Jersey double-dipping statute and the statute on which it is based. The above passage seems to serve notice that the policy behind the statute will no longer be applied outside of its narrow borders a significant change in New Jersey law.

While the court rejected the dollar-for-dollar policy which underlies the statute, it accepted that property division and spousal support are related. "We start from the bedrock proposition that all alimony awards and equitable distribution determinations must both jointly and severally satisfy basic concepts of fairness." Id. "[A]limony and equitable distribution are separate yet interrelated and ultimately subject to an overriding sense of fairness." Id. at *5. "Principles of fairness that properly account for the dichotomy between alimony, on the one hand, and equitable distribution, on the other, are what inform our analysis." Id.

The court then found that its amorphous "fairness" test was met on the facts, even though the trial court had not made any attempt to adjust its alimony award in light of the method used to value the business:

Because we embrace the premise that alimony and equitable distribution calculations, albeit interrelated, are separate, distinct, and not entirely compatible financial exercises, and because asset valuation methodologies applied in the equitable distribution setting are not congruent with the factors relevant to alimony considerations, we conclude that the circumstances here present a fair and proper method of both awarding alimony and determining equitable distribution.

We find no inequity in the use of the individually fair results obtained due to the use of an asset valuation methodology normalizing salary in an on-going close corporation for equitable distribution purposes, and the use of actual salary received in the calculus of alimony. The interplay of those two calculations does not constitute "double counting."

Id. at *6. While the opinion is limited to the facts presented, it does not suggest that the court was eager to hold that spousal support awards must ever be adjusted in light of a business valuation method.

Three of the seven judges dissented from the court's opinion. The dissenters refused to hold that there is functionally no overlap between business valuation methods and the issue of spousal support. At the same time, the dissent also did not approve of the husband's position that support should be based upon normalized income. Rather, the dissent suggested a remand:

Rather than a hard and fast rule, I would instead encourage courts to carefully analyze the facts in each case and to consider modulating either the corporate value or the alimony award to the extent that the same income was considered in both calculations. I would therefore reverse and remand the case to the trial judge for application of that flexible approach to the issues before him.

Id. at *9 (Long, J., dissenting). The dissent's notion that the trial court should "consider modulating either the corporate value or the alimony award" is expressly based upon the approach taken by New York in McSparron and Grunfeld. It is not much more definite than the majority's "fairness" doctrine, but the express analogy to New York law gives it somewhat more content, and it is much more consistent with existing New Jersey authority on double-dipping generally.

Steneken v. Steneken: Analysis

The rule that individual goodwill constitutes property for purposes of equitable distribution is declining in popularity. The nationwide case law on this issue was equally divided ten years ago. Today, a clear and growing majority of states will not divide individual goodwill. Brett R. Turner, Equitable Distribution of Property 6.22 (2d ed. 1994 & Supp. 2004).

Since New Jersey is the leading state holding that individual goodwill does constitute property, the declining popularity of the rule suggests that there are flaws in the New Jersey case law. Steneken demonstrates those flaws in action. A majority of states allow a full award of spousal support with no reduction for double-dipping, but most of those states exclude individual goodwill from the marital estate. New York has a very broad definition of marital property, including all forms of goodwill, but it also adjusts the spousal support award downward when individual goodwill or educational degrees are included in the marital estate. By combining a very broad definition of marital property with a refusal to adjust spousal support, New Jersey law is uniquely unfavorable to owners of individual goodwill.

In the Steneken court's defense, the argument in favor of a support adjustment was not articulated well on the facts, or at least was not articulated well in the court's opinion. The husband's main argument was that the valuation of the business could not be based upon income which was used to award support. But there is a distinction between dividing the marketable ongoing concern value of a business (net assets and enterprise goodwill) and dividing its future earnings (individual goodwill). The trial court was surely on solid ground in treating the ongoing concern value of the business as marital property. Even if an income-based method is used to compute ongoing concern value, income is still being used only as a tool to measure value; it is not being treated as a marital asset. This is a major distinction between Steneken and the pension cases, for the retirement benefits which the statute excludes from consideration in setting spousal support are the same retirement benefits which the court has treated as marital property. When the court uses income to measure ongoing concern value it is not dividing that income. If the business can in fact be sold on the open market for the value computed, the owner possesses both a marketable asset with the computed value, and a full unmodified stream of future earnings. Treating the entire asset as marital property, and the full income as a source for support, is not double-dipping.

But this conclusion does not hold true if the business has unmarketable individual goodwill. Individual goodwill is marital property in states following the New Jersey approach because it has value in the hands of the owner. That value is not transferable, but the definition of marital property includes many assets which are not transferable. Retirement benefits are the most immediate example. Just as the value of retirement benefits lies in the payments which the owner will eventually receive, the value of individual goodwill lies in the future earnings of the owner earnings which will not be attributable only to postdivorce efforts, but are also attributable in part to individual goodwill acquired during the marriage. In other words, like retirement benefits, individual goodwill is the present value of a benefit which will be received in the future, but which was earned during the marriage.

If individual goodwill is deferred compensation for marital efforts, however, then the owner does not have both individual goodwill and an unmodified stream of future earnings. The value of individual goodwill lies only in the future earnings it will produce. States which follow the majority rule insist that future earnings are necessarily a product only of future effort. States which follow the minority rule recognize, properly in this author's opinion, that some of the future earnings are a product of individual goodwill acquired during the marriage. But a given dollar of future earnings cannot be a product of both presently existing individual goodwill and future efforts. If the court determines that a portion of the owning spouse's future earnings is attributable to presently existing individual goodwill, that portion has already been earned, and it cannot be treated as future income for purposes of spousal support. That reality is the concept which underlies McSparron and Grunfeld.

Did the concept apply on the facts of Steneken? The answer depends entirely upon whether the business at issue, Esco, was marketable. If Esco was marketable, then the most likely future course of events is that the husband will collect the income of the business until retirement age, and then sell the business for full value. It is not only possible, but indeed highly likely, that the husband will receive both the full marketable value of the company and his full unreduced share of the company's future income. Because the husband will receive both the full value of the business and the full amount of its future income, it was not at all unfair to include the full value of the business as a marital asset, and to treat the husband's full income as a basis for setting spousal support. This was true even though income was used to measure the value of the business, for income was being used only as a tool to measure the marketable ongoing concern value. Just as a hammer used to build a chair does not become part of the chair, income used to measure the marketable ongoing concern value of a business is not being treated as marital property.

If the husband's interest in Esco was not marketable, however, that is, if it consisted in part of individual goodwill unique to the husband and not transferable to another owner, then the result reached by Steneken is wrong. Unmarketable individual goodwill is not an independent asset in the same manner as enterprise goodwill. Individual goodwill can be realized in only one form: future earnings. Thus, when income is used to measure individual goodwill, dollars of future earnings are being treated as marital property, on the basis that they are attributable to present goodwill and not to future postdivorce efforts. Already earned dollars, however, are not income for purposes of spousal support. McSparron and Grunfeld are right: Spousal support must be adjusted when individual goodwill (or an educational degree) is treated as marital property.

Like the Steneken dissent, the author would stop short of asserting that dollars considered in dividing individual goodwill absolutely must be excluded from support. Dollars considered in valuing individual goodwill absolutely do constitute property and not income. If they are divisible at all, it must be because they have already been earned. In some circumstances, however, support can be based upon property as well as upon income. Individual goodwill should be no less subject to consideration in setting support than any other type of property. But the court cannot insist that future earnings are a product of presently existing goodwill for purposes of equitable distribution, and then treat the same future earnings as future income for purposes of spousal support. The same amount cannot be treated as both an asset earned during the marriage and an asset earned after the divorce.

It was ultimately the husband's burden in Steneken to present the court with the facts and argument to justify a reduction in spousal support. There is no indication in the opinion that the value of Esco included individual goodwill, or even any goodwill at all. It is entirely possible that Esco was a marketable business, and that the majority's ruling was correct. The husband therefore failed to carry his burden.

In future cases, however, the same issue may arise in a case in which the business is clearly not marketable, and a significant portion of its value clearly does depend upon treating future earnings as a product of presently existing goodwill. In this sort of case, the double-dipping argument is much stronger, and the analogy to New Jersey's statutory bar on double-dipping of retirement benefits is much stronger. The author hopes that the majority's "fairness" test will be read sufficiently flexibly to permit a better analysis, and perhaps a different result, when individual goodwill is at issue.

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