Goodwill Hunting in Divorce

In general terms, goodwill is the value in excess of the net tangible worth of a business enterprise.  Within the context of closely-held business, there has evolved the distinction of professional (or personal) goodwill and enterprise (or corporate) goodwill.  Professional goodwill is that portion of goodwill that is dependent on the presence, skills, expertise, network, and performance of a key individual.  Enterprise goodwill is the portion of goodwill that flows from the enterprise primarily based on name recognition, location, and workforce in place.

Case law regarding the inclusion of goodwill in assets subject to division for divorce varies wildly from state to state.  Mississippi takes an extreme position in excluding all goodwill from division.  Other states include all goodwill in assets subject to division.  Currently, most states exclude professional goodwill from division.  In recent months, three rulings have been made at the state appellate level related to the division of goodwill for purposes of divorce.  All three cases involve dental practices and the implication of covenants not to compete on the value of the practice included in the division of assets.

Chronologically, the first case is McReath v. McReath, which was heard by the Wisconsin Court of Appeals.  The husband had purchased his dental practice and admitted that as much as 95% of the price was for professional goodwill, as evidenced by a covenant not to compete (“CNTC”).  The Court found that the goodwill supported by the CNTC was salable goodwill.  The Court ruled that salable goodwill should be divided.

On the heels of McReath, the Tennessee Court of Appeals ruled on McKee v. McKee.  In McKee, the Court ruled that a CNTC supported the existence of professional goodwill.  At its core, a CNTC is protecting an enterprise by restricting an individual from exercising his personal talents and abilities.  As such, the Court treated the goodwill as professional, excluding it from division.

Most recently, the Ohio Court of Appeals decided Banchefsky v. Banchefsky.  In this case, the husband, a cosmetic dentist, sold his practice during the divorce proceedings.  The purchase agreement specifically allocated $15,000 (total sales price $580,000) to a CNTC and $416,000 to goodwill.  Based on the Multi-attribute Utility Model (“MUM”), the husband’s valuation expert argued that the professional goodwill was $215,000.  Despite acknowledging the value of using MUM to calculate professional goodwill, the Court found it to be unnecessary since there was a recent arm’s length transaction to support the $15,000.  As a result, the Court accepted the amount allocated by the purchase agreement to the CNTC as separate property.

Courts will continue to wrangle over goodwill in divorce cases.  The primary caveat remains avoidance of the double dip, which can occur when alimony is awarded.  If the alimony is based on total earnings which support the goodwill, whether professional or enterprise, then division of the goodwill is redundant.  Business valuation analysts and attorneys need to weigh and assess the interaction of maintenance payments and division of goodwill to avoid such a double dip.