The Appellate Division of the New Jersey Superior Court recently decided a divorce case that serves as a primer for valuing a partnership interest in a law firm — particularly the goodwill component — for purposes of equitable distribution. Here’s why the appellate court reversed and remanded this case to the trial court.

Round one: Wife wins

The husband was an equity partner in a large law firm. He specialized in complex tax matters, billing more than 2,000 hours per year. The firm’s shareholder agreement calculated partners’ interests based on their termination credit accounts (TCAs).

The wife’s expert valued the husband’s TCA at just over $350,000 and added nearly $1.2 million for goodwill. But her expert adjusted both figures downward at trial.

On the other hand, the husband’s expert valued the TCA at $285,000 and concluded that there was no separate goodwill component. The trial judge rejected this opinion, finding it “incredible” that the firm “had no goodwill value.” The court simply accepted the wife’s expert’s unadjusted valuation without explanation — even though the expert adjusted his conclusion during cross examination.

Round two: Husband gets the KO

The appropriate treatment of goodwill in divorce cases varies from state to state, requiring experts to consult with legal counsel. The appellate court’s opinion provides valuable insight that may apply in New Jersey and jurisdictions with similar laws. The value of goodwill is subject to equitable distribution in New Jersey, similar to the interpretations in several other states.

One way to evaluate goodwill is to calculate the amount by which the husband’s earnings exceeded reasonable compensation of a similarly situated employee. However, the trial judge failed to analyze the differences in the experts’ opinions on reasonable compensation, which drove their value conclusions.

The appellate court held that the trial judge should have made specific factual findings to support the value of goodwill. And it should have explained why corrections to the wife’s expert’s valuation were ignored.

Clearly, the trial court misunderstood the husband’s expert’s conclusions. Rather than suggest the firm had no goodwill, the expert asserted that the partners’ TCAs accounted for goodwill. In addition, because the husband’s compensation matched his earning capacity, there was no additional goodwill component.

This case also reminds us that equitable isn’t necessarily synonymous with equal. The trial judge awarded the wife 50% of the husband’s interest, but failed to make any findings supporting that result.

Back to the drawing board

The appellate court concluded that valuing a law firm partnership interest demands a “nuanced valuation methodology” with specific factual support. The opinion provides detailed guidance to help the trial court understand how to value the business interest on remand.

© 2017

Return to the Litigation & Valuation Report – January/February 2018