When a couple divorces, a business run by one or both spouses may be considered community property if it was started during the marriage or if both spouses are owners. In that case, a court may award the business to one spouse and order the person to pay the other spouse half of the company’s value. That value often includes something called “goodwill,” a term that generally refers to the intangibles that help make the business successful, like reputation, customer relationships, location, and operation methods. As California’s Fourth District Court of Appeals recently explained, however, that goodwill is separate from similar intangibles brought to the table by the spouse who runs the company.
Wife filed for divorce from Husband in July 2007, after a roughly nine-year marriage during which she gave birth to two children. Among the various issues to be resolved in the proceedings that followed was what to do with two businesses: MCDI, a real estate development company that Husband owned and had operated for 29 years at the time of the divorce, and MCDII, which Husband and Wife incorporated together a year before they married. The spouses each owned a 50 percent share in MCDII, with Wife handling the company’s marketing efforts and Husband running the company’s home development business. The Court explained that the couple earned millions of dollars in income from the two businesses, which allowed them to live an “affluent” lifestyle.
After various rounds of litigation, a trial judge ultimately awarded control of MCDII to Husband. In determining the value of the businesses so that Wife could be compensated for her share of it, the court included $474,000 in goodwill. The appeals court later explained that this determination was based on Husband’s reputation for the quality of houses that he had built in the past, as well as his relationships with vendors and contractors, his various contacts, and his overall “know how.”
Reversing the decision on appeal, the Fourth District said the trial judge conflated business goodwill with Husband’s future earning capacity. “The value of goodwill existing at the time of marital dissolution is separate and apart from the expectation of the spouses’ future earnings,” the Court explained. “It is therefore improper to base a goodwill valuation on the expectancy of future earnings.”
In particular, the Court said the valuation seemed to be based on the expectation that Husband would be able to increase his business income if and when the housing market rebounded. That determination was based on his personal skill, reputation, and experience, factors that could not be considered community property. Even if that earning capacity was divisible, the Court said the trial judge’s calculation was too speculative because it relied on the assumption that the housing market would bounce back.
As this case shows, business valuation is a complicated legal issue that often requires detailed evidence and expert input. If you are considering a divorce in California, this is just one of the many issues that you should first consider with the counsel of an experienced lawyer. With more than 30 years of experience, San Jose divorce lawyer John S. Yohanan is an accomplished family law attorney who has helped a number of clients resolve a wide variety of issues on optimal terms. Call our office at (408) 297-0700 or contact us online to schedule a consultation.
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