Valuation of a Professional Practice in a California Divorce Action

By#Christopher#C.#Melcher#

1.# Introduction#

The#va luation#of#a#professional#practice#is#one#of#the#most#expensive#tasks #in#a#marital#dissolution #action .#

The#sp ous e#w ho#operates#the#practice#will#soon#realize#that#the#methods#used#for#valuing#h is#o r#her#

practice#h ave #little#to#do#with#the#fair#market#value#of# the#practice,#and#wil l#rightfully #compl ain#that#a#

willing#bu yer#might#not#even#e xist .#Concerns#about#“doub le‐dipping”#also# exist#w hen#the#sa me#ear nings#

which#are#used#to#find#a#value #in#the# practic e#are#also#used#for#calculating#sup port.#Still,#if#there#is# a#value#

to#the# practic e#based#on#marital#e fforts,#it#has#to#be#divided.#

Several#cases#in#Cali fornia#have#reviewed#the#methods#used#by#experts# in#valuing#a#professi onal#practice.#

One#thing#which#is#consistent#between#all#of#th ese#decisions#is#that#the #court#will#uphold#any#method #for#

valuing#th e#pract ice, #inc luding# goodwill,#so#long #as#the#evidence#legitimately#establishes# value.#

2.# General#Principles#

When# valuing#a#professional#practice,#a#trial#court#should #determine#th e#existence#and#v alue#of#the#

follow ing:#

(a)#fixed#assets,#which#we#deem#to#include#cash,#furniture,#equipment,# supplies#and#law#library;#(b )#ot her#

assets, #inc luding# pro perly#aged #accounts#receivable ,#costs# adv anced#with#due#regard#f or#their#

collectabi lity,#work#in#progress#partially#completed#bu t#not#billed#as#a#receivable,#and#work#completed#

but#not#bi lled;#(c )#goodwill#of#the#pra ctitioner#in#hi s#law#b usiness#as#a#going#concern;#and#(d )#liabilities#of#

the#practitioner#related #to#his#bus iness.#

(In#re#Mar riage#of#Lopez#(1974)#38 #Cal.#App.#3d#93,#110,#disapproved#on# oth er#g rou nds ,#In#re#Mar riage#of#

Morrison#(1978)# 20#Cal.3d#437,#453.)#

The#factors#listed#in#IRS #Revenue#Ruli ng#59‐60#should#also#be #used#to#evaluate#closely#held# stock,#

“[u]nless#there#is #some#stat utory#or#decis ional#proscription#on#th eir#use.”#(In#re#Marriage #of#Hewitson#

(19 83)#142#Cal.App.3d#874,#888.)#These#factors#are:#

(a)#The#nature#of#the#busin ess# and#the#hi story#of#the#enterprise#from#its#inception.#

(b)#The#ec onomic#outlo ok#in#gene ral#and#the#condi tion#and#outlook#of#the#specifi c#in dustry#in#particular.#

(c)# The#bo ok#value#o f#the#st ock#and#the#fi nancial#co ndition#of#the#business.#

(d)#The#earning#capacity#of #the#company .#

(e)#The#dividend#paying#capacity.#

(f)#Whether#or#not#the#enterprise#has#goodwill#or#other#in tangible#value.#

(g)# Sales#of#stock#and#the#size#of#the#block#of#stock#to#be#valued. #

(h)#The#market#price#of# stocks#of#corporations#engaged#in#the#same#or#a#simila r#line#of#business #ha ving#

their#stocks#activ ely# traded#in#a#free#a nd#open#market,# either#on#an#exchange#or#over‐the‐count er.#

(Id.#at# p.#883,#fn.#9,#quoting#IRS#Revenue# Ruling# 59‐60#.)#

However,# the#use#of#factor# (h)#of#Revenue#Ruling#59‐60,#which#involves#a#comparison#to#a#publ icly #

traded#company,#ha s#been#crit icized.#Specifically,#it#has#been#found #improper#to#compare#the#price‐

ear nings#of#a# publicly#traded#corporation#to#a#close#co rporati on#as#the#excl usive#means#t o#value#the#

later.#(In#r e#Marriage#of#Lotz#(1981)#120#Cal.App.3d#379,#384.)#

3.# The#Standard#of#Value#

Except#when# assets#are#divided#in#kin d,#the#court#is #obligated#to#rule#up on#the#value#of#the#asse ts#and#

divide#them#equally #between#the# parties .#(See#Fam.#Code,#§§#2550#৸#In#re#Marriage#of#Cream#

(19 93)#13#Cal.App.4th#8 1.)#The #proper#standard#to#use# in#valuing#the #marital#assets#has#been#subject#to#

considerable#debate,#fuele d#by#th e#court’s#imprecise#use#of#terms#such# as#“going#concern#value ”,#

“investment#value”,#or#worse:# “value”.#

Fair#market#value#is# defined#by#the#Unite d#States#Treasury #Regulations#as#‘the#price#at#which#the#

property#would#change#hands#between#a#wi lling#buyer#an d#a#willing#sel ler,#nei ther#being #under#any#

compulsion#t o#buy#or#to#sell’#a nd#both#having#reasonable#knowledge#of#rel evant#f acts.#[Citations.]#Thi s#

definition#is#generally#accepte d#in#Ca lifo rnia."#

(In#re#Mar riage#of#Hewitson#(1983 )#142#Cal.App.3d#874,#882,#fn.#8;#see#also#In#re#Marriage#of# Cream#

(19 93)#13#Cal.App.4th#81,#89#(same#defin ition#without#the #“reasonable#kno wle dge#of#relevant#facts”#

element.)##

The#fair#mark et#v alue#standard#has#been#restricted# to#marketable#assets.#(In#re#Marriage#of#Cream#

(19 93)#13#Cal.App.4th#81,#89.#In#Cream,#the#court#overruled#an#order#requir ing# the#use#of#an#interspousal#

auction#to#dispose#of#a# privately#owned# geyser#where#the#husband#had#asked#that#it#be#awarde d#to#him#

at#more#than#its#fair#market#va lue.#Th e#court#stated:#“We#restrict#the#use#of#[th e#fair#market#value#

standard]#to#mar ketable#assets#be cau se#som e#marital#assets#are#not# marketable,#but#non etheless#may#

have#to#be#va lued.”#(Id.)#The#court#in#Cream #did#not#specify#what#method#should#be#used#to#value#an#

unmarketable#as set, #but#an#answer#might#be#found#in#Code#of#Ci vil#Procedure# section#12 63.320,#

subdivision#(b),#relating#to#eminent#domain :#

The#fair#mark et#v alue#of#property#taken#for#which#there#is#no# relevant#market#is#its#value#on#the#date#o f#

valuation#as#determ ined#by#any#method#of#valuation#that #is#just# and#eq uitable.#

Recognizing#t he#problems#inherent#in#valuing#goodwil l,#the#court#in#the#case#of#In#re#Marriage#of#Lopez#

issued#the#following#warning:#

While# ‘market#va lue’#and#the#value#for#marital#dissolution#purposes#of#‘professional#goo dwill’#may #be#

synonymous,#in#our#view#such#value#should#be#determined#with#considera ble#care#and#caution,#since#it#is#

a#unique#situation#in#which#th e#conti nuing#practitioner#is#judicially#forced#to#buy #an# intangible #ass et#at#a#

judicially#determined#value#and#c ompelled#to#pay#a#former#spouse#her#share#i n#tangi ble#assets.#(Ci v.#

Code,#§4800.)#

(In#re#Mar riage#of#Lopez#(1974)#38#Cal.#App.# 3d#93,#110#(italics#in# original),#disa ppr ove d#on#other#

gro unds,#In#re#Marriage#of#Morrison#(1978)#20#Cal.3d#437,#453.)#

Lopez#moved #away#from#the#fair#market#value#s tandard#and#t oward# one#ba sed#on#intrins ic#value.#This#is#

evident#by#the#court’s#statement#that#factors#such#as#the#practiti oner’s#age#and#health#should#be#used#in#

valuing#pr ofessional#goodwill,#wh ich# may#be#more# relevant#to#the#owner‐spouse#than#to#a#hypothetical#

buyer#of#g oodwill#on#the#open #market.#(See# below,#“Valuatio n#Methodology#in#General”.)##

The#standard#of#value#in#a#goo dwill#case#was#also#address ed#in#the#case#of# In#re#Marriage#of#Foster,#

where#the#court#stated:##

The#va lue#of#community#goodwill #is#not#necessarily#the#speci fied#amou nt#of#money#that#a#willing#buyer#

would#pay#for#such#goo dwill.#I n#vi ew# of#the#exigencies#that#are#ordinarily#attenda nt#a#marriage#

dissolutio n#the#a mount#obtainable#in#the#m arketplace#mi ght#well#be#less#than #the#true#value#of#the#

goodwill.# Community#goodwil l#is#a#portion#of#the#community#va lue#of#the#professional#practice#as#a#

going#concern#on#the#date#of#the#diss olution#of#the#marriage .#

(In#re#Mar riage#of#Foster#(1974 )#42#Cal.App.3d#5 77,#584.)#

The#Foster#court#cor rectly#notes#that#a#sale#of#goodwill#during#a#divorce#might#comm and#less#than#its#

“true #value”#becau se#of#the#pressures#involved#in#a#divorce.#However,#if#a #fair#market#value#ap pro ach #is#

used,#this#concern#is#moot# bec aus e#the#d efinition#of#“fair#market#value”#assumes#that#the#hypothetical#

buyer#and#seller#are#not#under #any#compulsion#to#buy #or#sell.#It#app ears#that#the#court#was#just#trying#to#

say#that#the#c ommunity#intere st#in#th e#goodwill#cannot#be#va lued#as#if#the#practic e#were#bei ng#

liquidated.#

4.# Date#of#Valuation#

The#ge neral#rule# under#Cali fornia#law #is#that#ass ets# and#lia bilities #are#to#be#valued#as#of#the#date#of#trial.#

(Fa m.#Code,#§#25 52,#subd.#(a).)#Professional#practices,#howev er,#will#typically#be#v alued#as#of#th e#date#of#

separation#(In#re#Marriage#of#Dun can #(2001) #90# Cal.App.4th#617,#625),#or#more#tec hnicall y#on#th e#day#

after#the#date#of#separa tion#(see#Fam .#Code, #§#2552,#subd.#(b)#(“the# court#for#g ood#cause #shown#may#

value#all#or#any#port ion#of#the# assets#and#liabilities#at#a#date#after#separation#and#before#trial#to#

accomplish#a n#equa l#division#of#the#commu nity#estate#of# the#parties#in#an#equitable# manner.”) #The#

rea son#for#the#rule#is#that#post‐separation#e arnings#are#th e#separate #property#of#the#spouse# who#earned#

the#money.#(Fam.#Code ,#§#771.)#

5.# Goodwill#

a.# Definition#of#“Good will”#

“The#‘good#will’#of#a #business#i s#the#expecta tion#of#continued#public#patronage.”#(Cal.#Bus.#&#Prof.#Code,#

§#1410 0.)#Goodwill#has#also#been# defined#by#cases# as:##

‘the#advantage#or#benefit#which#is#acquired#by#an#establishment#beyond#the#mere#value#of#the#capital#

stock,#funds#or#property#employed#th erein,#i n#consequence#o f#the#general#pub lic#patronage# and#

encouragement#whi ch#i t#receives#from#constant#or#habitu al#c ustomers,#on# account#of#its #loc al#position,#

or#common#c elebrity,#or#reputation#for#skill# or#affluence,#or#punctuality,#or#from#other#accidental#

circumstances,#o r#necessities,#or#even#from#ancient#pa rtialities#or#pr ejudices.#[Citation.]#.#.#.#it#is#the#

probability#that#the#old#customers#will#resort#to#the#old#p lace.#It#is#the#probability#that#the#business#will#

contin ue#in#the#futu re#as#in#the#past,#adding#to#the#profits #of#the#concern#and#con trib uting#to#the#means#

of#meeting#its#engagements#as #they#come#in.’#[Citations.]#

(In#re#Mar riage#of#Foster#(1974 )#42#Cal.App.3d#5 77,#581.)##

“The#trier#of#fact#may#take#into#consideration#the#s ituation#of#the#business #premises,#the#amount#of#

patronage,#the#personality#of#the#parties #engaged#in#the#b usiness,#the#length#o f#time#the#business#has#

been#establis hed,#and#the#habit#of#its#customer s#in#continuing#to#patronize#the#business.#The#court#may#

also#take#into#consideratio n#the#market#value#a t#which#the#business#goodwill#could#be#sold#on#

dissolutio n#of#the#marriage.”#(In#r e#Marriage#of#Webb# (1979)# 94#Cal.App.3d#335,#344.)#

A#spouse#may#ha ve#personal#goodwill#in#addition#to#a#share#of#any#goodwi ll#belonging#to#a#partnership#

or#corporatio n#in#which#the#sp ouse#has#an#interest.#(See#In#re#Marriage #of#Iredale#(2004) #121#Cal.App.4th#

321#(experts#valued# goodwill#of#a# law #firm#partner#based#on#a#pe rsonal#and#a#part nership#level) .##

b.# Valua tion#Methodology#in#General#

“Goodwill#value#ma y#be#measured#by#‘any#legitimate#met hod#of#evaluation#that#measur es#its#p resent#

value#by#taking#into#acc ount#some#past#resu lt,’#so#long#as# the#evidence#‘legitimately#establis hes #value.’#

[Citation#omi tted.]#”#(In #re#Marriage#of#Rosen#(2002)#105#Cal.App.4th#808,#819. )#

Certain#matters#mer it#consideration#which#may#be#said#reasonably#to#cont ribute#to,#diminish,#or#affect#

the#intangible#value #of#professional#goodwill#at#the#time#of#dissolution #and#the#continuity#and#retention#

of#the# benefits#thereof#whi ch#the#professional#practitioner#w ill#c ont inue#to#enjoy#after#the#marital#

dissolutio n.#In#that#context#some# such#factors#are#the# practitioner's#age,#health,#past#demonstrated#

ear ning#power,#p rofessional#re put ation#in#the#community#as#to#his#judg ment,#skill,#knowledge,#his#

comparative#professional#success ,#an d#the#nature#and#duration#of#h is#business#as#a#sole#practitioner#or#

as#a#member#of#a#partnership#or#professional#corporation#to#which# his#pro fessional#effo rts#have#m ade#a#

proprietary#contribution.#In#addit ion,#consideration#should#be#given#to#the#value#of#the#‘fixed’#and#‘ot her#

assets’ #of#the#professional#business#with#which #the#‘goodwill ’#is#to#c ont inue#its#relationship .#

(In#re#Mar riage#of#Lopez#(1974)#38 #Cal.#App.#3d#93,#109‐110,#disapprove d#on#other#grounds,#In#re#

Marriage#of#Morrison#(1978)#20#Cal.3d#437,#453.)#

c.# Pre ‐Marital#and#Post‐M arital#Efforts#Excluded#

A#profess ional#spouse’s#income#after#the#date# of#s eparation#is#irrelevant#for#v aluing#goodwill#belonging#

to#the# community.#(See #In#re#Marriage#of#Ro sen #(2002) #105#Cal.App.4th#808,#821.)# Stated#another#way,#

“community#goodwill#may#be# eva luated#by#no#met hod#that#is#dependent#upon#the#p ost‐marital#efforts#

of#either#spouse.”#(I n#re#Marriage#of#Fortier# (1973)# 34#Cal.App.3d#384,#387.)#Th e#reason#is#that#a #spouse’s#

ear nings#after#the#date#of#separation# are#his#or#her# own#separate#property.#(Ca l.#Fam. #Code,#§#771.)#

Likewise,#any#pre‐marital#a cquisition#of#goodwill#should#be#excluded#when#valuing#the#community#

interest#in#the#pr actice.#(See#In#re#Ma rria ge#of#Rives#(1982)#13 0#Cal.A pp.3d#138,#150#(“husband’s #skill,#

experience#and#r eputation#...#were#acquired#in#the#40#years#prior#to#the#rel atively#short#marriage#and#

thus#cannot#be#considered#to#have#been#acquir ed#by#operation#of#the#busi ness#as#a#c ommunity#asset.”)#

# #d.# Indicia#of#Owner ship#Requirement#

A#p reliminary#requir ement#for#goodwill#to#exist#is#that #the#spous e#have#some#owners hip#interest#in#the#

business#f or#which#he#o r#she#provides#services.#(See#In#re#Marriage#of#Slivka#(1986)#183#Cal.App.3d#159.)#

In#Slivka,#the# hus band#was#a#radiologist#for#four#years.#For#the#last#two#years,#he#was#a#partner#i n#a#

me dical#group,#which#in#turn#had#a#contract#with#a#health#maintenance#or gan ization #(Kaiser)#to#provide#

me dical#services#to#the#HMO’s#members.#(Id.#at#p.#163 .)#The#husban d#made#no#capital#contribution#to #

the#medical#group#on#becoming#a#partner,#will#receive#no #payment#on#his#departure, #and#cannot#sell#his#

partnership#interest.#The#medical#group’ s#only#contract#is#with#Kaiser;#there#is#no# other#patient#base.#The#

husband’s#compensation#c ons ists#of#a#base#salary,#overtime,#and#bonuses.#The#court#observ ed#that#the#

husband#“is#most#similar#to#an#employee#who#has#no# ownership#interest#and# is#paid#for#services#

rendered.”#(Id.#a t#p.#164.)#Based#on#these#facts,#the#court#of#appeal#held#that#ther e#w as#s ubstan tial#

evidence#to#support #the#trial#court’s#r uling#that# the#husband#had#no#go odwill# of#any#demonstrable#value.#

(Id.#at# pp.#163‐164.)##

e.# The#Exce ss#Earn ings#Method#

The#most#often#used#approach#recognized#by#California#courts#in#es tablish ing# goodwill#is#the#excess#

ear nings#method.#

Pursuant#to#[the#excess# earnings]#met hod,#one#f irst#determines#a#practi tioner's#av erage#annual#net#

ear nings#(before#income#taxes)#by#refere nce #to#any#period#that#seems#reasonably#illu strative#of#the#

cur rent#rate#of#earni ngs.#One#then#determines#the#ann ual#salary#of#a#typical#sa laried#employee#who#has#

had#exper ience#commensurate#with#the# spo use #wh o#is #the#sole#p ractitioner#or#sole#owner/employee.#

Next,#one# deducts#from#the#average#net#pret ax#earnings#of#the#business#or#practice#a#'fair#return'#on#th e#

net#tangible#assets#used#by #the#business. #Then,#one#determines#the#'excess#earnings'#by#sub tracting#th e#

annual#salary#of#the#average#salaried#person#from#the# average#net#pretax#earnings#of# the#business#or#

practice#remaining#after#deducting#a# fair #return#on#tangible#a ssets.#Fina lly,# one#capitalizes#the#exce ss#

ear nings#over #a#p eriod#of#years #by# multiplying#it#by#a#facto r#equal#to#a#speci fic#period# of#year s,#

discounte d#to#reflec t#present#valu e#of#the#exces s#earnings#over#that#period.#The#period#varies#according#

to#fact ors# such#as#the#type#of#business,#its#stability,#and#it s#earnings#trend.#

(In#re#Mar riage#of#Garrity#&#Bishton#(1986)#181#Cal.App.3d#675,#688,#fn.#14.)#

# #i.# The#“Average#Sal aried#P erson”#and#th e#“Similarly#Situated#Professional”#Standards#

The#Garrity#&#Bishton#case#used#the#“average#salaried#person”#standard#for#determining#the#goodwill #of#

a#law#practice.#This#standard#c ompares#the#subject #spouse’s#average#annual#net#p retax#earning s#to #“a#

typ ical#sal aried#e mployee#who #has#had#expe rience#commensurate#with#the#[subject]#spo use”).#(In#re#

Marriage#of#Garrity#&#Bisht on,#supra,#181#Ca l.App.3d#at#p.#688,#fn.#14.)##

More#recent#decisio ns,#however,#have#used#a#“simi larly#situated# pro fessional”#standard.#(Se e#In#re#

Marriage#of#Iredale#(2004)#121 #Cal.App.4 th#321; #In#re#Marriage#of#Ro sen#(2002) #105#Cal.App.4th# 808 ,#

823.)#Under#this#standard,#reasonable#compe nsation#is#based#upon#“‘the#cost#of#hirin g#a#nonowner#

outsider#to#perform#the#same#average#amount#that#other# people#are#normally#compensated#for#

performing#simil ar#s ervices .’”#( In#re#Marriage#of#Iredale,#supra,#121#Cal.App .4th#32 1,#q uot ing# In#re#

Marriage#of#Rosen,#supra,#105#Cal.App.4th#at#p.#82 3.)#The#int ent#is#to#take#into#account#all#of#the#services #

that#the#spouses#contributes#to#the#professional#practice. #For#example,#the#cost#of#hi ring#an #employee#to#

perform#the#daily#functions#of #the#owner#would#not#always#be#the#true#replacement# cost#of#the#owner.#

In#most#cases,#the#owner#is #responsib le#for#bringing#business# to#the#firm#and#shap ing# the#direction#of#t he#

practice.#The#value#of#these#non‐billable#services#must#be#included#when#determ ining#the#s alary#whic h#

would#be# required#to#attract#a#replacement# for# the#ow ner .##

In#I redale, #one#of#the#issues#was#whether#it#was#proper#for#the#trial#court#to#use#the#“similarly#situated#

professional”#standard# instead#of#the#“average# salaried#person”#in#valuing #a#wife’s#partnership#interest#

in#a#large#law #firm.#The#court#of#appeal#held #that#

...#the#method#of#comparing#[t he#wife’s]#compe nsation#to#what#it#would#cost#t o#hire#an#associate#

(actually#1.4#associates)#did#not#account #for#the#nonbillable#hours#expend ed#by#[her],#nor#would#an#

associate#be#likely#to#have#a#client#base#comparable#to#[hers] .#Comparing#[the#wif e’s]#compensation#to#

that#of#similarly#situated#professiona ls,#r ather#than#to# a#salaried#employee,#was#indeed#a#more# rational#

and#reasonable#met hod#by #wh ich#to#calc ulate#the#value#of#[her]#goodwill#in#this#c ase.##

(In#re#Mar riage#of#Iredale,#supra,#121#Cal.App.4th#321.)#

ii.# Use#of#Compensation#Su rveys#

If#a n#expert#relies#on#a#surv ey#t o#find#reasonable#compensation,# the#sur vey#must#be#stati stically#valid#and#

relevant#to#the#practice#being#valued.#(In#re# Marria ge#of#Rosen#(2002)#105#Cal.App.4th#808.)#The#Rosen#

cas e#involved#the#va luation#of#the#husba nd’s#so lo#law#practice#in#southern#California#who#handled#state‐

appointed#criminal#appeals.#The#wife’s#expert#t ook#the#av erage#of#two#nati onal#compensation#surveys#to#

find#that#the#reasonable#compensation#to#h ire#an#attorne y#to#replace#the#husband#was#$100,000.#The#

court#of#appeal#f ound#that#the#expert’s#opinion#was#inadmissible,#stating:##

[Th e#w ife’s]#expert#testified#he#did#no t#have#any #particular #knowledg e#of#lawyer#compensation,#other#

than#what#he #had#learned#from#valuations#he#h ad#performed.#He#admitted#he #wa s#not#familiar#wit h#a#

law#practi ce#l ike#[the#husband’s].#He#did# not#condu ct#a#survey#or#perform#any#kind#of#study#of#lawyer#

compensation#in#So uthern#California.#Rather,#he#relied#entirely#upon#two#surveys#of# compe nsa tion#(the#

Altman#W eil#survey#and#the#Robert#Morr is#survey),# neither#of#which#dealt#with#a#s ole#practit ioner#lawyer#

handli ng#state‐funded#criminal#appeals.#The#expert#di d#not#attempt#to#relate#the#information#i n#the#

surveys#to #an#analysis#of#[the#husband’s]#law#practice. #

***#

[Th e#w ife’s]#expert#might#just#as#w ell#have#pl uck ed#the# $10 0,000#figure#from#thi n#air.#We#do#not#

disapprov e#of#compensation#surveys# as#a#general#matter.#We#realize#they#c an#be#usef ul#when#used#

properly.#But#we#question#whether#a#nation al#survey#of#lawyer#com pensation#(su ch#as#the#Altman#Weil#

survey)#is# a#proper#b asis#for#offering#an#opinion #on#averag e#la wyer#compensati on#in#S out hern#California.#

(Se e#Evid.#Code,#§801,#subd.#(b).)#We#also#question#whether#the#Altman#Weil#surv ey#i s#applicable#to#[the#

husband’s]#law#prac tice,#which#consists#alm ost# exclusi vely#of#handli ng#state‐funded#criminal#appe als.#

The#ex pert#though#d id#not#hold#hi mself#t o#the#compensation#figures#in#the#Altman#Weil#survey, #but#

turned#to# another#survey—the#Rober t#M orri s#survey—purporting#to#show#average#compensation#for#

officers#and#directors#of#va rious#kinds#of#businesse s.#We#believe#the#Robert#Morris#survey#is#inapplicable#

to#a#sole#practitioner#lawyer,#such#as# [the#husband],#who#doe s#not#have#off icers#or#direct ors.#[The#wife’s]#

expert#then#used#his#own#‘judgment’#to#come#u p#with# a#compensation#figure#based#upon#the#numbers#in#

these#two#survey s,#even#though#he#admitted#he#did#not#have# any #particular#knowl edg e#abou t#lawyer#

compensation#and#did#not#know#of#a ny#attorney#w ith#a#la w#practice#like#[the#husban d’s] .#In#essenc e,#[the#

wif e’s]#expert #did#nothing#more#than#pick#$100,000#because#it#was#about#halfway#bet ween#$125,00 0#

and#$67,000.# Those# two#numb ers# bear#no#particular#materiality#to#the#issue#of#reasonable#compensation#

in#this#case.##

(Id.#at# p.#822. )#

The#us e#of#informal# surveys#by#an#expert#in#forming#an#op inion#has#also#be en#criticized#as#being#based#

upon#unreliable# hearsay.#(Korsak#v.#A tlas #Ho tels ,#Inc.#(1992)#2#Cal.Ap p.4th#1516.)#Before#an#expert#may #

rely#upon#hearsa y#in#forming#an#o pinion,#it#must#be#show n#that#the# hearsay#in format ion#is#of#a# type#that#

ma y#reasonably#be#r elied#u pon#by #profes sionals#in#the#field#in#formi ng#an#opinion#on #the#subje ct.#(Id.#at#

p.#1524;#Cal.#Evid.#Code,#§#801,#subd.#(b).)#

In#Korsak,#a#mechanical #engineering#expert#contacted#several #unnamed #hotel#workers#about#their#usual#

plumbing#practices#as#the#basis#for#his#opinion#tha t#th e#opposing#party#was#negligent#in# failing# to#

perform#certain#mainte nance#at#its#hotel.#There#was#n o#showing#that#the#survey#was#scientifically#

conducted,#that#the#information#received#w as#r eliable ,#or#that#it# was#of#a#type# nor mally#r elied#u pon#by #

engineers#in#forming#ex pert#opinions .#In#holding#that#the# expert’ s#te stimony#w as#inadmissib le,#the#court#

of#app eal# stated: #

...#it#does#no t#appear#that#the #information#[the#expert]#presented#resulted #fro m#any#form#of#scientific #

study,# survey, #or#investigation.#We#do #not#doubt#there# may#be#cases# in#which#a #qualified# researcher#

could#con duct#a#survey# of#som e#relevant#form#of#activity#and#reliabl y#re por t#such#results#to#a#tri er#of#fact#

or#to#a nother#expert .#[Citation#omitted.]# Not hing#in #this#record,#h owever,#suggests#the #expert #relied#

upon#any#scient ific#sampling#of#the#hotel#industry .#Rather,#he#made#an#un explained,#casual#sampling#of#

unknown# sources#within#the#‘hotel#business.’#The#authenticity,#r eliability,#or#the#represe ntative#nature#of#

the#responses#are#totall y#undeterminable#based#upon#[the#expert’s]#testimony.#

(Korsak,#supra,#2# Cal.App.4th#at#1526.)#

iii.# Past#Earnings#

Excess#earnings#must#be#based#on#“‘a#practi tioner’s#average#annual#net #earnings#(bef ore#inc ome#taxes)#

by#reference#to#any#period#tha t#se ems#reasonably#illus trat ive# of#the#current#rat e#of#earnings.’”#(In#re#

Marriage#of#Rosen,#supra,#105#Cal.App.4th#at#p.#820,#quoting#In#re#Marriage#of#Garrity#&#Bishton#(1986)#

181#Cal.App.3d#675.)#“T he#past#ea rnings#to#which#the#[ excess# earnings]#formula#is# applied#should#fairly#

reflect #the#proba ble#future#ear nings.#Ord inarily, #the#pe riod#sh ould#not#be#less#than#five#years,#and#

abnormal#years,#whether#above#o r#below#the#average,#should#be #eliminated... .”#(Rev.#Rul.#6 8‐609#( 1967‐

1#Cum.#Bul.#5 76).)#It#should#also#be#kept# in#mind,#however,#that: #

Prior#e arnings#records#u sua lly#are#the#most#reliable#guide#as#to#the#future#e xpe ctancy,#bu t#resort#to#

arbitrary#f ive‐or‐ten#year#averages#without#regard#to#current#trends#or#future#prospects#will#not#produce#

a#realistic#valuation.#If#for#instance,#a#record#of#progre ssiv ely# increasing#or#decreasing#ne t#income#is#

found,#then#grea ter#wei ght#ma y#be#ac corded#the#most#recent#years'#profits#in#estimating#earnin g#

power....#

(Rev.#Rul.#59‐ 60#(1959‐1#Cum.# Bul.#23 7,#2 41).)#

Both#of#the#Revenue#Rulings#quot ed#abo ve#r efer#to#using#past#earnings#as#a#guide# for#“future#

expectancy”#of#e arnings#or#“pr obable#future#earnings”.#This#is#at#odds#with#the#requirement#that#post#

separation#(i.e.,#future)#earnings#be#exclude d#when#va luing#goodwil l.#

(Se e#“Pre‐Marital#and#Post‐Marital#Efforts#Excluded”.)#The#bette r#approach,#at#least#when#applied#to#a#

Cal ifornia#marital#dissoluti on#case,#w ould#be#to#say#that#a#reasonable#period#of#past#earnings#must#be#

selected#in#order#to# determine#the#“current#rate#of#earnin gs”#–#not#to#p redict#what#the#future#earnings#

will#be.#(S ee#In#re#Marriage #of#Rosen,# supra,#105 #Cal.App.4th#at#p.#820.)#This#was#the#v iew #off ered#by#the#

court#i n#the#case#of#In#re#M arriage #of#Lop ez:#

We#think#it#follows#that#in#marital#cases# the#expectancy#of#fu ture#earnings# is#not#synonymous#with,#nor#

should#it#be#t he#basis#for,#dete rmi ning#the#value#of#“goodwill ”#of#a#profess ional#practice,#but#is#simply#a#

factor# to#consider#in#deciding#if#such# an#asset#exists.##

(In#re#Mar riage#of#Lopez#(1974)#38 #Cal.#App.#3d#93,#108‐109#(i talics#removed),#disapproved#on#othe r#

gro unds,#In#re#Marriage#of#Morrison#(1978)#20#Cal.3d#437,#453.)#

iv.# Capita lization#Rate#

A#d etermination#of#the#pro per#capitalization#rate#presents#one#o f#th e#most#difficult#problems#in#

valuation....#Thus,#no#st andard#tables#of# cap italizat ion#rates#applicable# to#closely#held#corporat ions#can#

be#formul ated.#Among#the#mo re#important#factors#to#be#taken#into#consid eration#in# deciding#upon#a#

capitalization#rate#in#a#particu lar#case#are:#(1)#the#nature#of#the#business;#(2)#the#risk#involved;#and #(3)#

the#stability#or#irregularity#of#earning s.#

(Rev.#Rul.#59‐ 60,# §6#(1959‐1#Cum.# Bul.#23 7).) #This#rule#applies#to# “problems#involving#the#de termination#

of#the# fair#market#value#of#business#interests#of#any#type,# including#partnerships#and#proprietorshi ps,#

and#of #intang ible#assets #for #all# tax#purposes.”#(Rev.#Rul.#68‐609#(196 7‐1#Cum.#Bul. #576).)#

Several#cases#have#discussed#“ factors ”#which#a#trial#co urt#sho uld#consider#i n#determining#whether#the#

evidence#presented#supports#a#go odwill# valuati on.#These#factors #are#often# mentioned#as#thi ngs#wh ich#

the#appraiser #failed# to#consider#in#valuing#good will,#and#typically#involve#the#business#owner’s# age,#

health ,#or#desire# to#r etire.#Since#these#considerations#r elate#to#th e#future#earni ng#capacit y#of#the#owne r‐

spouse,#it#could#be#argued# that#they#are#not#part#of#the#goodwill#equati on.#(See#“Pre‐Marital#and#Post‐

Marital#Ef forts#Excluded”.)#It#makes#more#sense#to#view#these#factors#as#affecting#the#capitalization#rate,#

although#the#effect#remains#that#future#earning#capacity#is#being#co nsidered.#Here#is#an# example#of#how#

the#courts#have#dealt#with#this#issue:#

Certain#matters#mer it#consideration#which#may#be#said#reasonably#to#cont ribute#to,#diminish,#or#affect#

the#intangible#value #of#professional#goodwill#at#the#time#of#dissolution #and#to#the#continuity#and#

retention# of#t he#ben efits#thereof#which#the#profess ional#practitioner#will#c ontinue#to#enjoy#after#the#

ma rita l#dissolution.# In#that#context#some#such#f actors#are# the#practitioner's#age,#health,#past#

demonstrated#earning#power,# pro fessional#r eputation#in#the#community#as#to#his#judgm ent,#skill,#

knowledge,#h is#comparative#professional#success,#and#the#na ture#and#d uration#of#his#business#as#a#sol e#

practition er#or#as#a#member#of#a#partnership#or#professional#cor poration#to#w hich#hi s#pr ofessional#

efforts#have#made#a#proprietary#contributio n.#

(In#re#Mar riage#of#Rives#(19 82)#130#Ca l.App.3d#138,#150,#quoting#In#re#Marriage#of# Lopez,# 38#Cal.App.3d#

at#pp.#109‐110.)#The#court#went#on#to#stat e:#“ In#v iew#of#husband’s #advanced#age#and#u ncontroverted#

desire#to#retire,#a#goodwill# factor#far#in#excess#of#the#value#of#the#physical#assets#of#the#business#was#

unjustified.”# (Id. #at#p.#152#(italics#added).)##

The#potential#loss#of#a#major#customer#may#also#affect#the#goodwill#value# of#a#business. #(In#re#Marriage#

of#Rives#(1982)#130#Cal.App.3d#138,#158.)#However, #this#should#prob ably#not#be#consi dered#unless#the#

result#is#“immediate#an d#specific.”#(See#In#re#M arri age#of#Fonstein#(1976)#17#Cal.3d#738#(discou nting#

award#of#community#asset#based# on#income#tax#consequences).)#

f.# The#Foster#Method#

Using#the#last#three# months#of #accounts#receivable s#to#value# goodwill#has#been#referred#to#as#the#Foster#

Method.#(I n#re#Marriage#of#Foster#(1974)#42#Cal.App.3d#577.)#The#issue#in#Foster#w as#whe ther#the#expert#

retained#by#a#wife#to#va lue#her#hu sband’s#medical#practice#used# “a#proper#method#of#evaluating#

goodwill#. ..#and#whether#the#evidence#is#sufficient#to#support#a#finding #that#the#value#of #the#goodwill# of#

[the#husband ’s#practice]#was#the#s um#of#$27,000.”#(Id.#at#p.#580.)#The#expe rt#for#the#wife#explai ned#that#

the#fai r#va lue#of#a#medical#practitioner’s#goodwill#could#b e#determined#as#follows:#

‘One#way#is#to#take#t he#net# income#for#th e#year#and #subtra ct#from#that#what#a#comparable#employer#

[sic]#would#have# as#a#salary #in#a#compara ble#situation,#and#take#that#difference,#and#multiply#that#by#a#

factor# any where#from,#one#year#factor#of #anywhere #fro m#two# to#ten.’#He#testified#further#that#‘You#can#

take#the#n et#earnings#of #the#business,#one#year's#ne t#earnings#of#the#bus iness.#You#can#take#two#years#

net#earnings#of#the#business.#You# can #take#three#years#net#earnin gs#of#the#business.#You#can#take#three#

months#charges#to#accounts#receivab le.#You #can#take#t hree#months#receipts#on#ac counts#rec eivable.’#(Id.#

at#p.#579.)##

Although#it#is #not#entirely#clear#from#the#record #wh ich#metho d#the#e xpe rt#u sed,#he#testified#that#he#

“to ok#the# approximatio n#of#three#mo nth s#received#on# account,#latest#three#months#that#I#had,#because#

some#of#the#other#ways#I#felt#were#resulted#in#a#figure# that#was#too#high.”#( In#re#Marriage#of#Foster,#

supra,#42#Cal.App.3d#at#581.)#The#court#of#appeal#stated#that#“it #is#clear#that#at#le ast# one#of#the se#

me tho ds#was#utilized”#and#found#tha t#th e#expert’s#testimony#“provided#su fficient#evidence#to#support#

the#sum#o f#$27,000#as#the#valuation#of#the#goodwi ll.”# (Id. #at#p.#584.)#In# other#words,#the#court#believed#

that#the#expe rt’s#metho dology#was#legitimate#and#that#the#opinion#was#supported#by#substanti al#

evidence.#

The#Foster#decision# has#been#interpreted#as#approving,#at#least#tacitly,#any#of#the# goodwill#v aluation#

me tho ds#described#by#the#expert,#which# included#(a)#the#excess#earnings#appr oac h,#(b)#using#the#net#

ear nings#of#the#business#over#a#one,#t wo#or#three#year#period,#or# (c)#using#three#months#of#accounts#

receivable.#(See#In#re#M arri age#of#Foster,#supra,#42#Cal.App.3d#at#p.#579.)#It#has#also#been#ob served#tha t#

the#last#two#methods#are#n ot#clearly#defined#in#the#case.#For# example,#does#th e#“net#earnings#o f#the#

business”#inc lude#the#spouse’s#reasonab le#compensation?#It#is#a lso# not#we ll#understood#wh y#three #

months#of#accounts#rec eivables#would#b e#used#to#value#goodwill#without#taki ng#into#account#t he#

profitability#of#the#prac tice.#

The#main# point#to#be#learned#from#Foster#is#that#goodwill#may#b e#valued#by#any#legit imate#method.#The#

holding#in#Fo ster#makes#this#evident: #

In#sum#we#conclude #the#ap plicabl e#rule#i n#evaluating#commu nity#goodwill# to#be#that# such#good will#may#

not#be #valued#by#any#method#that#takes#into#account#the#post‐marital#efforts#of#either#spouse# but #that#a#

proper#means#of#arriving#at#the#value #of#such#goodwill#contemplate s#any#legitimate#method#of#

evaluation#th at#mea sures#its#present#value#by#taking#into#account#some#past#result.#Insofar#as#the#

professional#practice#is#concerned#it#is#assumed#th at#it#wi ll#continue#in#the#future.#(In#re#Marriage#of#

Foster,#supra,#42#Cal .App.3d#at #p.#584.)##

6.# Accounts#Receivable#

For#most#profess ional#practices,#the#major#assets#“are#not#capital#assets,#but#those#related#to#the#direct#

rendering#of#profession al#services ,#most#particularl y#accounts#receivable#and#work#in#progress....”# (In#re#

Marriage#of#Green#(1989)#213#Cal.App.3d#14,#21.)#It#is# common#f or#experts#to#discount#accounts#

receivable#for#uncollectibility#based#on#past#collection#rates. #(See#In#re#Marriage#of#Nich ols,#supra,#27#

Cal .App.4th#at#pp.#667‐668 .)#

7.# Effect#of#Shareholder/P artnership#Agreements#

A#shareholde r#or#partnersh ip#agreement#may#sometimes#be#considered#in# valuing#the#community#

property#interest#in#a#partnership#or#corporation.#(In#re#Marriage#of#Nichols#(1994)#27#Cal.App.4th#661.)#

In#Nichols ,#the#court #of#appeal#affirmed#the#tria l#co urt’ s#reliance#on#a#share holder’s#buy‐sell#agr eemen t#

which#provided#that#the#husband#had#no#interest#in#the#law# corporation’s#accounts#receiva ble,#work#i n#

progre ss,#or#goodwil l.#(In#re#Marriage #of#Nichols#,#supra,#27#Cal.App.4th#at#pp.#671‐672.)#In#assessing#

whether#to#use#an#p artnership#or#sha reholder#a greement#in#v aluing#a#community#interest#in#an#entity, #

the#court#in#Nich ols# stated#that#the#following#factors#should#be#considered:#

(1)#the#proximity#of# the#date#of#th e#agreeme nt#t o#the#date#of#separation#to#ensure#that#t he#agreement#

was#not#entered# into#in#contemplation#of#marital#dissolution;#(2)#the#existenc e#of#an #independ ent#motive#

for#entering#into#the#bu y‐sell#agre ement,#such#as#a#desire# to#prot ect# all#partners#against#t he#effect#of#a#

partnership#dissolution ;#and#(3)#whether#the#value#resulting# from#the#agreement' s#purchase#price#

formula#is#similar#to#the#value#produced #by#oth er#approaches.#(I d.#at#p.#672.)#

The#Nichols#c ourt#also#noted#that#per sonal#goodwill#may#exist#in dependen t#of#the#goodwill# of#t he#firm#

itself,#stat ing# that#the#“husban d#has#personal#goodwill #regard less#of# whether#he#rema ins# with#the#firm,#

and#th is#goodwill#ca nnot#be#eliminated#by#a#recital#in# the#sto ck#purchase#agreement. ”#(Id.#a t#p.#673,#n.#

4.)#

The#court#came#to#the#s ame#conclusion#in#the#case #of#In#re#Marriage#of#Iredale#(2004)#121#Cal.App.4th#

321.#In#Ire dale,#the#wife #wa s#a#partner#in# a#la rge#law#firm.#The#comm unity#interest#in#the#firm#was#valued#

in#addition#to#wi fe’s #ow n#personal#goodwill.#In#doing#so,#t he#trial#court#use d#the#partnership#agreement#

as#a#reference#to#determine#th e#community’s#speci fic#interest#in#the#firm.#I n#upholding#the#decision,#the#

court#of#appeal#held#that#the#wife’s#interest#in#the#firm,#pursuant#to #the#pa rtnership#agreem ent#she#

signed #wh en#she#joined#the#firm#does#not#inclu de#an#entitlement,#at#any#ti me,#to# collect#a#portion#of#the#

accounts#receiva ble,#work#in#progress,#or #goodwill#of#the#law# firm.#The#trial#court#reasonably#concluded#

that#[the#wife’s]#interest#was#limit ed#to#the#value#of#her#capital#a cco unt,#which#reflec ted#the#value# of#her#

interest#in#the#hard#assets#of#the#f irm ,#but#not#the#f irm's#accounts#receivable,#work#in#progress,#or#

goodwill.#(In#re#Mar riage#of#Iredale,#s upr a,#121#Cal.App.4th#321.)#

On#the#other# hand,#courts#have#disregarded# partnership#agreements#in#div orce#cases .#The#typic al#

rationale#is#that#a#partner’s#withdrawal#rights#under#the#partnership#agreement#is#not#relevant#unl ess#

the#partners#actually#intends#to#withdraw;#instead,#it#i s#th e#community’s#interest#in#a n#ongo ing#business#

which#is#bein g#valued#in#a#marital #dis solution#action.#(See#In# re#Marriage#of#Fenton#(1982)#1 34#Cal.App.3d#

451.)#

8.# Dis counts#for #Inc ome#Tax#Consequences#

Income#tax#consequ ences#which#are#not#“immediate#and#specific”#are#not#considere d#w hen#valuing#

community#a ssets.#( In#re#Marriage#of#Fonstein#(1976)#17#Cal.3d#738.)#The#C alifornia#Suprem e#Court#

stated:#

Regardless#of #the#certainty#tha t#tax#liability#will#be# incurred#if#in#the#future#an# asset#is#sold,#l iquidated#or#

otherwise #reduced#to#cash, #the#trial#court#is#not #required#to#s peculate#on#or#consi der#such#tax#

consequence s#in#the#ab sen ce#of#proof#th at#a#taxable#event#has#occurred#durin g#the#marr iage#or#wil l#

occur#in#connect ion#with#the#division#of#the #comm unity#property.#[Cita tion.]#

(Id.#at# p.#748.#fn.#5.)#