Molloy v. Molloy, 2

• Decision Date: 22 March 1988
• Docket Number: CA-CIV,No. 2,2
• Citation: 761 P.2d 138,158 Ariz. 64
• Parties: In re the Marriage of John F. MOLLOY, Petitioner-Appellee, v. E. Josephine MOLLOY, Respondent-Appellant. 5916.
• Court: Arizona Court of Appeals

Page 138

761 P.2d 138

158 Ariz. 64

In re the Marriage of John F. MOLLOY, Petitioner-Appellee, v. E. Josephine MOLLOY, Respondent-Appellant.

No. 2 CA-CIV 5916.

Court of Appeals of Arizona,

Division 1, Department A.

March 22, 1988.

Reconsideration Denied May 4, 1988.

Review Denied Sept. 20, 1988.

Mesch, Clark & Rothschild, P.C. by J. Emery Barker, Tucson, for petitioner-appellee.

[158 Ariz. 65] O'Connor, Cavanagh, Anderson, Westover, Killingsworth & Beshears by Philip C. Gerard and Larry L. Smith, Phoenix, for respondent-appellant.

OPINION

FIDEL, Judge.

A wife appeals from a decree of marital dissolution, arguing that the trial court inappropriately restricted her effort to present expert testimony evaluating the marital community's interest in her husband's law firm. We conclude that the wife is correct. In doing so we hold that a shareholder's interest in his law firm's goodwill is an asset subject to expert evaluation and inclusion in the marital community estate for purposes of equitable distribution.

John F. Molloy (Husband) petitioned for divorce in 1984. His wife, E. Josephine Molloy (Wife), moved pursuant to A.R.S. § 25-324 that the court allocate community funds in advance of trial for payment of expert appraisers' fees to appraise Husband's law practice, a community asset. ¹ Wife requested "a reasonable amount not less than $10,000" for that purpose. Husband responded that the value of the community's interest in his law firm was conclusively established by the stock redemption and deferred compensation agreements among shareholders in the firm, and he moved in limine that the trial court prohibit Wife "from presenting any evidence of a 'going business value,' 'goodwill value' or any other value not strictly provided for by the terms and conditions of [those] agreements...."

The trial court granted Husband's motion and prohibited Wife "from presenting any evidence of a value of [Husband's] interest in said corporation other than as can be determined from existing agreements between [Husband] and the corporation." The court permitted Wife the opportunity, however, to challenge "any inconsistency or irregularity in the determination of a 'value increment' as defined in the Stock Redemption Agreement which may have occurred by reason of the existence of this action."

The parties proceeded to trial. The court ultimately accepted Husband's estimates of $25,000 as the present value of his deferred compensation plan and $10,000 as the present value of his law firm stock pursuant to the stock redemption plan. Wife did not use the leeway extended by the court to claim "inconsistency or irregularity [in Husband's stock evaluation] ... by reason of the existence of this action." That is, she did not then claim (and does not now claim) that Husband and his law firm manipulated the law firm's agreements to undervalue Husband's interest as reflected within them in order to advance his position in this case. Wife was precluded, however, from introducing expert testimony to the effect that the actual value of Husband's law practice, including goodwill, exceeded that derived from examination of the firm's agreements alone.

A decree of dissolution was entered on October 30, 1985, and amended on July 21, 1986. Husband was awarded his law firm stock and deferred compensation plan at the values indicated above. The sole basis for Wife's appeal is her claim that she should have been permitted to present evidence of greater value. The court undervalued Husband's law practice, she argues, and thereby undervalued the total community property to be equitably divided between the parties.

Despite some overlap, we glean three separate arguments by the Husband for upholding the decree: (1) because law firms possess unique attributes, their goodwill, unlike the goodwill of other forms of professional associations, is not subject to expert evaluation as an asset of the marital estate; (2) even if Husband has a cognizable interest in his law firm's goodwill, its valuation is controlled by firm agreements (i.e., the deferred compensation plan and stock redemption plan); (3) appellate review of the trial court's ruling in limine is precluded by Wife's failure to make an offer of proof at trial.

Law Firm Goodwill

In Mitchell v. Mitchell, 152 Ariz. 317, 732 P.2d 208 (1987), our supreme court considered the evaluation of community property rights in the goodwill value of an accounting firm. It held that the trial court was not bound in evaluating the community's interest by the firm's termination buy out provisions or by the specification among those provisions that no value be placed on firm goodwill. The court recognized the goodwill of a spouse's professional practice as a community asset to be evaluated for the purpose of equitable distribution upon marital dissolution. Id. at 321, 732 P.2d at 212.

Wife invokes Mitchell; Husband argues that it does not apply. A law firm, he points out, is ethically proscribed from selling its goodwill. See, e.g., Geffen v. Moss, 53 Cal.App.3d 215, 125 Cal.Rptr. 687, 79 A.L.R.3d 1232 (1975); Drinker, Legal Ethics, pp. 161, 189, Columbia Univ. Press (1965). Nor may it extract binding covenants not to compete from its members. E.R. 5.6, Rules of Professional Conduct, Rule 42, Rules of the Supreme Court. These restrictions, he suggests, distinguish law firms from other professional organizations and render the evaluation of a law firm's goodwill inappropriate.

The supreme court characterized the Mitchell issue broadly: "Is Goodwill of a Professional Partnership a Community Property Asset?" 152 Ariz. at 319, 732 P.2d at 210. It expressly rejected an argument "that a partner's goodwill is a personal, non-divisible asset because it is not readily marketable." 152 Ariz. at 320, 732 P.2d at 211. In so doing, it held as follows:

[B]ecause the professional practice of the sole practitioner or partner will continue after dissolution of the marriage, with the same goodwill as it had during the marriage, we find that a refusal to consider goodwill as a community asset does not comport with Arizona's statutory equitable distribution scheme. We prefer to accept the economic reality that the goodwill of a professional practice has value, and it should be treated as property upon dissolution of the community, regardless of the form of business. Wisner v. Wisner, [129 Ariz. 333, 631 P.2d 115 (App.1981) ] (corporation); In re Marriage of Fonstein, [17 Cal.3d 738, 131 Cal.Rptr. 873, 552 P.2d 1169 (1976) ] (partnership); In re Marriage of Watts, 171 Cal.App.3d 366, 217 Cal.Rptr. 301 (1985) (partnership); In re Marriage of Fenton, 134 Cal.App.3d 451, 184 Cal.Rptr. 597 (1982) (corporation); In re Marriage of Slater, [100 Cal.App.3d 241, 160 Cal.Rptr. 686 (1979) ] (partnership); In re Marriage of Foster, 42 Cal.App.3d 577, 117 Cal.Rptr. 49 (1974) (sole practice); In re Marriage of Lopez, [38 Cal.App.3d 93, 113 Cal.Rptr. 58 (1974) ] (partnership); Golden v. Golden, [270 Cal.App.2d 401, 75 Cal.Rptr. 735 (1969) ] (sole practice); In re Marriage of Hull, 712 P.2d 1317 (Mont.1986) (professional corporation); Lockwood v. Lockwood, 205 Neb. 818, 290 N.W.2d 636 (1980) (partnership); Dugan v. Dugan, 92 N.J. 423, 457 A.2d 1 (1983) (solely owned professional corporation); In re Marriage of Hall, 103 Wash.2d 236, 692 P.2d 175 (1984) (professional corporation); Matter of Marriage of Fleege, 91 Wash.2d 324, 588 P.2d 1136 (1979) (sole practice); Marriage of Lukens, [16 Wash.App. 481, 558 P.2d 279 (1976) ] (sole practice).

152 Ariz. at 321, 732 P.2d at 212.

The Mitchell court focused not on marketability or transferability of a professional's goodwill but, rather, on the value of that asset to the professional himself as an ongoing member of his profession. We have included in our quotation the long chain of cases invoked by the court to support this approach, because four among them--In re Marriage of Fonstein, In re Marriage of Fenton, In re Marriage of Lopez, and Dugan v. Dugan--involved a lawyer's goodwill. Indeed, in Dugan the Supreme Court of New Jersey expressly held that "inability to sell a law practice does not eliminate existence of goodwill and its value as an asset to be considered in equitable distribution." 92 N.J. at 434, 457 A.2d at 6. By its selection of supporting cases, our supreme court demonstrated an intent that its holding apply to a range of professions including lawyers. (Other professions represented among the cited cases are physicians, dentists, and C.P.A.'s.) Thus, from Mitchell we derive the holding that lawyers, like other professionals, face evaluation of their professional goodwill as a community asset upon marital dissolution.

As a caveat to this holding, we emphasize that a distinction lies between future earning capacity and goodwill. As stated by the Supreme Court of New Jersey,

Future earning capacity per se is not goodwill. However, when that future earning capacity has been enhanced because reputation leads to probable future patronage from existing and potential clients, goodwill may exist and have value. When that occurs, the resulting goodwill is properly subject to equitable distribution.

Dugan, 92 N.J. at 433, 457 A.2d at 6.

Impact of Firm Agreements

We next address Husband's contention that, even if his share of his law firm's goodwill is a community asset subject to evaluation, his law firm shareholder agreements establish a preclusive measure of his law firm interest, including goodwill, and render unacceptable and inadmissible any effort to evaluate that interest by independent measure.

Husband points out that goodwill is, in fact, an element of consideration in his firm's deferred compensation plan, to the extent permitted by the Rules of Professional Conduct. E.R. 5.6, Rules of Professional Conduct, Rule 42, Rules of the Supreme Court, provides in part:

A lawyer shall not participate in offering or making:

(a) a partnership or employment agreement that...