restaurant-240Brave v. Brave, 2013 Ark. App. LEXIS 570 (Oct. 2, 2013)

For over 25 years, Arkansas courts recognized a tight “professional license goodwill” exception in divorce cases. It applied primarily in cases involving professional partnerships such as medical and dental offices and treated the professional spouse’s personal goodwill as his or her separate property for the purpose of dividing marital property. But a recent appeal in which the co-owner and chef of a successful restaurant claimed that the business’s goodwill was personal to him and, therefore, nonmarital property sought to expand the scope of the exception.

Conflicting goodwill testimony

After marriage, the husband and wife opened a restaurant, in which both were 50% shareholders. They had equal legal power to make decisions, cut checks, and run the business. The husband was a trained chef and created and executed the menu, whereas the wife handled the “front end” of the business. She was responsible for staffing, dealing with financial matters, and holding the establishment’s liquor license. She received a salary from the restaurant, but over the next 10 years her involvement diminished and she worked there sporadically. The restaurant achieved great success.

At trial, the spouses presented two “nationally-certified business appraiser experts” who valued the restaurant using various methods, including the income approach. (The opinion provides no further details about their testimony.) In addition, the husband offered testimony from a business consultant who was “admittedly not a business valuation expert,” but an employee of the restaurant in charge of accounting and payroll. He professed to use the income approach “to value the goodwill associated with [the couple’s] business.” He said he based his calculation on the restaurant’s value as an ongoing business with a replacement chef for the husband. He determined the business was worth slightly more than $819,000 and stated it had no equity without goodwill.

He admitted he could not determine whether the goodwill was corporate or personal. At the same time, he maintained the husband was the business. “The whole business is his personality.” He described the restaurant as “a unique operation in a hard-to-find location” and the husband as irreplaceable. On direct examination, he said that stating a replacement value “was my most difficult decision to make, what number do you plug in there to replace [the husband].” Yet, on cross-examination, he agreed that the restaurant would not suffer if the husband were absent for “two weeks”; he subsequently increased the period to two months. When asked what would happen to the goodwill if the husband were gone for two years, he said “goodwill is something that is an intangible asset and it depreciates over time.” Buyers look at the goodwill number and know “they can’t maintain that necessarily over a period of time,” he added.

The record also showed that the husband had trained other employees to manage the kitchen and “mimic everything wonderfully,” which allowed him to vacation for weeks at a time.

The trial court found that the real estate of the business entity was worth $495,000, and the restaurant’s value—including furniture, fixtures, goodwill, and equipment—was $895,000. Deducting debt of $550,000, the court found the business had a net value of $840,000, including real property. The wife’s one-half interest in the restaurant was worth $420,000, it declared. The court did not expressly mention the opinions of the business appraiser experts in its order or divorce decree.

As to goodwill, the court considered the opinion of the business consultant, acknowledging that the loss of the husband to the business would be “very, very damaging.” It noted that the husband “has built up goodwill” and that, if he were to leave the business, “it would not be the same.” But the court concluded that, as long as the restaurant still had its name, “was still there,” and “still had the menu, people would come for a while.”

In a subsequent hearing on the husband’s post-trial motion for additional findings, the trial court found the restaurant had corporate goodwill that was marital property. It considered the valuation testimony he had offered “not helpful … to the [personal] goodwill argument.” Even though the court understood the husband’s argument that some of the goodwill “might be personal,” it said it had no “way to allocate it.”

An ‘essential’ ingredient to success

The husband appealed the order to pay the wife $420,000 to the Arkansas Court of Appeals. The principal argument was that the trial court erred when it failed to recognize that the restaurant’s goodwill was personal to him and thus was nonmarital property.

On review, the Court of Appeals noted that goodwill was marital property only if it belonged to the business and was not dependent on the presence or reputation of a particular individual. “Any value that attaches to the entity solely as a result of personal goodwill represents nothing more than probable future earnings capacity, which … is not a proper consideration in dividing marital property in a divorce proceeding.”

Until now state courts had not recognized personal goodwill in a nonprofessional business, the appellate court pointed out. However, “under the unique facts of this particular case, we are extending the concept to [the restaurant] because [the husband’s] presence is essential to the success of the restaurant.” According to the appellate court, the trial court itself had recognized that there was personal goodwill in the restaurant and also had acknowledged that the restaurant’s success was in large part due to the husband’s hard work. The trial court simply stated it had no basis on which to allocate how much of the goodwill was personal and how much was corporate. Finding that the trial court had erred, the appellate court remanded, ordering it to perform the very allocation it earlier had been unable to make.

Dissent wonders about ‘utility’ of remand

The opinion triggered two strong dissenting opinions. Both judges agreed that the majority was mistaken when it expanded the scope of the “professional license goodwill” exception to include other commercial enterprises. “What does ‘under the unique facts of this particular case’ mean?” one of the dissenting judges asked. Under existing law, the exception never applied beyond a licensed professional practice, specifically a medical or dental practice. But, considering the majority’s language, the exception now could easily reach ‘”every small business with a key man.”

The second dissenting judge noted the contradictions in the testimony the business consultant gave. He was not a business valuation expert but a tax advisor, the dissent pointed out. It also said that the majority practiced “selective reliance” on his testimony. It emphasized that the majority failed to take proper note of his statement that his computation rested on the restaurant’s value with a replacement chef for the husband. The majority also did not mention the witness’s changing testimony about how long the husband could be absent before the restaurant would suffer. “A main aspect of personal goodwill associated with a business, however, is that the personal goodwill is not saleable and the business cannot survive if the so-called key person is cleaved from it.” Here, the witness’s own testimony “directly undermined” the husband’s personal-goodwill argument, the dissent found. Finally, it wondered about “the utility and fairness” of requiring the lower court to determine what part of the restaurant’s value was personal goodwill. “How is the circuit court to do now what it could not do before?” the dissent asked.