In 2014, I authored a post on this blog entitled Stern Revisited – Using the Shareholder Agreement to Determine Value. I noted then that it seemed that after the Appellate Division’s decision in Brown v. Brown which changed the landscape by doing away with discounts and essentially ushered in more of a value to the holder construct, that the consideration of an agreement was dead. Rather, a myopic view of methodologies focused on income seemed to be the norm – disregarding all else.
This was the case even though there was New Jersey Supreme Court case law (Stern v. Stern and Bowen v. Bowen to be precise ) that suggests the use of a “trustworthy” buy-sell agreement to establish value, noting that in some instances it may appropriately establish a presumptive value of a party’s interest. Often the issue is what is a “trustworthy” buy-sell agreement? What makes an agreement trustworthy? It is updated frequently and routinely used when people enter and exit a business. In my 2014 post, I blogged about the use of the buy-sell agreement in deciding the value of a medical practice where there had been 32 purchases or sales of interests in the practice in the recent past. In the case cited in that blog, the Appellate Division noted “We find no error in the judge’s considered decision that the practice’s regularly updated corporate agreements were a better measure of value than plaintiff’s expert’s projection of cash flows through 2020, discounted by a rate chosen on the basis of U.S. Treasury bonds, augmented by selected risk premiums and reduced by an assumed long-term growth rate.” Simply put, what the doctor would have received if he left the practice was used as the value. Unlike many valuation calculations, there was no subjectivity to that number. But this case was an unreported decision which means that it wasn’t precedential and there haven’t been many, if any, reported decision on the issue in some time.
That is, until August of 2017 when the Slutsky case was decided. In that case, the husband was a partner at a major New Jersey law firm. Though his income was substantial, he was not a rainmaker, and thus, worked on business generated by other attorneys at his firm. In valuing the husband’s interest in the firm, the big issue was whether there was goodwill to be added to the amount that the husband would have been due under the firm’s partnership agreement. The wife’s expert added goodwill; the husband’s expert did not. The trial judge sided with the wife’s expert finding it “”incredible” the firm had no goodwill value. ” The Appellate Division disagreed and reversed.
The Court noted that:
As Dugan instructs, the start of the examination of goodwill considers whether excess earnings exist. Dugan, supra, 92 N.J. at 439-40. This was a highly contested issue on which the experts used slightly different resources and offered greatly disparate opinions. Factual findings regarding this pivotal question were not provided.
Moreover, the court returned to Stern and the husband’s argument in that case regarding “the propriety of considering his earning capacity as being a separately identified and distinct item of property” and pointed out the passage in Stern that held as follows:
[A] person’s earning capacity, even where its development has been aided and enhanced by the other spouse, as is here the case, should not be recognized as a separate, particular item of property within the meaning of N.J.S.A. 2A:34-23. Potential earning capacity is doubtless a factor to be considered by a trial judge in determining what distribution will be “equitable” and it is even more obviously relevant upon the issue of alimony. But it should not be deemed property as such within the meaning of the statute.
Of note, in this case the Appellate Division framed the real issue as follows:
Here, a nuanced valuation methodology is required because defendant is an equity partner in a large firm, who generally is not responsible for originations, and who is bound by the firm policies and a shareholder agreement.
In this case, the Appellate Division found that the formula in the firm’s agreement actually captured good will. In addition, the court noted:
We believe the trial judge misunderstood Hoberman’s conclusion, as suggesting goodwill did not exist for the firm. Actually, Hoberman’s opinion asserted the TCA of each equity partner accounted for any goodwill. Further, plaintiff, who was not an originator but a worker in a highly specialized legal area, was actually paid what a similarly skilled lawyer would be paid. Thus, defendant’s compensation matched his earning capacity, nothing more. This view considered whether defendant’s “future earning capacity has been enhanced because reputation leads to probable future patronage from existing and potential clients” and concluded it did not. Accordingly, there was no additional component of goodwill. Id. at 433.
In this matter, any analysis of goodwill must evaluate the firm’s shareholder’s agreement to determine whether it is an appropriate measure of the total firm value, including goodwill. That formula computes an exiting partner’s interest, calculated as a portion of the firm’s excess earnings. See Levy, supra, 164 N.J. Super. at 534. The Court must discern the objectiveness and accuracy of the formula and calculations. When “it is established that the books of the firm are well kept and that the value of partners’ interests are in fact periodically and carefully reviewed, then the presumption to which we have referred should be subject to effective attack only upon the submission of clear and convincing proofs.” Stern, supra, 66 N.J. at 347.
The take away here is that Stern lives now for the same reasons that that it was originally decided. If a regularly updated and followed agreement was disregarded, the titled spouse would be stuck getting only what the agreement allows, which the other spouse could wind up with a lot more, or less, if valuation methodologies with subjective components are used. On the other hand, say that there are two similarly situated law firm partners with a similar book of business and making similar money, but one worked at a large firm with a regularly updated and followed shareholders agreement and the other at a smaller firm without a formal agreement, it seems like a safe bet that the values of their practices would be extremely different. One other question to ponder. Would the result have been different if the husband here was a major rainmaker? Perhaps that will be addressed in a future case.
Eric Solotoff is the editor of the New Jersey Family Legal Blog and the Co-Chair of the Family Law Practice Group of Fox Rothschild LLP. Certified by the Supreme Court of New Jersey as a Matrimonial Lawyer and a Fellow of the American Academy of Matrimonial Attorneys, Eric is resident in Fox Rothschild’s Morristown, New Jersey office though he practices throughout New Jersey. You can reach Eric at (973)994-7501, or firstname.lastname@example.org.