The Terms of a Partnership Agreement may Limit the Community’s Interest in the Goodwill of the Company

A partnership agreement, which does not provide a partner an interest in the firm’s goodwill, may limit a spouse’s partnership interest to the value of that person’s capital account.

In Iredale, Wife was a partner in a large law firm and at trial the divorce court valued the community portion of Wife's partnership interest at $238,347.  This value was determined by adding the value of her capital account with the firm to Wife’s personal goodwill of $42,318.  None of the firm’s goodwill was assigned to the community.

Wife testified in the divorce trial that she held .00781 interest in the firm and was not involved in firm management.  When she became a partner, she was not required to buy into the firm's accounts receivable, work in progress, or goodwill. Wife’s expert testified that Wife’s law practice interest contained no portion of the firm’s goodwill and the value of her interest in the firm should be measured by her capital account, approximately $183,000, because pursuant to the partnership agreement, individual partners did not own any of the accounts receivable, work in progress, or goodwill of the firm. Furthermore, Wife’s expert concluded that Wife had received reasonable compensation for her services when compared to her peers, and that she was not receiving excess compensation, therefore the value of her goodwill in the firm was zero.

Husband's expert valued Wife's partnership interest at $813,000 which included $330,000 for Wife’s interest in the goodwill of the firm.  To arrive at these figures, Husband’s expert analyzed the firm as a whole and appraised the entire firm's tangible and intangible assets and then multiplied those figures by Wife's percentage interest. On cross-examination, Husband’s expert acknowledged that the firm had existed for many years as an established national law firm before Wife became a partner, and thus the firm already possessed substantial goodwill.

The divorce court assigned none of the firm’s goodwill to Wife, capped Wife’s interest in the firm to the value of her capital account, and valued the community interest in Wife’s personal goodwill at $42,318. Husband appealed.

The Second District Court of Appeal affirmed the divorce court’s ruling, holding that the circumstances of each case, and each professional practice, will vary and call for different methods of valuation. Here Wife's interest in the law firm partnership was limited by the partnership agreement to the value of her capital account and did not include accounts receivable, work in progress, or goodwill. The court reasoned that because Wife did not buy or otherwise acquire an interest in the accounts receivable, work-in-process, or goodwill of the law firm under the Partnership Agreement, and on termination she would not receive any share of firm's goodwill, the goodwill was not a community asset to be valued or divided.

In re Marriage of Iredale & Cates (2004) 121 Cal. App. 4th 321