McReath Decision Leaves Some Questions Answered
July 25, 2011
On July 12, the Wisconsin Supreme Court issued its opinion in McReath v. McReath, involving the challenging issues of salable goodwill and double-counting of property and income.
In a case involving important issues, how did the court do?
Overall, pretty well. But, fortunately for someone (like me) who likes to critique their decisions and unfortunately for future divorcing parties and their attorneys (also me), they left some significant questions which may cause difficulties ahead.
McReath involved a review of the published opinion of the Court of Appeals affirming the circuit court’s order that Tim pay Tracy $796,720 to equalize the property division upon the couple’s divorce, as well as $16,000 per month for 20 years in maintenance.
For reasons not explained by the circuit court or Court of Appeals and totally ignored by the Supreme Court, there was no child support order, despite the existence of two minor children. Go figure.
The first question presented was whether the entire value of the salable professional goodwill of Tim’s interest in Orthodontic Specialists could be counted as divisible property in the marital estate.
On this issue, the Supreme Court held that a circuit court shall include salable professional goodwill in the divisible marital estate when the business interest to which the goodwill is attendant is an asset subject to Wis. Stats. §767.61.
The second question presented was whether the circuit court double-counted the value of Tim’s professional goodwill by basing Tracy’s maintenance award on Tim’s expected future earnings when the future earnings would arise from Orthodontic Specialists.
Here, the Supreme Court concluded that the salable professional goodwill in Orthodontic Specialists was similar to an asset that produces income.
Consequently, the circuit court did not double-count Orthodontic Specialists’ professional goodwill and, therefore, did not erroneously exercise its discretion when it awarded Tracy maintenance from the income produced by the practice while, at the same time, including the value of the practice (a value derived from its earnings) in the marital estate.
Accordingly, the Supreme Court affirmed the decision of the Court of Appeals. So much for the holdings. Now the analysis.
A Cavalier Approach
The portion regarding saleable goodwill makes a great deal of sense and is consistent with the trend in Wisconsin law for many years. See Gregg Herman, “The Slow Death of Holbrook,” 11 W.J.F.L. 1 (January, 1991).
There is no reason a professional business should be treated differently than any other asset – if it is salable, it is included in the marital estate.
What differentiates professional practices from other assets is what is being sold. Other than desks and chairs (and maybe accounts receivable and work in progress), the only real value is the ability of the practice to generate income. When support is an issue, it usually arises from the same income that comprises part of, or all of, the value of the business.
Therein lies the rub. Wisconsin courts have long recognized that it is fundamentally unfair to double-count the same item for property and for spousal support.
Double-counting is a very complex issue and is not always easy to determine. Whether it exists at all and to what extent depend on the entity involved. As a result, in my articles after the Supreme Court accepted review in McReath, I recommended that the Supreme Court not make any black letter law, but rather allow trial courts discretion to make orders that they find to be fair in each individual circumstance.
Not for the first time (or, I’m sure, the last), the Supreme Court has ignored this advice and found that the trial court did not violate any rule against double-counting. Here is part of their reasoning:
“… If Tim so chose, at the time of the property division, he could have sold Orthodontic Specialists and realized this value. Or, he could retain Orthodontic Specialists, earn income from it and sell it at a later time. Consequently, Tim has the option of continuing to generate substantial income from Orthodontic Specialists without diminishing its value.”
How many times as divorce lawyers have we heard from business owners some version of the following:
“Rather than paying her half of the business and then maintenance from my income, I’ll just sell the business, split the proceeds with her, and then I won’t have to pay maintenance as I won’t have any income.”
Good divorce lawyers discourage this strategy, as the courts would merely impute income to the owner, finding the sale to be manipulative and maybe dissipation.
Would the same answer be given if the business included a portion for personal goodwill and maintenance was ordered? Or, could the argument be made that the only way including the value of the business for property division and the income derived from the business for maintenance was not double dipping would be if the owner really had this option?
In addition, the Supreme Court gave little consideration to the complicated, yet critical issue of a non-compete clause. Would anyone pay full price for Dr. McReath’s practice if he could open up across the street the next day? Highly unlikely.
Yet, the value of a non-compete does not always accurately reflect the value of the professional’s services as it can be negotiated for tax and other reasons.
Further, a non-compete has additional complications in family law. To be effective, a non-compete has to be limited by geography and time.
It is difficult enough to say to a professional: “Hey, you can get a job outside the geographical restrictions, earn income available for support and there will be no double-counting problem.” Where there are minor children involved, it is far more difficult to relocate if the professional would like to have a meaningful relationship with them.
How does the Supreme Court deal with these difficulties? It doesn’t. It simply ignores them.
Ignoring the importance of a non-compete when dealing with the sale of a professional practice is not realistic. It is difficult to believe that the Supreme Court intends to allow professionals to sell their practices to avoid support obligations. To use language suggesting that there is no double-counting only when the professional has the option of selling the business is problematic.
The basic holding of McReath — that saleable professional goodwill is divisible property — clarifies an important area of family law.
However, by treating the issue of double-counting cavalierly, the court has created potential significant issues in the future.
This article originally appeared in the Wisconsin Law Journal.