If you or your spouse owns a law practice or has an ownership interest in a law firm, that interest may be one of the most valuable assets involved in your divorce. But determining what it's worth can be complicated.
A lawyer's interest in a practice isn't limited to the money sitting in a business bank account. Depending upon the circumstances, its value may include capital accounts, accounts receivable, work in progress, tangible assets, partnership interests, and even professional goodwill.
And New Jersey has specifically addressed these issues in divorce cases involving lawyers.
Is a Law Practice Marital Property?
A lawyer's ownership interest in a law practice or law firm may be subject to equitable distribution if it was acquired during the marriage. That doesn't mean the non-lawyer spouse becomes a partner in the law firm. It means the economic value of the lawyer's interest may need to be identified, valued, and considered when the marital estate is divided.
New Jersey uses equitable distribution, which means marital property is divided fairly based upon the circumstances of the marriage and the factors established by law. The difficult part with a law practice is often determining exactly what the lawyer owns and what that interest is worth.
How Do You Value a Law Practice?
There isn't necessarily one number you can pull from the firm's tax return and call the value. New Jersey courts have recognized that the value of an interest in a professional law practice may include several components.
Depending upon the structure of the firm, those can include:
- Capital accounts
- Accounts receivable
- Work in progress
- Tangible business assets
- Business liabilities
- Partnership or shareholder interests
- Professional goodwill
If the lawyer is a partner or shareholder in a larger firm, the partnership or shareholder agreement may also become extremely important.
For a significant practice, a business valuation or forensic accounting professional may be needed to determine the value of the lawyer's interest.
What Is Professional Goodwill?
Goodwill is one of the most interesting parts of valuing a law practice. It isn't a desk, computer, bank account, or piece of real estate. It's intangible.
Think about a lawyer who has spent years developing a reputation, building relationships, generating referrals, attracting repeat clients, and establishing a successful practice. That reputation may give the practice an economic value beyond its tangible assets.
New Jersey has recognized that professional goodwill in a law practice can be property subject to equitable distribution. But that doesn't mean every successful lawyer automatically has a huge goodwill asset. Goodwill has to actually exist, and its value has to be supported.
Isn't Goodwill Just the Lawyer's Future Income?
No, and this distinction is important. A lawyer's future earning capacity by itself isn't a marital asset that can simply be assigned a value and divided. Goodwill is different.
New Jersey courts have distinguished between the possibility that someone will earn money in the future and the existing economic value created by an established professional reputation that is likely to generate future business.
That distinction can become extremely important when experts are valuing a professional practice.
What If the Lawyer Is a Partner in a Firm?
Then I'd want to see the partnership agreement. The same applies to a shareholder agreement or other document governing the lawyer's ownership interest. These agreements may contain provisions addressing what happens to a lawyer's interest upon retirement, withdrawal, disability, or death.
They may also address capital accounts and other payments owed to a departing lawyer. Those provisions can provide important evidence about what the ownership interest is worth.
But don't automatically assume that whatever number appears in the partnership agreement conclusively establishes the value for divorce purposes. The agreement, the firm's financial records, and the particular facts still need to be examined carefully.
What About Accounts Receivable and Work in Progress?
These can also matter. A law firm may have performed substantial work for clients but not yet collected payment. Depending upon the firm's billing arrangements and accounting practices, there may also be work in progress that has economic value.
New Jersey's Supreme Court has specifically recognized accounts receivable and work in progress among the components that can be considered when determining the monetary worth of a professional partnership interest.
Again, we're not necessarily dividing individual client bills between divorcing spouses. We're determining the value of the lawyer's ownership interest in the practice.
Does the Other Spouse Get Part of the Law Firm?
Usually, that's not what equitable distribution means in practical terms. The non-lawyer spouse isn't simply handed part of the law practice and made a partner.
Instead, the lawyer may retain the practice while the economic value of the other spouse's equitable-distribution interest is addressed through the overall property settlement.
That might involve cash, investment accounts, retirement assets, equity in the marital home, payments over time, or another combination of marital assets. The goal is to account for the value without unnecessarily disrupting the ongoing law practice.
What If the Lawyer Owned the Practice Before the Marriage?
Then the analysis can become more complicated. The fact that the lawyer owned the practice before marriage may be important when determining what is subject to equitable distribution.
But that doesn't necessarily end the inquiry. We may need to examine what happened to the practice during the marriage, whether its value changed, what generated that change, and what contributions were made during the marriage.
A practice that existed before a 25-year marriage may look very different at the time of divorce. That's why the history of the practice and reliable financial records can matter.
Be Careful About Double Counting
A successful lawyer's income may also be relevant to alimony or support. At the same time, the lawyer's ownership interest in the firm may be an asset subject to equitable distribution.
Those are separate issues, but the financial analysis has to be handled carefully.
You don't want the same stream of economic value improperly counted once when valuing the practice and then again for another purpose without considering the overlap. This is one of the reasons professional-practice divorces can require sophisticated financial analysis.
What Records Should You Gather?
If a law practice or law-firm interest is going to be a significant issue, the relevant documents may include:
- Partnership or shareholder agreements
- Business tax returns
- Profit-and-loss statements
- Balance sheets
- Capital account statements
- Accounts receivable reports
- Work-in-progress reports
- Compensation records
- Retirement or withdrawal provisions
- Buyout provisions
- Prior valuations
- Business debt information
- Other documents describing the lawyer's ownership interest
The exact documents will depend upon whether you're dealing with a solo practice, small partnership, professional corporation, or equity interest in a larger firm.
Don't Assume the Practice Is Worth Nothing
I've seen people make this mistake with professional practices. The lawyer may say: "It's just me." "My clients can leave whenever they want." "I can't sell myself." "The firm owns everything." Or: "My partnership agreement says my interest is only worth X."
Maybe. But those statements don't necessarily answer the equitable-distribution question. New Jersey courts have been dealing with the valuation of lawyers' professional interests for decades.
The right approach is to determine exactly what the lawyer owns, what economic benefits are attached to that interest, whether goodwill exists, and what reliable evidence supports the valuation. If a law practice represents a significant portion of your marital estate, getting that number right can make a substantial difference in the overall financial settlement.
If you're preparing for divorce and want to understand property division, professional practices, and the other financial decisions ahead of you, my free Divorce Smarter Course will walk you through the major issues involved in a New Jersey divorce.
Until next time,
Steve