Divorce And Agency Value: Separating Goodwill

DIVORCE AND AGENCY VALUE: SEPARATING GOODWILL

In my agency valuation work with agents and their spouses in divorce cases over the past 15 years, the issue of professional goodwill has often arisen.

When a couple divorces, they seek to divide their community interest between them. All assets and liabilities must be assessed to enable the court to make an equitable division of property. If one of the spouses is an insurance agent, his or her book of business thus becomes subject to valuation, and such intangible property often depends a great deal on professional goodwill.

In my opinion, there are two types of goodwill in every insurance agency. The first is

intrinsic goodwill. Simply stated, this is the continuation of the client base even after the owner has departed because of death, disability, or retirement. It takes into account the ability of the agency to retain clients through very little effort of the owner.

Elements of this goodwill include the service of tenured staff, insurance companies (including their products and prices), location, history of the agency in the community, and other factors. These elements are not based factors that are separate from the clients' dependence on the agents' expertise, reputation, contacts, and special relationships.

A doctor's clinic serves as a good analogy. If a sole-practitioner physician dies, becomes disabled, or retires, intrinsic and professional goodwill both come to an end. If another physician acquires the practice, the clinic might retain some patients from the previous doctor. These patients retain the new doctor because of past good experiences, friendly nurse and staff, location, and the clinic's long history in the community. This is intrinsic goodwill.

The new doctor, if experienced, may bring professional goodwill of his or her own. That is, the new doctor may keep some patients and attract new ones with skill and personal qualities.

In divorce cases involving a professional person, Texas courts have tended not to grant the spouse an interest in professional goodwill. In one case, the court held that the goodwill of a professional person may be as much an asset to be sold as that of a merchant. The professional person is seen to have individual goodwill that can't be detached from his or her person, and thus can't become a part of the community property.

Take the landmark case Rathmell v. Rathmell, for instance. In 1975, agent John Rathmell, and his non-agent spouse divorced. After a settlement, which divided the agency's value between the parties, the spouse appealed, alleging that disclosure of the agency's value had been improper. Attorneys filed a Bill of Review asking the Court of Appeals to correct the inequity.

Although a number of issues were involved, the Court of Appeals made an important decision concerning the division of professional goodwill. It determined that the sale and service of insurance accounts, which primarily exist in an intangible form, was based on the professional goodwill of the individual agent. What's more, the agent had the opportunity to compete for the business without the prohibitive contractual considerations that might exist in an employment contract.

The court essentially decided that the trial court had erred in not assessing this type of goodwill and attributing such value to the agent. The Court found that the appellant, the insurance agent John Rathmell, had developed professional goodwill even though he was not a lawyer or a doctor. It went on to state that the value of the Rathmell companies should have excluded the value attributable to the time, toil, and talent Rathmell expended after the divorce and/or his willingness not to compete with the agency. (It's important to note that Rathmell served without an employment contract, and was not obligated to refrain from competing for the corporation's business. In addition, there was no buy-sell agreement that established the valuation method to be employed in transfer of the firm.)

In this case and others, the court established a doctrine of non-divisibility of professional goodwill. It's obvious that this issue has many facets. For instance, sometimes both spouses work in the agency, and have achieved a loyal following through their individual and collective goodwill.

Another landmark case in Texas arose from the divorce proceedings of a physician (Nail v. Nail). The court held that the 'accrued goodwill of his medical practice did not constitute property subject of the division upon divorce as part of the estate of the husband and wife.' The opinion continued, 'Professional goodwill has the following attributes: It attaches to the person of the professional man or woman as a result of confidence in his or her skill or ability. It does not possess value as an asset separate and apart from the professional's person or from his individual ability to practice his profession. It would extinguish in the event of the professional's death, retirement, or disability.'

Frequently, I'm the only consultant making the appraisal. This is common, as it is in mediation action directed by the court. This can save significant amounts of time, money, and (maybe most important) grief.

It's also important to add that both parties often disagree on their own vested interest in this issue of professional goodwill. As a result, there has been a movement to change the law. A spouse contended to the Court of Appeals that the Nail v. Nail case law was wrongfully decided. The Court of Appeals basically responded, 'Appeal it to the Texas Supreme Court, and let them grant a writ of error and change the law.'

The Supremes refused to do so. In December 1993, the Texas Supreme Court denied a writ of error in Guzman v. Guzman, and let the issue of non-divisibility stand. They concluded, 'Two Texas Courts of Appeals have recognized that a professional person practicing with others under a corporate structure or as a partnership may have accrued personal professional goodwill, and that there might exist at the same time goodwill attributable to the business or partnership-but goodwill that exists separate and apart from a professional's personal skills, abilities, and reputation is divisible under divorce.'

Where does this leave a consultant attempting to determine an agency's value? The court has made it clear that if the aforementioned conditions exist, the personal professional goodwill must be allocated a value. If not, the findings of value are offensive to Texas law.

Let's use an example. An agency is a corporate entity, and the agent is the firm's sole shareholder. The contending spouse has been active in the firm to a minor extent in primarily clerical work, but not to the extent of having created personal professional relationships with insureds or markets. The agent and spouse begin the divorce process, which requires evaluation of the business to determine the community interest to be divided.

The value components to be considered in determining the agent's professional goodwill might include:

1. the number of major accounts produced by the professional
2. the revenue of such accounts in relation to the agency's gross commission revenues
3. the tenure of such accounts in the agency
4. the accounts' tenure with the carrier insuring them
5. the loss history of such accounts
6. the accounts' payment history
7. the personal relationships that the agent enjoys with the decision-makers in the insured firms

Questions affecting professional goodwill might include:

1. Did the agent originate the agency?
2. How much personal supervision does the agent provide on major accounts?
3. Does the agent have significant relationships with the major carriers providing products and services to the agency?
4. Does the agent have important contacts with community members (participation in clubs, networks, and social or civic organizations), which provide exposure that leads to business relationships for the agency?
5. Does the agent have a covenant not to compete in the event that he or she leaves the firm?

These are not the only considerations to be investigated by the evaluation consultant, but in my opinion, they're the benchmarks from which to determine that elusive value: personal professional goodwill.