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The Goodwill Value of a Law Firm

While conceding that there is “no definitive formula” for ascertaining a law firm’s goodwill, the Washington Court of Appeals acknowledges “the monetary value of a reputation”

Dixon v. Crawford, McGilliard, Peterson & Yelish, 2011 WL 4348058 (Wash. App. Div. 1)(Sept. 19, 2011)

Crawford, McGilliard, Peterson & Yelish is a small, general-service, Seattle-area law firm that was formed in 1980. For a quarter-century, the firm operated without a written partnership agreement, and the partners equally divided the firm’s profits. By the mid-2000s, more than half of the firm’s annual revenues were coming from public defense contracts with local jurisdictions.

In 2006, Crawford McGilliard suffered a significant loss when one of the five equity partners, Steve Dixon, left the firm, taking with him all of his public defense clients. Two years later a non-equity partner, Tim Kelly, also left. Claiming an equity interest in the firm, Kelly sued for an accounting and purchase of his interest. Concerned about potential liability in the event Kelly’s suit was successful, Dixon intervened in the suit. Kelly eventually dropped his claim, but Dixon continued his suit, asserting a right to a judicial buyout.

Lynton Kotzin  
 

Experts' Views of Goodwill

To establish the value of his one-fifth share in the firm, Dixon hired a valuation professional, who used the “capitalization of excess earnings” approach. Defining goodwill as the “difference between the firm’s earnings and the remaining partners’ collective ‘replacement values,’” the expert determined the value of Dixon’s 20% interest to be between $350,000 and $360,000. That figure included both the tangible and intangible (i.e., goodwill) values.

Meanwhile, the law firm presented three accounting experts to value the entire practice. One expert testified that, in his experience, law practices carried no goodwill value; however, the other two experts conceded that they do. All three of the firm’s experts agreed that, to the extent there is any goodwill value, the capitalization of excess earnings method used by Dixon’s expert was an appropriate approach. Two of the experts (the ones who conceded goodwill value) used substantially higher “replacement values” for the remaining partners than did Dixon’s expert, and they ultimately concluded that there was no goodwill value in this particular firm, leaving only the tangible assets, which all four experts agreed were worth between $36,000 and $48,000 for a one-fifth share.

The trial court found that the law firm was “highly respected” and had “enjoyed success as a preeminent public defense firm.” The court also held that (a) the firm had goodwill value and (b) the excess earnings method was the appropriate methodology. The court concluded that the firm’s value was $1.16 million and awarded Dixon $232,142 for his share, plus nearly $100,000 in statutory interest.

Appeal

The firm appealed the trial court’s decision, arguing that (a) there was no goodwill value, (b) the capitalization of excess earnings approach was proper only in matrimonial cases, and (c) the firm should be valued only as a going concern. The Washington Court of Appeals denied the firm’s appeal, ruling that the firm had failed to cite any “law, policy or disciplinary rule” that barred a dissociated partner from receiving his share of that value that constituted goodwill. As to the method for valuing goodwill, the court was influenced by the fact that three out of the parties’ four experts (including two of the firm’s experts) agreed that it applied in this case.

The firm also argued that, by including the earnings from its public defense practice, the trial court had essentially “forced” the sale of the firm’s contracts and treated its clients as “commodities.” The appellate court rejected that argument, too, finding that public defense contracts are no different for purposes of valuing firm goodwill than agreements to handle large litigation cases for employees, union members, or any other large class of clients.

“There is no definitive formula for ascertaining the value of goodwill,” the court noted, essentially defining goodwill as “the monetary value of a reputation.” In the absence of a partnership agreement that excluded a departing partner’s claims to goodwill, the court determined that the trial court’s ruling was logical and provided an “accurate reflection of the goodwill value of the firm as a whole.”

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