Brave v. Brave, 2014 Ark. LEXIS 232 (April 17, 2014)

What a difference a court makes! A divorce case involving a successful restaurant made news several months ago when the state Court of Appeals extended the scope of personal goodwill to businesses other than professional partnerships, requiring the trial court to exclude the value of the husband’s personal goodwill from its calculation. To block a revaluation, the wife appealed to the state’s highest court, which reviewed the trial court’s determination as if the appeal had been filed with it in the first case.

EBITDA valuation. At divorce, the husband and wife vigorously contested the value of their successful restaurant. Both were 50% shareholders, but in the course of the marriage the husband, as the chef and creator of the menu, had come to play the greater role in its day-to-day operations. At trial, the spouses presented two “nationally certified business appraiser experts” who valued the restaurant using various methods, including the income approach, but their testimony proved inconsequential to the trial court’s valuation. Instead, the court looked to a valuation the husband’s business consultant, who was not an accountant or financial expert, offered. He said he did an “EBITDA valuation of the business” and determined the restaurant was worth slightly more than $819,000. When asked how much of it was goodwill, he replied “[t]he goodwill part is the value of the business.” This value excluded fixtures, furniture, equipment, or anything in it, all of which had a fair market value of over $82,000. At the same time, he also included a $120,000 value in his calculation; he said it represented the value for a new owner to replace the husband.

The trial court ultimately found the testimony “not helpful … to the argument that we should recognize personal goodwill.” But, it said, unlike most testimony in divorce cases that was developed solely for the purpose of litigation, this opinion tried to get at what the business would sell for. “The person that comes in to say this is my belief based on my assessment of what this would sell for in the open market. So that was good testimony.” The trial court valued the real estate of the business entity at $495,000 and the restaurant at $895,000, including fixtures and equipment. Deducting debt of $550,000, it determined the business had a net value of $840,000, including real property. The wife’s half interest in the restaurant was worth $420,000.

The husband challenged the valuation at the state Court of Appeals. The trial court was wrong not to recognize that the restaurant’s goodwill was personal to him and thus nonmarital property, he contended. The appellate court noted the difference between corporate and personal goodwill and pointed out that, up to the present, state courts had not recognized personal goodwill in a business that was not a professional practice, such as a medical or dental office. But, “under the unique facts of this particular case, we are extending the concept to [the restaurant] because [the husband’s] presence is essential to the success of the restaurant.” It remanded the case to the trial court, ordering it to perform an allocation between personal and corporate goodwill.The opinion spurred a strong dissent from two judges who said the majority “selectively relied” on the witness’s statements that supported its finding of personal goodwill while ignoring others that disproved it and who cautioned that the court’s vague language risked allowing the exception to apply to “every small business with a key man.” (An extended discussion of the Court of Appeals decision and the court’s opinion appear in the February edition of Business Valuation Update and at BVLaw.)

No extension of personal goodwill. Subsequently, the wife appealed the Court of Appeals decision to the state Supreme Court, which reviewed the trial court’s ruling as to goodwill as if the appellate decision had never happened.

To assess whether the trial court erred in finding no corporate goodwill, the Supreme Court homed in on very different aspects of the consultant’s testimony than the Court of Appeals had done. The high court did not adopt the husband’s position that there was personal goodwill in nonprofessional practices, such as the restaurant at issue. Also, even if there was, the Supreme Court said, there was no evidence that the trial court erred in finding corporate goodwill only in this instance. The witness said he valued the restaurant as if sold on the open market and this valuation included goodwill. Moreover, his valuation took into account the replacement for the husband. “Goodwill is characterized as corporate goodwill … if the evidence establishes the salability or marketability of the goodwill as a business asset,” the court pointed out. Therefore, the trial court did not err in assigning the goodwill to the business. The state Supreme Court set aside the Court of Appeals’ decision; there was no revaluation.

Editor’s Note: It is worth reading both appellate decisions to compare the reviewing courts’ differing selection of valuation-related facts either to affirm or deny the existence of personal goodwill. This exercise supports the dissent’s critique as to selective reliance.

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