IN RE: the MARRIAGE OF Claudia and Richard NICHOLS. (1994)

These appeals from the judgment of dissolution of the 22–year marriage of Claudia Nichols (wife) and Richard Nichols (husband) and from a post-judgment order awarding attorney fees and costs center on a dispute over the value of a community asset, husband's shareholder interest in his law firm.

Wife's expert valued the interest by determining the book value of the law firm's net assets—its fixed assets such as furniture plus its accounts receivable and work in progress, minus its liabilities—and multiplying that figure by husband's percentage interest in the firm.   Using this method, wife's expert concluded the interest was worth $142,000.   Husband's expert valued the interest in accordance with a stock purchase agreement which husband signed when he became a shareholder.   The agreement provides that shareholders joining the firm shall pay, and those leaving the firm shall be paid, for their interest in the firm's net assets with the exception of accounts receivable, goodwill and work in progress.   Because in becoming a shareholder husband did not pay for any portion of the firm's accounts receivable or work in progress, and since the firm had followed the shareholder agreement for many years and had no plans to modify it, husband's expert concluded the agreement fairly represented husband's interest in the firm.   Applying the agreement's formulation, the expert valued the interest at $11,347.

Except for the agreement's exclusion of goodwill, the trial court held “that the stock purchase agreement should control” in valuing husband's shareholder interest in the law firm.   Accepting the testimony of husband's expert, the court found the interest was worth $11,347.¹

Wife contends the trial court incorrectly valued husband's shareholder interest in his law firm without considering all of the firm's assets, particularly its accounts receivable and work in progress.   We agree the court erred in failing to consider the firm's accounts receivable and work in progress.   As we shall explain, at any given moment the major assets of most law firms are those related to the rendition of professional services, particularly accounts receivable and work in progress.   As a shareholder in an ongoing practice, husband was entitled to receive his pro rata share of the law firm's accounts receivable and work in progress in the form of future salary, bonuses and benefits.   The stock purchase agreement does not affect husband's entitlement to those items since it applies only if husband withdraws as a shareholder, and no evidence suggested he would withdraw.   Because his entitlement derived from his rendition of professional services during the marriage, husband's share of the accounts receivable and work in progress was community property rather than his separate property.  (Fam.Code, § 760;  further section references are to the Family Code unless otherwise specified.)   By failing to divide husband's share of accounts receivable and work in progress pursuant to section 2550, the trial court effectively awarded a community asset to husband without awarding any offsetting value to wife.

Accordingly, we shall reverse the portion of the judgment which valued the community property interest in husband's law firm and shall direct the trial court to redetermine that issue.   As to husband's cross-appeal from the portion of the judgment awarding wife spousal support and from the post-judgment order awarding her attorney fees and costs, we shall reverse those orders and direct the trial court to reconsider them in light of its redetermination of the community property interest in husband's law firm.   We also shall direct that the existing spousal support order remain in effect pending further trial court proceedings.

FACTS

The parties married in August 1963 and separated in June 1986.   Husband is an attorney and a shareholder in the Sacramento law firm of McDonough, Holland and Allen (McDonough);  he joined the firm as a shareholder in 1978.   Wife was not employed outside the home during the marriage.

After wife filed a petition for dissolution of their marriage, the parties stipulated to the division and valuation of most of their community property, and agreed that all assets would be valued as of the trial date of December 31, 1990, with the exception of husband's professional goodwill, if any, which would be valued as of the date of separation.   They further stipulated that, if husband were found to have goodwill, its community value would be $35,000.

The only issues reserved for trial were (1) the value of husband's shareholder interest in his law firm, (2) whether he had goodwill, (3) the amount of permanent spousal support to be paid to wife, and (4) wife's entitlement to an award of attorney fees and costs.

Each of McDonough's shareholders owns essentially the same number of shares (approximately a 2.677 percent interest), and each has an equal voice in firm management.   Shareholder compensation does not depend on the number of shares held.   Rather, each shareholder draws a salary based on “units” of seniority, up to a maximum number of units.   Husband has the maximum units.   Compensation also includes a bonus which is calculated pursuant to a formula based on billable hours and dollars brought in.   A committee awards up to ten shareholders an additional bonus for “subjective factors,” such as “rainmaking [the ability to bring in work]”.

Upon becoming a shareholder of the firm, each attorney signs a stock purchase and sale agreement.   Pursuant to this agreement, the price of the attorney's stock is determined by a formula which is based on the book value of all the firm's assets except its accounts receivable, goodwill, and work in progress.²  When a shareholder dies, becomes disabled or otherwise unable to practice, or withdraws from the firm, the agreement requires that his or her stock shall be sold back to the firm at the formula price.

Husband signed the stock purchase agreement when he became a shareholder.   Community property assets were used to pay $4,800 for the purchase of husband's interest.

McDonough has separate pension and profit sharing plans which are funded exclusively by the firm.   McDonough contributes approximately 20 percent of salary to the programs which are fully vested from the commencement of employment or shareholder status.   The firm also has a medical reimbursement plan, as well as medical, dental, life, disability and vision insurance.

The firm's finances are structured so that shareholders do not build wealth through the value of their stock, but through the pension and profit sharing plans and through other vehicles such as an equipment leasing partnership in which a shareholder may choose to participate.   McDonough's policy is that the cost to a shareholder to buy into the firm, or the cost to the firm to buy out a shareholder, should be kept relatively low;  the actual figures have ranged between approximately $5,000 and $20,000.   A low buy-in price benefits the firm by making it easy to attract good attorneys;  a low buy-out price benefits the firm by minimizing the burden on shareholders when attorneys die, become unable to practice, or leave.

Cecelia Delury, a certified public accountant called to testify by wife, valued husband's interest in the McDonough firm at $142,000.   Because the firm maintains its books on a cash basis (which does not consider accounts receivable or work in progress), Delury added those items to the firm's stated assets as shown on its balance sheet.   Delury estimated that the largest portion of the firm's accounts receivable—those more than 90 days old—were 50 percent collectable.   The firm had informed Delury that those accounts were only 10 percent collectable;  however, in light of her experience with other professional firms, Delury concluded the 10 percent figure was not reasonable.   Delury considered the fact that husband's interest in his firm was “a very small percentage,” but determined this fact was “not relevant” because husband was not leaving the firm and the firm was not being liquidated.   Delury had never seen a minority discount applied to a professional corporation.   She declined to apply a “marketability discount” based upon the stock purchase agreement's “substantial restriction as to price and ․ ability to sell the interest in the law firm” because she assumed husband would continue as a partner in the firm.

David Schultze, a certified public accountant called by husband, testified that husband's interest in his firm could be valued according to the stock purchase agreement for the following reasons:  when husband joined the firm, he did not acquire an interest in then-existing accounts receivable or work in progress;  the firm had existed for 36 years, had adhered to the stock purchase agreement for the 17 years it had existed as a corporation, and did not plan to change the agreement;  husband has no control over the terms of the agreement;  and, unless the firm were to change the agreement or decide to liquidate (both of which are unlikely), husband never will receive more for his interest in the firm than the stock purchase agreement allows.   Applying the shareholder agreement, Schultze valued husband's interest in the McDonough law firm at $11,347, a figure which did not include accounts receivable, goodwill, or work in progress.   Schultze testified that husband's goodwill was worth an additional $35,000.   Schultze disputed Delury's opinion that the firm's receivables more than 90 days old were 50 percent collectable;  he agreed with the firm's estimate of 10 percent collectability.   Schultze admitted there were no studies of minority or marketability discounts involving professional corporations;  however, he claimed husband's interest should be subject to a minority discount of 80 to 90 percent.   Thus, even if accounts receivable and work in progress are included among the firms assets, the minority discount would reduce the value of husband's interest to approximately $12,500 to $25,000.

In deciding to value husband's shareholder interest in the McDonough law firm in accordance with its stock purchase agreement (with the exception of goodwill), the trial court explained:  “[Husband's] law firm, McDonough, Holland & Allen has been in existence for 36 years.   In 1974, the firm incorporated.   Since its incorporation, all shareholders in the firm are required to sign, as a condition of becoming a shareholder, the stock purchase agreement.  [Husband] joined the firm as a shareholder in 1978 and signed the stock purchase agreement as a condition of becoming a shareholder.   The stock purchase agreement has not changed in any material way since 1974.  [Husband] has no control over the terms of the stock purchase agreement and no evidence was presented that any material change in the stock purchase agreement is contemplated.   The purpose of the stock purchase agreement is to permit easy access and egress from the firm and to prevent splits in the firm which would have major economic impacts on the continued viability of the firm.   There has never been a major split at McDonough, Holland & Allen.   Furthermore, in the case of every shareholder who has retired or left the firm, including two named shareholders, the stock purchase agreement was followed.   Those shareholders received only those amounts then due under the terms of the stock purchase agreement.  [¶]  There was no evidence that the stock purchase agreement's purpose was to deprive spouses of any rights and no evidence of any collusive intent or purpose of the stock purchase agreement was introduced.  [¶] The Court additionally finds that the firm has a generous pension and profit sharing plan and gives large yearly bonuses as a supplement to salaries.   There was no evidence that the firm has contemplated either a liquidation or that [husband] is contemplating leaving the firm.  [¶] In light of these factors, the Court finds that the stock purchase agreement should control, with respect to valuing [husband's] shareholder's interests in the law firm of McDonough, Holland & Allen.  [¶]  Based on the evidence presented, the Court finds that pursuant to the stock purchase agreement, [husband's] interest in the firm as of December 31, 1990, (the date stipulated to by [the parties] ), was $11,347.   The Court, therefore, adopts that value as the community property interest in the law firm.”

On the issue of goodwill, the trial court held that “a spouse's interest in goodwill ․ is not determined by a stock purchase agreement.  (In re Marriage of Fenton (1982) 134 Cal.App.3d 451 [184 Cal.Rptr. 597];  In re Marriage of Slater (1979) 100 Cal.App.3d 241 [160 Cal.Rptr. 686];  In re Marriage of Lopez (1974) 38 Cal.App.3d 93 [113 Cal.Rptr. 58] [disapproved on other grounds in In re Marriage of Morrison (1978) 20 Cal.3d 437, 453, 143 Cal.Rptr. 139, 573 P.2d 41].)”  In light of husband's status as a senior member of the largest and one of the oldest law firms in Sacramento, the court found that he had professional goodwill, and valued the community interest therein at $35,000.

The parties stipulated that wife had a community property share of husband's pension plan in the sum of $21,690 and a community property interest in his profit sharing plan in the sum of $83,350.   They agreed that husband would have that total amount “rolled over into a tax deferred account in [wife's] name at a financial institution designated by [her].”

In addition, the trial court awarded wife permanent spousal support of $2,350 per month and attorney fees and costs of $19,640.

Wife appeals “as to only one issue of the Judgment of Dissolution and that is the value of the community interest in the law firm of which [husband] is a shareholder.”   She contends the trial court erred by valuing husband's interest in his law firm without considering its accounts receivable and work in progress.   Husband cross-appeals “from that portion of the judgment ․ awarding spousal support to [wife] and from the order after judgment ․ awarding attorney fees to [her].”  He seeks “to preserve the issue of attorney fees and spousal support should this court remand the case for redetermination of the value of the community's interest in [his] professional practice.”   According to husband, “[i]f a higher value is placed on the [community interest in his law] practice than originally found by the trial court, [wife's] need for spousal support and her entitlement to attorney fees will have to be adjusted accordingly.”

DISCUSSION

I

 Wife cites In re Marriage of Lopez, supra, 38 Cal.App.3d 93, 113 Cal.Rptr. 58 to support her claim that, in valuing husband's shareholder interest based on the McDonough law firm's stock purchase agreement, the trial court erred because it “failed to consider all required factors in valuing [husband's] interest in the law firm.” ³

Lopez held in pertinent part:  “In determining the value of a law practice or interest therein, the trial court should determine the existence and value of the following:  (a) fixed assets, which we deem to include cash, furniture, equipment, supplies and law library;  (b) other assets, including properly aged accounts receivable, costs advanced with due regard for their collectability;  work in progress partially completed but not billed as a receivable, and work completed but not billed;  (c) goodwill of the practitioner in his law business as a going concern;  and (d) liabilities of the practitioner related to his business.”  (38 Cal.App.3d at p. 110, 113 Cal.Rptr. 58;  italics added.)   Lopez has been followed by other courts and has been cited by commentators with evident approval.  (In re Marriage of Kilbourne (1991) 232 Cal.App.3d1518,1522,284Cal.Rptr.201;  In re Marriage of Garrity and Bishton (1986) 181 Cal.App.3d 675, 688–689, 226 Cal.Rptr. 485;  2 Hogoboom & King, Cal. Practice Guide:  Family Law (The Rutter Group 1992) ¶ 8:315.)

Of the various Lopez factors, accounts receivable, work in progress, and work completed but not yet billed are very significant to proper valuation because they usually represent the law firm's major assets.  “The courts have recognized that ‘[a]t any given moment the major assets of most law firms are not capital assets, but those related to the direct rendering of professional services, most particularly accounts receivable and work in process.’ ”  (In re Marriage of Kilbourne, supra, 232 Cal.App.3d at p. 1522, 284 Cal.Rptr. 201, quoting In re Marriage of Green (1989) 213 Cal.App.3d 14, 21, 261 Cal.Rptr. 294.)

The present case is no exception;  the value of the McDonough firm's accounts receivable and work in progress far exceeds the value of its other assets.   Stating, “[Husband's] own expert testified that [husband] has an interest in the accounts receivable and work in progress as a shareholder,” wife argues that “a valuation of [husband's] interest in the law firm must include a valuation of the accounts receivable and work in progress.”  (Emphasis in brief.)

Husband retorts that the trial court “properly exercised its discretion to value [his] shares in the law firm in accordance with the stock purchase agreement.”   Relying on cases in which courts have considered stock purchase agreements for valuation purposes (e.g., In re Marriage of Fonstein (1976) 17 Cal.3d 738, 131 Cal.Rptr. 873, 552 P.2d 1169;  In re Marriage of Slater, supra, 100 Cal.App.3d 241, 160 Cal.Rptr. 686;  In re Marriage of Green, supra, 213 Cal.App.3d 14, 261 Cal.Rptr. 294), husband argues “the trial court was entitled to rely on the stock purchase agreement․  [¶]  Even though other valuation methods might be appropriate in particular cases, the trial court was not required to use them.”

 The cases cited by husband do not hold that use of a stock purchase agreement to value an interest in the partnership for purposes of marital dissolution is acceptable in every case, i.e., that a shareholder agreement which excludes payment for accounts receivable and work in progress always will fairly value a community property shareholder interest.   Rather, the appropriate valuation methodology must be determined on a case-by-case basis.   (In re Marriage of Slater, supra, 100 Cal.App.3d at pp. 246–247, 160 Cal.Rptr. 686 [“The value of the contractual withdrawal right may provide a basis for ascertaining the value of the community interest;  however, it does not preclude consideration of other facts.”], citation and emphasis omitted.)

Husband suggests several reasons why the McDonough stock purchase agreement was an appropriate valuation method in this case despite the fact it excludes “major assets” of the law firm, i.e., accounts receivable and work in progress.  (Cf. In re Marriage of Kilbourne, supra, 232 Cal.App.3d at p. 1522, 284 Cal.Rptr. 201.)

Husband places great emphasis on the fact that, in becoming a shareholder, he “never paid to acquire an interest in the firm's receivables.”   He argues:  “The most basic flaw [in wife's position] that the value of [husband's] shares should include an interest in the law firm's receivables and work in progress ․ [flies] directly in the face of the stock purchase agreement, which specifically excluded receivables from the price the community paid for the shares, and from the price at which they could be sold․  [¶] ․  [I]t would have cost the community another $50,000–$70,000 if receivables had been included․  [Wife's expert] never explained the fairness or equity in allowing the community, which never paid a penny for receivables, that ․ windfall [the community would receive if the value of husband's shareholder interest were to include a portion of the firm's accounts receivable and work in progress].”  We are unpersuaded.

 The fact that in becoming a shareholder husband did not pay to obtain a portion of the then-existing accounts receivable and work in progress (which obviously had not been generated by personal services rendered by husband), and that in the future he will not obtain a portion of the value of accounts receivable and work in progress in existence when he leaves the firm, simply means that his shareholder interest has a value separate from the law firm's receivables and work in progress.

 It does not follow that accounts receivable and work in progress generated while he is a shareholder of the firm have no value to husband and the community.   To the contrary, husband acknowledges that shareholders derive an “economic value ․ from the receivables in the form of salary, bonuses, and pension contributions when the receivables are actually paid to the firm.”   In other words, by remaining with the firm, as he plans to do, husband will receive in due course—in the form of salary, bonuses, and pension contributions—his share of the value of the accounts receivable and work in progress which existed when the parties separated.   Because this value is attributable to professional services rendered by husband during the course of the marriage, it is a community asset which must be divided equally.  (§§ 751, 760, 2550.) ⁴

Hence, factoring in accounts receivable and work in progress as part of the value of husband's interest in the McDonough firm does not create a “windfall” for wife.   To do otherwise, as did the trial court here, actually gives a windfall to husband by allowing him to have the undivided benefit of assets which are attributable to the community because they resulted from the skill and labor of husband performed during the course of the marriage.

The fact that, due to his contractual agreement, husband would not receive in the form of salary, bonuses and pension contributions his share of accounts receivable and work in progress if he were to leave the firm does not mean the assets have no present value.  (In re Marriage of Fenton, supra, 134 Cal.App.3d at p. 465, 184 Cal.Rptr. 597.)  “The asset being divided in this proceeding is [husband's] interest in his partnership, not his contractual withdrawal rights.”  (In re Marriage of Fonstein, supra, 17 Cal.3d at p. 745, 131 Cal.Rptr. 873, 552 P.2d 1169.)   Moreover, the hypothetical which would result in his loss of benefits from accounts receivable and work in progress is not supported by the evidence.   It is undisputed that husband intends to stay with the McDonough firm.   Therefore, valuing husband's interest in the law firm by using the stock purchase agreement formulation which excludes accounts receivable and work in progress does not fairly reflect the value husband will receive from his shareholder interest by remaining with the firm.   Rather, use of that valuation method unreasonably treats wife, but not husband, as if the aforesaid, unsupported hypothetical had in fact occurred.

We note that the trial court's treatment of accounts receivable and work in progress is inconsistent in principle with the trial court's treatment of goodwill.   The shareholder agreement provides that no allowance shall be made for accounts receivable, work in progress, or goodwill in computing the book value of the firm's assets.  (See fn. 2, ante.)   Nevertheless, relying on In re Marriage of Fenton, supra, 134 Cal.App.3d 451, 184 Cal.Rptr. 597 and In re Marriage of Slater, supra, 100 Cal.App.3d 241, 160 Cal.Rptr. 686, the trial court found husband had goodwill in the sum of $35,000.

 As husband acknowledges, “Fenton and Slater stand for the proposition that, when professional goodwill exists, it cannot be eliminated simply by provisions in a buy-sell agreement between a spouse and his or her partners or shareholders.   The court must look behind the agreement to determine as a matter of fact whether goodwill actually exists.   If so, it must then be valued and divided.”   Husband fails to explain why this rule should be limited to goodwill and does not apply to community assets such as husband's share of accounts receivable and work in progress.

Fenton and Slater demonstrate that a valuable community asset may not be excluded from the division of community property merely because a shareholder agreement precludes a shareholder from paying for that asset upon joining the firm or being paid for the asset upon withdrawing from the firm.   This rule is as applicable to accounts receivable and work in progress as it is to goodwill.   Hence, the trial court must look behind the stock purchase agreement to determine as a matter of fact whether those assets actually exist.   If so, they must be valued and divided between the parties.

Accordingly, we conclude that the trial court abused its discretion by valuing husband's shareholder interest using the formulation in his law firm's stock purchase agreement which excluded the value of accounts receivable and work in progress.

In light of our determination, we need not address husband's other arguments concerning the validity of the opinion of wife's expert.   Those arguments should be addressed to the trial court on remand.

II

Husband cross-appeals “to preserve the issue of attorney fees and spousal support should this court remand the case for redetermination of the value of the community's interest in [his] professional practice.”   He asserts that, “[i]f a higher value is placed on [his interest in his law] practice than originally found by the trial court, [wife's] need for spousal support and her entitlement to attorney fees will have to be adjusted accordingly.”

Wife does not dispute that her need for spousal support and attorney fees may change depending upon the manner in which the community property will be equalized.   Accordingly, on remand the trial court must reevaluate wife's needs for spousal support and attorney fees in light of its redetermination and division of community property.

DISPOSITION

Those portions of the judgment which value the community property portion of husband's shareholder interest in his law firm and which award spousal support to wife are reversed, as is that portion of the post-judgment order granting attorney fees and costs to wife.   In all other respects, the judgment and order after judgment are affirmed.   The matter is remanded to the trial court for further proceedings consistent with this opinion.   The existing spousal support order shall remain in effect pending those proceedings.   Husband shall pay wife's costs on appeal.

FOOTNOTES

1.   The trial court found that husband had professional goodwill and valued the community interest therein at $35,000.

2.   Husband's stock purchase agreement states in pertinent part:“2. Purchase.   If the shareholder's employment with the corporation is terminated for any reason, including death or permanent disability, or if the shareholder ceases to be an eligible shareholder or becomes a disqualified person ․, the corporation shall purchase his shares and the shareholder or his personal representative or other successor in interest shall sell them to the corporation according to the terms of this agreement.“3. Purchase price.   The purchase price of the shareholders' [sic ] shares shall be equal to their book value at the beginning of the calendar month within which his employment is terminated;  provided, however, that no income attributable to services rendered by the corporation after the shareholder becomes a disqualified person shall be considered in determining the value of his shares.   In determining the book value of his shares no allowance shall be made for accounts receivable, accounts payable or goodwill.”The agreement does not expressly refer to work in progress;  however, because the corporation maintains its books on a cash rather than an accrual basis, neither accounts receivable nor work in progress appears on the corporation's books and neither is included in the corporation's book value.The book value of the shares is the shares' percentage of the book value of the corporation.

3.   As pointed out in the reply brief, husband misrepresents wife's contention when he claims her argument “is a plea that this court should accept her accountant's opinion which the trial judge found unpersuasive, and reject the testimony of [husband's expert], which the trial court found convincing.”   Actually, wife challenges the methodology used by the trial court to value husband's shareholder interest in the McDonough firm, contending the court “abused it's [sic ] discretion by not determining and valuing all assets of the law business.”  (Emphasis in brief.)

4.   Asserting it “is axiomatic that income and accruals after separation are separate property” (§ 771), husband suggests the salary, bonuses and pension contributions he gets after separation as a result of accounts receivable and work in progress which existed at the time of separation are his separate property.   Not so.   To the extent the future benefits are attributable to husband's efforts and skills before separation, they are community assets even though they are not actually realized until after separation.  (§ 760;  see In re Marriage of Lopez, supra, 38 Cal.App.3d at pp. 105, 108, 113 Cal.Rptr. 58.)

SCOTLAND, Associate Justice.

SIMS, Acting P.J., and NICHOLSON, J., concur.