Legal myopia hurts value of 'goodwill'

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Published on 5/21/07

Longtime readers of this column know I strongly believe in the ethical and economic correctness of selling a law practice. Central to that belief is my conviction that a law practice has goodwill that can be sold.

"Goodwill" in this sense is the client base and client loyalty that the selling lawyer has created over the life of the practice. Firms with bad publicity and malpractice and disciplinary matters hanging over them have little or no goodwill.

Until now, the issue of whether goodwill exists has been limited to the selling negotiations. Typically smaller firms understand the value of their client relationships and reputations and, when negotiating for the sale of a practice, discuss compensation for goodwill.

However, larger firms argue that there is no goodwill and will walk away from a transaction if the "seller" wants to be compensated for their goodwill. The parties may not talk about goodwill; they may say there will be no deal if the seller insists on goodwill.

Oftentimes, however, there is a "credit" for a factor that might be analogous to goodwill in terms of the cost of the capital buy-in. There has to be some adjustment for this factor, irrespective of what it is called.

Now, however, the heavy hands of some state bar associations (which often oppose the concept of selling a practice) are creating more problems. For example, the new marketing regulations adopted by the New York State Bar assert that "a lawyer in private practice shall not practice under a trade name."

If lawyers' names must be used in the title of a firm, as this seems to require, any lawyer who would be interested in purchasing a law firm would either have to "retire" the selling lawyer (and keep the name in the firm "trade name" since the rule enables the name of a deceased or retired member of the firm to be retained), or change the firm name.

If the firm name is changed, deleting the previous lawyer's name, one might question whether the value of the firm's goodwill is decreased or even destroyed.

Many buyers assert that clients will not remain with the firm once its proprietor leaves, and thus offer a lower purchase price. The selling lawyer then is left to assert that goodwill infers that the reputation of the firm continues beyond the removal of any one individual. With that reputation comes the client list, the phone number and the on-going nature of the practice (with staff and systems in place).

What's the result? Negotiations that are already complex become even more so as the parties have to work around the "trade name" restriction.

After investing years of hard work and financial resources in growing the practice and building goodwill, the selling lawyer may have to forego the opportunity to reap the benefits of that years-long investment - all due to state-bar myopia.

For the sole or small firm practitioner, that's déjà vu all over again.

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