FINBY* – EMPLOYEE GOODWILL AND OTHER ISSUES
FACTS OF THE FINBY CASE
In 2009, Rhonda Finby worked as a financial advisor for UBS. The parties separated in February 2010.
Wachovia Securities (later acquired by Wells Fargo) induced Rhonda to join their firm by paying her what is known in the brokerage industry as a “transitional bonus.” The transitional bonus was based on her trailing twelve months production of $1,868,631 and her pre-hire assets of $192,671,911. In other words, they loaned her $2.8 million that was to be repaid from her salary, a salary that was artificially increased by $27,688 each month. Rhonda reported that additional salary on her tax return but actually never received it because the additional salary was used to make the loan payments. The loan would be paid off in 112 months via the additional salary. If she left the firm she would have to pay off the balance of the promissory note without the benefit of additional salary from Wells Fargo.
It is clear from the facts of the case that the transitional bonus was based solely on Rhonda’s book of business.
Wells Fargo also provided two other incentives, a “production bonus” and a “4front bonus” to their financial advisors in 2009. Rhonda achieved the production requirements of the “production bonus” and received another $373,726 in April 2010, two months after the couple separated. She also qualified for and received the “4front bonus” of $890,000 in mid-2010. Like the transitional bonus, Wells Fargo paid her the bonus amounts in return for a promissory note. As was the case for the transitional bonus, the purpose of paying the production bonus and the 4front bonus with a promissory note was to defer taxes on the bonuses to future years and provide a “golden handcuff” incentive for Rhonda to stay with the firm.
The case raises a number of issues relating to property division and support including:
- Should Rhonda’s book of business be considered a property right?
- If it is a property right, how should it be characterized, as community or separate?
- How should the phantom income recognized during the community be treated for tax purposes?
- How should the liability on the promissory notes be characterized?
- How is support affected by the determination of the character of the bonuses?
Should Rhonda’s book of business be considered a property right?
The appellate court reversed the trial court’s determination and held that Rhonda’s book of business is a property right. The court’s determination was based on the following reasoning:
- The court agreed with husband’s argument that wife’s status as a licensed financial advisor with the ability to induce clients to follow her when transferring to a new firm is similar to the goodwill found in other licensed personal service professions such as lawyers and physicians.
- The court relied on cases in other jurisdictions that support the position that a licensed professional is an asset subject to division in a marital dissolution.¹
- The court distinguished Rhonda’s situation from that of Mr. McTiernan in McTiernan & Dubrow (133 Cal. App. 4th 1090) by reasoning that Rhonda’s book of business was “transferrable” while Mr. McTiernan had no book of business to transfer. The court in McTiernan stated: “He cannot sell this standing to another . . . . That standing is his, and his alone, and he cannot bestow it on someone else. Thus, an essential aspect of a property interest is absent.”
- Finally, the court dismissed the fact that Rhonda’s right to the bonus was contingent on her remaining with Wells Fargo citing Marriage of Brown and Marriage of Fonstein.²
Does the result in Finby usher in a new era in family law appraisals in which employees who have a book of business have goodwill? That is a radical departure from the traditional demarcation between employees and self-employed individuals. Yet Finby appears to be the first case that provides precedent for making the argument that an opposing client who is an employee of a third party may have goodwill.
What if a non-owner associate employee in a law firm, accounting firm, or any other professional practice creates a book of business during marriage? Should that book of business be valued as goodwill even if the associate is an employee at the date of separation? Finby suggests that goodwill may exist. What about an insurance broker who works as an employed agent? Finby suggests that goodwill may exist as long as a third party is willing to pay a higher salary or bonus to the agent with the book of business than to a similarly situation agent without the book of business.
How should the property right and accompanying liability created during marriage but subject to contingency be characterized, community or separate?
The court found that the rights to the “transitional bonus,” the “production bonus,” and the “4front bonus” were community property because they were created during marriage. The court held that the bonuses were similar to other property rights that are created during marriage but may not vest until after separation (stock options, retirement benefits, etc.). The determination of the community and separate components was remanded to the trial court. As a result, there is no guidance in the appellate decision regarding exactly how to apportion the separate and community components, although the court does cite Marriage of Skaden as follows:
In re Marriage of Skaden, supra, 19 Cal.3d 679 noted “Brown . . . indicated [there were] two basic solutions” to the division of a community’s interest in a contingent benefit. (Id. at p. 688.) “[F]irst, a determination by the trial court of the present value of the rights or [obligations] adjudged to be marital property [or liability] and an equal division or adjustment of the same [citations] [,] and second, ‘if the court concludes that because of uncertainties affecting the vesting or maturation of [such] rights . . . it should not attempt to divide the present value . . . it can instead award [or confirm to] each spouse an appropriate portion of each . . . payment [or obligation] as it is paid [or incurred].’”
Andrew (Drew) Hunt of White, Zuckerman, Warsavsky, Luna & Hunt, was Rhonda’s expert. Mr. Hunt employed the time rule to determine the character of the transitional bonus and the accompanying loan. “He described the transitional bonus as a ‘mixed-type asset,’ with ‘approximately . . . 13 and a half percent of’ it ‘on an after-tax basis was community’ and the balance being wife’s separate property.”
The methodology appears appropriate not only for the transitional bonus but also for the other two bonuses Rhonda received. Under the time rule, the community portion of a bonus will be based on a numerator representing the period from the date the bonus was contracted to date of separation. The denominator of the fraction would be the period from the date the bonus was contracted to date the last payment of the promissory note is paid.
Often in cases like Finby where a stockbroker receives a bonus for joining another firm, the parties may not be financially prudent and may go on a spending spree. Under those facts, much, if not all, of the up-front transitional bonus may be spent by date of separation but the liability under the promissory note will remain largely unpaid. The result of the above fact situation may be that the community will have benefitted substantially from a loan that may be characterized as the separate liability of the employee spouse at the date of separation. The employee spouse’s financial picture may be enhanced if the bonus proceeds are traced to the acquisition of assets still in existence at date of separation. However, if all of the bonus spending was on lifestyle the employee spouse may still be responsible for paying off the loan by staying employed through the end of the contract term.
In Rhonda’s case any separate bonus funds calculated using a time-rule that can be traced to any bank account or brokerage account at the date of separation would be her separate property. Additionally, Rhonda would have a right to reimbursement under Family Code Section 2640 if any of the separate allocation of the bonus can be traced to the acquisition of a community asset that had equity at the date of separation.
There was another bonus Rhonda could receive that the court held to be Rhonda’s separate property. This was a recruitment bonus that she would receive if she remained actively with the firm through January 2016. The court, citing Brown, concluded that the recruitment bonus only constituted an expectancy because prior to the vesting date in 2016 Rhonda had no enforceable right to receive it.
How should the phantom income recognized during the community be treated for tax purposes?
Phantom income results when taxpayers must report income on their tax returns that they do not actually receive. Rhonda’s additional salary that she did not actually receive that was used to repay the Wells Fargo loan is an excellent example of “phantom income.” The phantom income portion of Rhonda’s W-2 during the marital period would be chargeable to the community when allocating taxable income. After separation, the income tax payable on the phantom income would be allocable to Rhonda.
How should the liability on the promissory note be characterized?
If part of the Wells Fargo transitional loan is community property then the community portion of the debt should be a community liability. The problem the parties face is that both the separate and community portions of the Wells Fargo transitional loan will be paid out of Rhonda’s separate salary post-separation.
Rhonda should be entitled to reimbursement from the community for the income tax she will be paying based on the repayment of the community portion of the debt with her separate property “phantom income” salary. One way of providing Rhonda with her reimbursement is for the court to retain jurisdiction over her right to reimbursement until the Wells Fargo loans are paid off. However, collectability of the reimbursement is a risk that only Rhonda faces if there is a retention of jurisdiction. The collectability risks to Rhonda include, but are not limited to, Mark Finby declaring bankruptcy before the full amount of reimbursement is repaid, or Mark dying and leaving insufficient assets in his estate to continue to be able to fund the reimbursement.
Forensic accountants can compute the present value of the future tax on the phantom income as a means of removing the collectability risk. Under the present value approach, the forensic accountant will calculate a credit to Rhonda in the property division for her future tax liability associated with the inclusion of the phantom income salary in her future income tax returns. This approach is not as mathematically certain as reserving jurisdiction but does eliminate the collectability risks noted above. There is some risk to Rhonda in the present value approach if she does not remain employed at Wells Fargo for the term of her notes. Were she to leave Wells Fargo and the payment of the notes accelerate then the amount of tax she would ultimately pay would probably be materially higher than the present value of the contemplated taxes over the contemplated repayment period.
How is support affected by the determination of the character of the bonuses created during marriage but received post-separation?
The court addressed the “double dip” issue created by the possibility that husband could receive a portion of the bonus post-separation and that Rhonda could be charged with those same funds as income but held it speculative and remanded the issue to the trial court.
A double dip is not relevant with respect to the “transitional bonus” because Rhonda did not receive any community funds after separation. All community funds were deposited in the parties’ accounts when received in 2009. Accordingly, there would be no further community funds available to Rhonda post-separation. However, she did receive the other two bonuses after separation.
Under what circumstances would the community portion of the other two bonuses that Rhonda may receive post-separation be construed as a double dip? We know that Wells Fargo will pay the bonus up front as a loan and we presume that the community will be entitled to its share of the loan under the time rule or some other appropriate allocation method. But Rhonda will be required to repay the community’s share of the loan proceeds with her future separate phantom income salary.
The following questions arise from the foregoing facts:
- Is the receipt of the community portion of the bonus in the form of loan proceeds income available for support or should the community portion of the loan proceeds be considered a receipt of property?
- How should the phantom income portion of Rhonda’s salary relating to the receipt of the Wells Fargo bonus loans post-separation be treated?
- What about the separate portion of the loan proceeds that Rhonda received post-separation? Should that portion of the loan proceeds be considered income available for support?
1. Arguably, the Wells Fargo bonus funds are a property right and not income. Each of the parties received their share of the community loan proceeds and should be responsible for their share of the community loan payments. If the proceeds are considered a property right then no double dip problem exists because neither party is charged with receiving income. The fact that neither of the parties will have to report the community loan proceeds on their income tax returns supports the position that the community loan proceeds are not income.
2. Rhonda will be entitled to reimbursement from the community for payment of the income tax on the community share of the Wells Fargo loan paid by her phantom income salary in the same manner as discussed above with respect to the transitional loan.
But it is inequitable to include the phantom income created by the loan payments in Rhonda’s income available for support because:
a. She is not actually receiving cash salary; and
b. She did nothing post-separation to manipulate her finances to reduce her spousal support.
Furthermore, not only should the phantom income be excluded from Rhonda’s income available for support but the tax generated by the phantom income on her repayment of the separate property portion of the Wells Fargo loans should also be excluded.
3. If, as noted above, Rhonda’s phantom income is not included in her income available for support an argument may be made that the portion of the Wells Fargo loan proceeds representing her separate property should be available for support when her bonus vests. Under the circumstances, an Ostler-Smith approach appears to be the appropriate method to deal with the receipt of her bonus funds.
The comments on the Finby case presented herein reflect a number of new financial issues that will be affecting many of our clients. Employed stockbrokers are not the only clients who receive W-2 income that will be affected by the Finby case. Other situations in which employees who are not self-employed or who do not own any interest in a business or professional practice but have a client following that are affected by Finby include:
- Insurance agents;¹
- Attorneys, accounting, and medical professionals; and
- Any business started during marriage or post-separation in which the spouse has a pre-existing transferable book of business.
Consider the employee who created a separate book of business prior to marriage and starts a new business during marriage. Is the character of the business community or separate? Finby supports the argument that such a book of business is separate property.
We hope that our discussion has provided our readers with information that will broaden their understanding of the novel and complex areas of family law that now exists as a result of the Finby decision.
One further note—after remand, the Finby case settled.
* In re Marriage of Finby, 166 Cal. Rptr. 3d 305 (2013).
1 Moll v. Moll, 187 Misc. 2d 770, 775 (N.Y. Sup. Ct. 2001) (clients serviced by stockbroker constitute marital asset; “the ‘thing of value’ is the personal or professional goodwill of a stockbroker or financial advisor”); Reiss v. Reiss, 654 So. 2d 268, 268-69 (Fla. Dist. Ct. App. 1995) (stockbroker’s “signing bonus” for clients he brought with him to new securities firm is a divisible marital asset); Niroo v. Niroo, 313 Md. 226, 234-35 (1988) (insurance agent’s anticipated renewal commissions on policies sold during marriage “are a type of property interest encompassed within the definition of marital property”); Pangburn v. Pangburn, 152 Ariz. 227, 230 (1986) (citing Brown, insurance agent’s “contractual right to commissions for future renewals . . . earned during coverture” includable within community estate).
2 In re Marriage of Fonstein, 17 Cal. 3d 738 (1976); In re Marriage of Brown, 15 Cal. 3d 838 (1976).